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The ability of a creditor to exercise its contractual, common law or statutory rights under non-bankruptcy law to set off amounts owed to a debtor in bankruptcy against the debtor s obligations to the creditor gives offsetting creditors an important advantage. Unlike many other creditors, creditors with setoff rights can receive preferential treatment in the form of full payment on their claims up to the amount of the setoff. However, a limitation on the exercise of setoff rights in bankruptcy is the Bankruptcy Code s requirement that the debts involved must be mutual, a concept that is not well understood and sometimes disputed in the courts. The U.S. Court of Appeals for the Third Circuit recently addressed the meaning of mutuality in this context as a matter of first impression. In
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On March 19, in a matter of first impression, the Third Circuit Court of Appeals (Court) held that triangular setoff is not permissible in bankruptcy due to Bankruptcy Code Section 553(a) s mutuality requirement, and that parties cannot evade that requirement by contracting around it.
See In re Orexigen Therapeutics, Inc., 990 F.3d 748 (3d Cir. 2021).
McKesson Corporation, Inc. (McKesson) and Orexigen Therapeutics, Inc. (Orexigen) were parties to a distribution agreement, where Orexigen would sell McKesson the drug Contrave, and McKesson would, in turn, sell the drug to pharmacies. The distribution agreement also had a provision (Setoff Provision) that stated McKesson could reduce any amounts it owed to Orexigen by any amount that Orexigen owed to McKesson or any of its subsidiaries. Separately, Orexigen and McKesson Patient Relationship Solutions (MPRS), a McKesson subsidiary, entered into a services agreement whereby
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TAKEAWAYS
Section 553 of the Bankruptcy Code requires “strict bilateral mutuality.”
Thus, a creditor cannot set off an obligation it owes to a bankrupt debtor against an obligation that the debtor owes to the creditor’s affiliate (a so-called triangular setoff).
Creditors cannot simply contract around section 553’s mutuality requirement it is a hard and fast prerequisite to any setoff effectuated in bankruptcy.
The Third Circuit’s recent decision in
In re Orexigen Therapeutics Inc., 990 F.3d 748 (3d Cir. 2021) holds that section 553 of the Bankruptcy Code, which governs creditor setoffs, requires “strict bilateral mutuality.” As a result, notwithstanding the parties’ contract, a creditor cannot set off an obligation it owes to a debtor in bankruptcy against an obligation that the debtor owes to the creditor’s affiliate (a so-called triangular setoff.)
1. AUTOMATIC STAY
1.1 Covered Activities
1.1.a The debtor violated numerous state court orders in actions
to recover amounts he misappropriated. The state court held him in
contempt and imposed monetary sanctions and ordered him to stop
managing property he did not own and to turnover proceeds from the
illegal management. The debtor filed his bankruptcy petition the
day before a state court hearing on sentencing the debtor to jail
for contempt. Section 362(a) stays any prepetition action or
proceeding against the debtor, but section 362(b)(4) excepts from
the stay any action by a governmental unit to enforce its police or
regulatory power.” The exception applies when the