It is not uncommon for businesses to have mutual debts. As long as both firms are able to fulfill their financial obligations, there will not be much of a problem. However, if one of the companies hits a financial rough patch, things can quickly become complicated—even more so if that firm files for bankruptcy protection.
If your company has mutual debt with a financially distressed business, you should be aware of your rights as a creditor. Through two key remedies—setoff and recoupment—you may be entitled to offset mutual debts. Here, our Columbia, SC bankruptcy attorneys explain the most important things you need to know about setoff and recoupment as debt collection tools.
Bankruptcy Offsets: Understanding the Remedies of Setoff and Recoupment
As described by the United States Department of Justice (DOJ), setoff and recoupment are two distinct legal remedies that allow companies to collect when there is a mutual debt. The right to set off mutual debt arises out of Section 553(a) of the Bankruptcy Code. In contrast, the right of recoupment is an equitable remedy created by the courts. It arises out of the common law. While setoff and recoupment are similar, they are subject to different rules and different limitations.
What Creditors Need to Know About Setoffs
The right to ‘setoff’ debt is one of the most powerful and effective collection tools for creditors of debtors that are nearing bankruptcy. In the most simple terms, a company that has mutual debts may be able to cancel out certain financial obligations in the event that it is no longer expecting to be repaid. Notably, a setoff is subject to an automatic stay (11 U.S. Code § 362). As such, there are actually two different types of setoffs:
- Pre-petition setoffs; and
- Post-petition setoffs.
If debt is set off before a bankruptcy petition is filed—meaning before the automatic stay is put into place—the action typically falls outside of reach of the bankruptcy code. In other words, the setoff will be permitted. However, once a bankruptcy petition has been filed, a creditor can only take a setoff after getting approval from a bankruptcy court. The right to unilateral setoff of that mutual debt is, at least temporarily, put on hold. For obvious reasons, setting off debt becomes far more complicated after a bankruptcy petition has been filed.
The bottom line: If your company has mutual debts with a firm that you believe is financially unstable and that may be on the path to bankruptcy, it is imperative that review your remedies immediately. The best option may be to set off debt as soon as possible. An experienced South Carolina bankruptcy lawyer can help you document and structure a setoff so that it is valid under state law. If a pre petition setoff is not done properly, it risks being disqualified by a bankruptcy court. Get professional guidance.
What Creditors Need to Know About Recoupment
Although similar to a setoff, recoupment is a distinct legal remedy—and there are some very important differences. Specifically, recoupment is a far more narrow, but also potentially more powerful debt collection remedy.
Much like a setoff, recoupment centers around companies that have mutual financial obligations to one and other. Though, in most courts, recoupment is not subject to an automatic stay. As such, a creditor may be able to offset the amount owed to a bankruptcy petitioner on a dollar-for-dollar basis without receiving approval from a bankruptcy court.
While the ability to avoid the automatic stay makes recoupement a more powerful remedy for creditors in cases in which a bankruptcy petition has already been filed, recoupment is only available for mutual debts that arise out of the same transaction (First Nat’l Bank v. Master Auto Serv. Corp).
What constitutes the “same transaction” is not always obvious or clear. Although courts have consistently found that mutual debts occurring out of a single contract meet this requirement, there have also been cases in which courts have ruled that a series of closely related transactions also satisfied this legal standard.
Call Our South Carolina Bankruptcy Lawyers for Immediate Assistance
At Crawford & von Keller, LLC, our top-rated South Carolina bankruptcy attorneys are skilled, results-oriented advocates for creditors. If you have questions about mutual debts, setoffs, or recoupment, we are here to help. To set up a strictly confidential, no obligation initial consultation, please contact our law firm today by calling 803-592-3863. With an office location in Columbia, we represent national clients in courts throughout the state of South Carolina.