In bankruptcy cases, the right to setoff is a powerful tool used by both debtors and creditors to avoid having to pay a debt owed to another. The right to setoff is defined as “[a] debtor’s right to reduce the amount of a debt by any sum the creditor owes the debtor the counterbalancing sum owed by the creditor.” A right to setoff usually arises when a debtor owes a debt to a creditor and the creditor owes a debt to the debtor. The purpose of a setoff is to “allow entities that owe each other money to apply their mutual debts against each other, thereby avoiding the absurdity of making A pay B when B owes A.” The court will reduce the two competing judgments into a single judgment and will arrive at a balance due or net figure, which is declared owing in a single judgment.
The Bankruptcy Code does not create a right of setoff. Rather, it recognizes the right to setoff existing under non-bankruptcy state law. The Bankruptcy Code has two sections that permit setoff: sections 553 and 558. To enforce setoff rights in bankruptcy cases, attorneys must be mindful of the different elements and requirements set forth in the different sections of the Bankruptcy Code.
This Article will discuss the provisions in the Bankruptcy Code applicable to setoff claims brought by either the creditor or debtor. It will examine policies and case law that support these provisions. Part I will analyze a creditor’s right to setoff under section 553 of the Bankruptcy Code. Part II will analyze a debtor’s right to setoff under section 558 of the Bankruptcy Code. Each part will consider different scenarios to demonstrate why each party would want to enforce a setoff claim against the other. Finally, this Article will conclude by exploring how different bankruptcy courts handle setoff claims.