In In re ADI Liquidation, No. 14-12092, 2015 Bankr. LEXIS 1611 (Bankr. D. Del. May 5, 2015), the debtors filed a joint motion with a creditors’ committee to reduce the allowed amounts of claims under 11 U.S.C. Section 503(b)(9), by asserting defenses of setoff and recoupment. A number of holders of Section 503(b)(9) claims objected to the joint motion, arguing that, among other things, the debtors’ right of setoff should be asserted against prepetition general unsecured claims prior to being asserted against administrative expense claims. U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware rejected the creditors’ claims in an opinion that explores many of the parameters of setoff and recoupment in the Chapter 11 context.
As many creditors are disappointed to learn, the Bankruptcy Code does not create a level playing field. With regard to setoff, a debtor has broad rights under 11 U.S.C. Section 558, which preserves for the estate all defenses that a debtor may have to a claim. As Carey noted, “Because Section 558 preserves to the debtor the defenses it would have had prepetition, the court must examine the transaction as though the bankruptcy had not been filed,” citing In re Papercraft, 127 B.R. 346, 350 (Bankr. W.D. Pa. 1991). As a corollary, “The prepetition/post-petition distinction is not relevant under Section 558,” he said, citing In re PSA, 277 B.R. 51, 53 (Bankr. D. Del. 2002). By contrast, a creditor’s setoff rights are preserved under 11 U.S.C. Section 553, which “restricts the exercise of a creditor’s rights so that prepetition setoff rights can be applied only to prepetition debts and obligations.” This disparate treatment of setoff rights serves the Bankruptcy Code’s goal of maximizing estate assets for ultimate distribution to creditors. However, this fulfillment of legislative goals is undoubtedly of little comfort to creditors who find that the debtor’s prepetition setoff rights may eliminate 100 percent dollars, while a creditor’s prepetition setoff rights may only eliminate proportional dollars.
