Are triangular setoff agreements enforceable in bankruptcy?

American Bankruptcy Law Journal

Volumn 83, Issue 2, 2009, Pages 325-343

  Bienenstock, Martin J ^a   DiAngelo, Chris ^b   Bannon, Eileen ^b   Cassey, Lee J ^c  

^a HARVARD LAW SCHOOL   (United States)

^b Structured Finance Group   (United States)

^c Department of Business Solutions and Governance ^*

Author keywords

[No Author keywords available]

Indexed keywords

EID: 68149166921     PISSN: 00279048     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (62)

1. In re SemCrude, L.P., 399 BR. 388, (Bankr. D. Del. 2009).
2. 11 U.S.C. § 102(2).
3. 3399 B.R. at 391 (emphasis in original).
4. Id. at 392.
5. 11 U.S.C. § 553(a) provides: (a) Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case, except to the extent that-(1) the claim of such creditor against the debtor is disallowed; (2) such claim was transferred, by an entity other than the debtor, to such creditor- (A) after the commencement of the case; or (B) (1) after 90 days before the date of the filing of the petition; and (ii) while the debtor was insolvent (except for a setoff of a kind described in section 362(b)(6), 362(b)(7), 362(b)(l7), 362(b)(27), 555, 556, 559, 560, or 561); or
6. the debt owed to the debtor by such creditor was incurred by such creditor-(A) after 90 days before the date of the filing of the petition; (B) while the debtor was insolvent; and (C) for the purpose of obtaining a right of setoff against the debtor (except for a setoff of a kind described in section 362(bX6), 362(b)(7), 362(b)(l7), 362(b)(27), 555, 556, 559, 560, or 561).
7. 399 B.R. at 396.
8. Id. at 399.
9. It must be recognized, however, that § 553's failure to provide that title 11 shall not affect setoffs of nonmutual debts does not mean other Bankruptcy Code provisions do not protect those setoffs. This is discussed infra Part III(C).
10. "Accordingly, the Court holds that non-mutual debts cannot be transformed into a 'mutual debt' under section 553 simply because a multi-party agreement allows for setoff of non-mutual debts between the parties to the agreement." Id. at 398.
11. 'This is not to say that setoff would necessarily be appropriate against SemCrude if it were a guarantor of SemStream or SemFuel's debt, however. The Court notes that a split of authority exists regarding the issue ⋯. The Court does not reach this issue in this case because the only guarantor in this matter is SemGroup, an entity that is not owed a debt by Chevron." Id. at 397 n.7.
12. Id. at 397-98. .
13. "Section 101(5) of the Code defines a 'claim' as a 'right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured' or a 'right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.' Although Chevron may be able to assert a state law right to the equitable remedy of setoff, this right is not based on a breach of performance that gives rise to a 'right to payment,' as noted above. A setoff agreement such as the one in this case only creates a right to pay less or nothing, not a right to receive a payment."
14. Id. at 398 n.8.
15. Id. at 397-98.
16. The legislative history of 11 U.S.C. § 102(2) provides: Paragraph (2) specifies that 'claim against the debtor' includes claim against property of the debtor. This paragraph is intended to cover nonrecourse loan agreements where the creditor's only rights are against property of the debtor, and not against the debtor personally. Thus, such an agreement would give rise to a claim that would be treated as a claim against the debtor personally, for the purposes of the bankruptcy code. However, it would not entitle the holders of the claim to distribution other than from the property in which the holder had an interest. S. REP. No. 95-989, 95th Cong., 2d Sess. (1978) at 315. After the Senate Report was issued and during the House-Senate conference to reconcile their respective bankruptcy bills, 11 U.S.C. § 1111(b)(1)(A) was added, see 124 Congressional Record H 11089 (September 28,1978)(statement of Congressman Don Edwards), which actually does entitle holders of nonrecourse claims to distributions from property in which they do not have an interest in some circumstances. See infra note 16.
17. "Hartford Underwriters Insurance Co. v. Union Planters Bank, 530 U.S. 1, 6 (2000)(quoting United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241(1989), quoting Caminetti v. United States, 242 U.S. 470, 485 (1917)).
18. 11 U.S.C. § 1111(b)(1)(A) provides: A claim secured by a lien on property of the estate shall be allowed or disallowed under section 502 of this title the same as if the holder of such claim had recourse against the debtor on account of such claim, whether or not such holder has such recourse, unless- (1) the class of which such claim is a part elects, by at least two-thirds in amount and more than half in number of allowed claims of such class, application of paragraph (2) of this subsection; or (ii) such holder does not have such recourse and such property is sold under section 363 of this title or is to be sold under the plan.
19. 399 B.R. at 398.
20. S. REP. No. 95-989, 95th Cong., 2d Sess. (1978), at 309.
21. "399. B.R. at 392.
22. Id. at 396.
23. "Washington Credit Corp., v. D'Urso, 278 F.3d 138, 149 (2d Cir. 2002).
24. "399 B.R. at 392.
25. In re Garden Ridge Corp., 338 B.R. 627, 633-634 (Bankr. D. Del. 2006).
26. See, e.g., In re Lang Machinery Corporation (Equibank v. Lang Machinery Co.), 1988 WL 110429 (Bankr. W.D. Pa. 1988)("For a valid 'triangular' setoff to exist, Debtor must have formally agreed to permit" aggregation of debts by two creditors), cited with approval in U.S. Bank v. Custom Coals Laurel (In re Custom Coals Laurel), 258 B.R. 597, 607 (Bankr. W.D. Pa. 2001);
27. In re Virginia Block. Co., 16 B.R. 560, 562 (Bankr. W.D. Va. 1981) (citing Inland Steel Co. v. Berger Steel Co., Inc., 327 F.2d 401, 403-04 (7th Cir. 1964)) ("The Berger court found that a setoff arrangement accommodating a parent corporation and its subsidiary would be allowable only in those unique situations in which the parties to the transaction had, at the outset of their relationship, entered into a separate agreement clearly establishing the intention of the parties to treat the parent and subsidiary as one entity. Given this strict construction, it is clear in this proceeding that the debts are not mutual debts within the meaning of § 553.");
28. In re Balducci Oil Co., Inc., 33 B.R. 847, 853 (Bankr. D. Colo. 1983) (mutuality found between three parties, as a matter of contract law, where there was an express contractual agreement clearly evincing the intent of the parties to treat the parent and subsidiary as one entity).
29. 399 B.R. at 399 (footnote omitted).
30. Chem. Bank N.Y. Trust Co. v. Kneel (In re Seatrade Corp.), 369 F.2d 845, 848 (2d Cir. 1966).
31. "The triangular setoff agreement is governed by Texas law. Texas law recognizes the right of setoff so long as such amounts are liquidated and calculable. See e.g., Alley v. Bessemer Gas Engine Co., 228 S.W. 963, 966 (Tex. Civ. App. Amanllo 1991), writ dismissed (June 15, 1921);
32. Commercial State Bank v. Van Hutton, 208 S.W. 363 (Tex. Civ. App. San Antonio 1919);
33. see also In re Williams, 61 B.R. 567, (Bankr. N.D. Tex. 1986) (Under Texas law, debtor's bank that issued a promissory demand note had a valid right of offset on date petition was filed, even though the note had not matured by its terms.)
34. See supra note 8.
35. "Equibank v. Lang Machinery Co. (In re Lang Machinery Corp.), 1988 WL110429*3 (Bankr. W.D. Pa. 1988).
36. In In re Ingersoll, 90 B.R. 168,171 (Bankr. W.D.N.C. 1987), a corporation (Rosdon) owed a husband and wife over $440,000, which debt was guaranteed by Rosdon's owner. The note provided Rosdon could set off against its note any amounts the husband or wife owed Rosdon. Subsequently, the husband and wife became indebted to Rosdon's owner for $22,000, and the husband orally advised the owner he could offset the $22,000 against Rosdon's note if the $22,000 were not paid. When the wife commenced a chapter 13 case, the owner requested leave to set off the $22,000 against the $440,000. The court denied the owner's request, ruling "[a]ny comments [husband] may have made regarding [owner's] right to set off Rosdon's debt do not constitute a contractual right for offset. Those statements lack the formality of a binding contract and amount at most to a statement of opinion ⋯." Id. In respect of the owner's contention that his guaranty of Rosdon's note rendered the two debts mutual, the court ruled: "While that may be the effect of his guaranty, it does not change the fact that the debts are between different parties in different capacities, and, thus, not subject to offset." Id. The latter ruling may be justified on the facts because there was no cross default and therefore the $22,000 debt was matured due to bankruptcy, while the $440,000 was unmatured. "An unmatured claim may not be offset against a matured claim unless the indemnitor is insolvent. Collum v. Commercial Credit Co., 134 S.W.2d 826, 827 (Tex.Civ.App.-Amarillo 1939, writ dism'd w.o.j.)." In re The Charter Co, 63 B.R. 568, 571 (Bankr. M.D. Fla. 1986). Otherwise, Ingersoll is contrary to Bloor v. Shapiro, 32 B.R. 993, 1002 (S.D.N.Y. 1983)(Bankruptcy Act Chapter X case), where the court ruled: "If the guarantee agreements entitled the [guarantors] to assert the [primary obligors'] claims, which were closely related to the guarantees, then the trustee's liability under such claims would be debts owed to the [guarantors], to the extent of the [guarantors'] liability under the guarantees. Such claims could thus be asserted by the [guarantors] as set-offs ⋯." Accordingly, as belt and suspenders, trading parties will better position themselves to avoid attacks on triangular setoffs if they utilize guarantees containing express triangular setoff language. The master agreements and termination provisions should assure the parties will be setting off matured debts against matured debts.
37. "References to "qualifying" contracts in this article are to contracts (a) held by one of the entities listed in Bankruptcy Code §§ 555, 556, 559, 560, or 561, and (b) constituting one of the types of contracts whose liquidation, termination, and enforcement are protected by such sections when held by one of such entities.
38. 11 U.S.C. § 101(25)(E) provides: The term "forward contract" means - (E) any security agreement or arrangement, or other credit enhancement related to any agreement or transaction referred to in subparagraph (A),(B),(C), or(D), including any guarantee or reimbursement obligation by or to a forward contract merchant or financial participant in connection with any agreement or transaction referred to in any such subparagraph, but not to exceed the damages in connection with any such agreement or transaction, measured in accordance with section 562.
39. 11 U.S.C. § 556 provides: The contractual right of a commodity broker, financial participant, or forward contract merchant to cause the liquidation, termination, or acceleration of a commodity contract, as defined in section 761 of this title, or forward contract because of a condition of the kind specified in section 365 (e)(1) of this title, and the right to a variation or maintenance margin payment received from a trustee with respect to open commodity contracts or forward contracts, shall not be stayed, avoided, or otherwise limited by operation of any provision of this title or by the order of a court in any proceeding under this title. As used in this section, the term "contractual right" includes a right set forth in a rule or bylaw of a derivatives clearing organization (as defined in the Commodity Exchange Act), a multilateral clearing organization (as defined in the Federal Deposit Insurance Corporation Improvement Act of 1991), a national securities exchange, a national securities association, a securities clearing agency, a contract market designated under the Commodity Exchange Act, a derivatives transaction execution facility registered under the Commodity Exchange Act, or a board of trade (as defined in the Commodity Exchange Act) or in a resolution of the governing board thereof and a right, whether or not evidenced in writing, arising under common law, under law merchant or by reason of normal business practice.
40. 11 U.S.C. §761(4)(J)
41. 11 U.S.C. § 741(7)(A)(ix).
42. 11 U.S.C. §§ 101(38A)(A)(master netting agreement), 101(47)(A)(v)(repurchase agreement),101(53B)(A)(vi)(swap agreement), 559, 560, 561.
43. 11 U.S.C. §§ 546(e-g) provides: (e) Notwithstanding sections 544, 545, 547, 548 (a)(1)(B), and 548 (b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of this title, or settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741 (7), commodity contract, as defined in section 761 (4), or forward contract, that is made before the commencement of the case, except under section 548 (a)(1)(A) of this title.
44. Notwithstanding sections 544, 545, 547, 548 (a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer made by or to (or for the benefit of) a repo participant or financial participant, in connection with a repurchase agreement and that is made before the commencement of the case, except under section 548 (a)(1)(A) of this title.
45. Notwithstanding sections 544, 545, 547, 548 (a)(1)(B) and 548 (b) of this title, the trustee may not avoid a transfer, made by or to (or for the benefit of) a swap participant or financial participant, under or in connection with any swap agreement and that is made before the commencement of the case, except under section 548 (a)(1)(A) of this title.
46. 11 U.S.C. §§ 362(b)(6), 362(b)(7), 363(b)(17), and 362(b)(27).
47. 11 U.S.C. § 544(a)(1) provides: (a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by-(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists⋯"
48. 11 U.S.C. § 551 provides: Any transfer avoided under section 522, 544, 545, 547, 548, 549, or 724 (a) of this title, or any lien void under section 506 (d) of this title, is preserved for the benefit of the estate but only with respect to property of the estate.
49. See 11 U.S.C. § 546(e-g), supra note 38.
50. U.C.C. § 9-322(a) provides: (a) [General priority rules.] Except as otherwise provided in this section, priority among conflicting security interests and agricultural liens in the same collateral is determined according to the following rules: (1) Conflicting perfected security interests and agricultural hens rank according to priority in time of filing or perfection. Priority dates from the earlier of the time a filing covering the collateral is first made or the security interest or agricultural lien is first perfected, if there is no period thereafter when there is neither filing nor perfection. (2) A perfected security interest or agricultural lien has priority over a conflicting unperfected security interest or agricultural lien. The first security interest or agricultural lien to attach or become effective has priority if conflicting security interests and agricultural liens are unperfected.
51. U.S. Aeroteam, Inc. v. Delphi Automotive Systems LLC (In re U.S. Aeroteam, Inc.), 327 B.R. 852, 863 (Bankr. S.D. Ohio 2005)(triangular setoff right treated and referred to as contractual right).
52. U.C.C. § 9-4O4(a)-(b) provides: (a) [Assignee's rights subject to terms, claims, and defenses; exceptions.] Unless an account debtor has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to:
53. all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and
54. any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.
55. [Account debtor's claim reduces amount owed to assignee.] Subject to subsection (c) and except as otherwise provided in subsection (d), the claim of an account debtor against an assignor may be asserted against an assignee under subsection (a) only to reduce the amount the account debtor owes.
56. Pursuant to U.C.C. § 9-109(d)(10)(B), article 9 of the U.C.C. does not apply to recoupments and setoffs, except § 9-404 applies to defenses or claims of an account debtor.
57. U.C.C. § 1-202 provides: § 1-202. Notice; Knowledge. (a) Subject to subsection (f), a person has "notice" of a fact if the person: (1) has actual knowledge of it; (2) has received a notice or notification of it; or (3) from all the facts and circumstances known to the person at the time in question, has reason to know that it exists.
58. "Knowledge" means actual knowledge. "Knows" has a corresponding meaning.
59. " Discover", "learn", or words of similar import refer to knowledge rather than to reason to know.
60. A person "notifies" or "gives" a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the other person actually comes to know of it.
61. Subject to subsection (f), a person "receives" a notice or notification when: (1) it comes to that person's attention; or (2) it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communications.
62. Notice, knowledge, or a notice or notification received by an organization is effective for a particular transaction from the time it is brought to the attention of the individual conducting that transaction and, in any event, from the time it would have been brought to the individual's attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating significant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individual's regular duties or the individual has reason to know of the transaction and that the transaction would be materially affected by the information. Notification is not satisfied by the filing of a security interest; it requires actual notice. Iowa Oil Co. v. Citgo Petroleum Corp (In re Iowa Oil Co.), 2004 U.S. Dist. LEXIS 20734, 2004 WL2326377, *6 , 55 U.C.C. Rep. Serv. 2d (Callaghan) 48 (N.D. Iowa, September 30, 2004).