In the complex landscape of bankruptcy, creditors often seek ways to offset amounts owed to the debtor against amounts owed by the debtor. Two mechanisms, setoff and recoupment, provide this opportunity, each with its unique characteristics and implications in a bankruptcy setting.

Setoff, rooted in state law, allows parties to apply their mutual debts against each other. This right is preserved in bankruptcy through Section 553(a) of the Bankruptcy Code. However, to exercise setoff rights, a creditor must demonstrate mutuality and pre-petition debts. Mutuality requires the same parties to be involved in both the debt owed by the debtor to the creditor and the debt owed by the creditor to the debtor. Pre-petition debts necessitate that both debts arise prior to the filing of the bankruptcy case. Importantly, creditors cannot affect their rights of setoff without relief from the automatic stay imposed by Section 362 of the Bankruptcy Code.

On the other hand, recoupment is a common law equitable precept and an affirmative defense against a debtor’s claim. Unlike setoff, recoupment is not covered by the automatic stay and can be exercised at any time during the bankruptcy case. However, the defining feature of recoupment is that the amounts owed among the debtor and the creditor must arise from the same transaction, making it a narrower concept than setoff.

Both setoff and recoupment can be powerful tools for creditors, allowing them to net amounts due among the parties. However, these are complex and distinct concepts that require careful navigation in bankruptcy. Therefore, it is crucial for creditors to seek experienced bankruptcy counsel to guide them through these concepts and maximize their rights. Read the full article here.