United States: Setoff And Recoupment In Bankruptcy: A Brief Overview

This article provides a brief overview of the somewhat related doctrines of setoff and recoupment in the Chapter 11 context. Setoff is recognized in the Bankruptcy Code to offset the claims of creditors and the debtor in a bankruptcy proceeding. Recoupment is a common law doctrine of similar effect. Sometimes overlooked by debtors and creditors alike, these doctrines can be of critical consequence in the settling of accounts between a creditor and the bankrupt debtor.   


The doctrine of setoff allows entities to apply their mutual debts against each other, thus "avoiding the absurdity of making A pay B when B owes A." Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18 (1995). Section 553(a) of the Bankruptcy Code provides that "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 ..." Thus, subject to certain limitations, the Bankruptcy Code does not create a right of setoff, but preserves rights of setoff that may exist under applicable non-bankruptcy law. 

To effect a setoff, a creditor must file a motion seeking to lift the automatic stay.1 The creditor bears the burden of proving its right of setoff and must demonstrate that both claims arose prior to bankruptcy and that they are owing between the same parties.2

Prepetition Claims and Debt

If a creditor is seeking to offset its debt to the estate against its claim against the estate, both the claim and the debt must have arisen prior to the petition date. The question of when a debt "arises" in bankruptcy is one of bankruptcy law, not state law.3
In Lehman Bros., the Bankruptcy Court for the Southern District of New York found that "for purposes of setoff, a debt arises when all transactions necessary for liability have occurred, regardless of whether the claim was contingent when the petition was filed." In re Lehman Bros. Holdings Inc., 404 B.R. 752, 759 (Bankr. S.D.N.Y. 2009) (emphasis added). There, a bank creditor was denied the ability to set off its claim asserted against funds transferred by the bank into the debtor's account following the commencement of a bankruptcy case. While the initial transfer instructions were issued on the business day prior to the bankruptcy petition date, the party that gave the transfer instructions maintained the right to change or reverse the transfer until three hours after the debtor filed for bankruptcy. Because the transfer was not "completed" and the actual book entry reflecting the transfer was not made until after the bankruptcy filing, the funds represented a post-petition debt and could not be set off.

On the other hand, courts have permitted setoff where a liability accrued prepetition, even where events relating to the liability occur after the petition date.4


Debts subject to setoff must be owed by and between the same two parties and in the same capacity. This requirement is often referred to as "mutuality."

Generally speaking, the requirement that the debts be owed by and between the same two parties is strictly construed. For example, even "a subsidiary's debt may not be set off against the credit of a parent or other subsidiary, or vice versa, because no mutuality exists under the circumstances." In re SemCrude, L.P., 399 B.R. 388, 393-394 (Bankr. D. Del. 2009) (creditor not permitted to set off debt it owed to one subsidiary against claim it held against other subsidiaries) (omitting internal quotations). Further, even if the debts are owed between the same two parties, setoff is generally unavailable if the debts are not owed between the parties in the same "capacity." This requirement means that each party must owe the other in its own name and not as a fiduciary or in the nature of a trust.

Several courts have suggested that mutuality is determined as of the petition date and have declined to find that a post-petition transfer destroyed mutuality.5


 Recoupment, which is not addressed by the Bankruptcy Code, is a common-law equitable principle which focuses on netting credit and debt that arise out of the same transaction. Whereas setoff may be applicable among two parties irrespective of their contractual relationship, recoupment focuses on amounts that may be owing among parties to the same transaction. For example, the right of setoff might arise between a manufacturer and a customer/supplier where the manufacturer owes the customer/supplier a particular sum under a supply contract, and the customer/supplier owes the manufacturer under a purchase order where the supplier purchased products from the manufacturer. The right of recoupment is most likely to arise where the parties are each owed amounts from the same transaction, such as where a supplier has a claim for goods delivered under a supply contract, but the manufacturer may have corresponding claims under the contract because a shipment of goods did not meet the specified contractual standards. The key issue with recoupment is whether the offsetting debts arise out of the "same transaction." 

The Second Circuit has adopted a restrictive "single integrated transaction test," under which "both debts arise out of a single integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations." Westinghouse Credit Corp. v. D'Urso, 278 F.3d 138 (2d Cir. 2002). Even if both debts arise out of the same contract, recoupment is unavailable "where the contract itself contemplates the business to be transacted as discrete and independent units." Id. at 147.

In Westinghouse, the parties entered into a $44 million sale of a business. Part of the purchase price was funded through an $8.2 million note secured by a purchase money mortgage on the property of the business. The sale contract provided that the seller would lease certain properties used in the business to the buyer, and also contained a provision for a purchase price adjustment based on a final valuation of the business. The district court ruled that the buyer was entitled to recoup the purchase price adjustment against the amounts owed for the note and the lease, finding that the adjustment, the note and the lease were all part of one integrated transaction. The Second Circuit disagreed. It held that the note and the lease were separate from the purchase price adjustment escrow, and were not subject to recoupment. 

Similarly, in Malinowski v. NYS Department of Labor (In re Malinowski), 156 F.3d 131 (2d Cir. 1998), the New York Department of Labor sought to recoup previous unemployment benefit overpayments made to the debtor from later claims for benefits. The Second Circuit held that the two instances where the debtor sought unemployment benefits did not constitute a single transaction, because they were based upon different episodes of unemployment.

The takeaway is that where a contract provides for multiple transactions, each transaction must be viewed separately for recoupment purposes. 

Some Applications and Further Considerations

Setoff and recoupment are important tools in the Chapter 11 context because they have the potential to fundamentally alter a creditor's potential liability to the bankruptcy estate.

One of the classic cases of setoff would involve a debtor and its bank. The bank may have a claim against the debtor related to a prepetition unsecured loan, and the bank may owe the debtor for cash the debtor keeps on deposit with the bank. Absent setoff, the deposited cash may be available for the satisfaction of all unsecured claims, including those related to the bank loan, on a pari passu basis. With the right of setoff (so long as it is provided for under applicable non-bankruptcy law, and is otherwise compliant with the provisions of Section 553 of the Bankruptcy Code), the bank can use setoff in its claim against amounts held on deposit, and rather than share pari passu in the amounts held on deposit, use those amounts to set off its claim against the estate. A creditor who also owes a debt to the estate may potentially trade a claim that is worth cents on the dollar against the whole dollars it would otherwise owe the estate. For this reason, a creditor with a valid setoff claim is treated as the holder of a secured claim under Section 506(a)(1) of the Bankruptcy Code.6

Attempts to apply the doctrine of recoupment very often arise from a disputed transaction where there remains some payment owed by one party, but that party has been dissatisfied with the other party's performance under the contract. As discussed above, one of the classic situations is a supply contract where the supplier has made delivery of subpar goods: The supplier is owed for its delivery, but there may be corresponding claims by the manufacturer for breaches of the contract.

Understanding where creditors may have rights of setoff and recoupment is also important to other creditors of the debtor. For example, a creditor valuing its claim against the debtor may make the assumption that the debtor's cash will be available for the satisfaction of all unsecured claims, but will be unaware that a large creditor has a setoff claim against the cash.  Similarly, the debtor may have affirmative litigations against one party that a creditor is counting on to provide value for its claim, but there may be recoupment claims by the defendant that would cancel out any affirmative recovery.


1 Section 362(a)(7) of the Bankruptcy Code expressly enjoins "the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor."

2  Even when a creditor meets the requirements for setoff, the decision to allow setoff is within the sound discretion of a bankruptcy court, and equitable considerations weigh heavily. See In re Bennett Funding Group, Inc., 146 F.3d 136, 140 (2d Cir. 1998); In re Ionosphere Clubs, Inc., 164 B.R. 839, 843 (Bankr. S.D.N.Y. 1994).

3 See Jeld-Wen, Inc. v. Van Brunt (In re Grossman's Inc.), 607 F.3d 114, 121 (3d Cir. 2010) (holding that "a 'claim' can exist under the [Bankruptcy] Code before a right to payment exists under state law"); United States v. Gerth, 991 F.2d 1428, 1433 (8th Cir. 1993) (stating that the term "debt" should be interpreted "as being coextensive with the term 'claim.'").

4 See In re BOUSA Inc., No. 89-B-13380 JMP, 2006 WL 2864964 (Bankr. S.D.N.Y. Sept. 29, 2006) (permitting setoff of amounts owing under contract where events giving rise to liability under contract occurred only post-petition); In re Prudential Lines, Inc., 148 B.R. 730 (Bankr. S.D.N.Y. 1992) aff'd in part, rev'd in part on other grounds, 170 B.R. 222 (S.D.N.Y. 1994) (permitting setoff of post-petition insurance premiums even though premiums were owing only after the petition date); Roberds, Inc. v. Lumbermen's Mut. Cas. Co. (In re Roberds, Inc.), 285 B.R. 651 (Bankr. W.D. Ohio 2002) (permitting setoff of insurance claims where claims were actually submitted after the petition date).

5 See Scherling v. Chase Manhattan Bank, N.A. (In re Tilson Roberts Corp.), 75 B.R. 76 (S.D.N.Y. 1987).

6 Section 506(a)(1) of the Bankruptcy Code provides that "[a]n allowed claim of a creditor ... that is subject to setoff under Section 553 of this title, is a secured claims ... to the extent of the amount subject to setoff."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions