TAKEAWAYS
Section 553 of the Bankruptcy Code requires “strict bilateral mutuality.”
Thus, a creditor cannot set off an obligation it owes to a bankrupt debtor against an obligation that the debtor owes to the creditor’s affiliate (a so-called triangular setoff).
Creditors cannot simply contract around section 553’s mutuality requirement it is a hard and fast prerequisite to any setoff effectuated in bankruptcy.
The Third Circuit’s recent decision in
In re Orexigen Therapeutics Inc., 990 F.3d 748 (3d Cir. 2021) holds that section 553 of the Bankruptcy Code, which governs creditor setoffs, requires “strict bilateral mutuality.” As a result, notwithstanding the parties’ contract, a creditor cannot set off an obligation it owes to a debtor in bankruptcy against an obligation that the debtor owes to the creditor’s affiliate (a so-called triangular setoff.)
1. AUTOMATIC STAY
1.1 Covered Activities
1.1.a The debtor violated numerous state court orders in actions
to recover amounts he misappropriated. The state court held him in
contempt and imposed monetary sanctions and ordered him to stop
managing property he did not own and to turnover proceeds from the
illegal management. The debtor filed his bankruptcy petition the
day before a state court hearing on sentencing the debtor to jail
for contempt. Section 362(a) stays any prepetition action or
proceeding against the debtor, but section 362(b)(4) excepts from
the stay any action by a governmental unit to enforce its police or
regulatory power.” The exception applies when the
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In its recent opinion arising out of the Orexigen
Therapeutics Inc. bankruptcy case, the US Court of Appeals for the
Third Circuit affirmed that while a creditor retains its direct
setoff rights against a debtor under Section 553 of the Bankruptcy
Code when both it and the debtor owe debts to one another, so
called triangular setoffs - setoffs relating to
affiliated third party debts - are not similarly protected, even if
provided for contractually.
1 In so holding, the Third Circuit
became the first US circuit court of appeals to reach the issue and
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In a March 19, 2021, decision in
., the Third Circuit joined the Second, Fifth and Seventh Circuits, prohibiting triangular setoff in a bankruptcy proceeding. A triangular setoff occurs when Party A attempts to set off a debt owed by it to Party B against a debt owed by Party B to Party C. This raises practical concerns for parties that have multiple contracts with a third party, particularly if affiliates or subsidiaries are parties to some of those contracts.
Background
In July 2016, Orexigen entered into a “Services Agreement” with McKesson Patient Relationship Solutions (MPRS), a wholly owned subsidiary of McKesson Corporation, Inc. The agreement concerned a loyalty rebate program, under which MPRS advanced funds to pharmacies to finance discounts and then billed Orexigen for reimbursement, creating an account payable by Orexigen to MPRS. Separately, Orexigen and McKesson were parties to a “Distribution Agreement,” under which, McKesson purchased drugs manufactured by