When dealing with an insolvent or bankrupt debtor, creditors will do everything in their power to reclaim the money they were owed. Whether securing transactions prior to sale or using specific legal defenses in the courtroom,
every credit manager can get hit by a debtor who won’t or can’t pay, so it’s best to have as many tools available as possible to better protect a company’s assets. Two of the most overlooked options that creditors can use to get back
part of what they’re owed are setoff and recoupment.
“What I find interesting in all of these conversations is the lack of knowledge that creditors have of this right,” said Bruce Nathan, Esq. in a recent CMA-sponsored webinar entitled “Setoff and Recoupment: Hidden Gold for Trade Creditors.” Nathan noted that setoff, although not explicitly listed in the Bankruptcy Code, is a state law right that is viewed as a self-help measure that creditors can use whenever they’d like. It can be used when a creditor and debtor are doing business with one another and owe each other money. It makes little sense to pay a debt when the payee owes the payor money, so setoff allows both parties to reduce their obligations to one another by setting off one claim against another.
There are, however, legal requirements that need to be satisfied for creditors to use setoff, and, in his presentation, Nathan discussed these, making certain that attendees knew how to avoid any legal missteps that might preclude any successful setoff. Nathan also noted that after a debtor has filed for bankruptcy, setoff needs court approval before it can be used. “Once a debtor files for bankruptcy, setoff rights are restricted,” said Nathan. “The automatic stay arising under Section 362 of the Bankruptcy Code would prevent a creditor from unilaterally exercising setoff rights.” Nathan also noted several other legal hoops that creditors have to jump through prior to successfully
reducing their claim using setoff, whether before or after a bankruptcy filing.
Recoupment, said Nathan, is very similar to setoff but with one important difference. “All that is required for recoupment to take place is that it arises from a single claim or transaction,” he said. “Recoupment is essentially a
defense to a debtor’s claim against a creditor.” Nathan also noted that recoupment is a slight improvement over setoff, because it is not governed by the automatic stay rule and does not require a creditor to get the permission of
the court to exercise the right.