Credit Research Foundation Staff
President
Bill Balduino
VP of Research
Matt Skudera
CFO
Cheryl Weaverling
Manager Member Services
Barbara Clapsadle
Communications Manager
Tom Diana
Chairman & Board of Trustees
Chairman
Sharon Nickerson
Acushnet Company
Past Chairman
Marty Scaminaci
Bemis Company Inc
Vice-Chairman, Finance
Frank Sebastian
SLD of adidas
Vice-Chairman, Membership
Kris Skupas, MBA
Schreiber Foods Inc
Vice-Chairman, Research
Michael Bevilacqua
PepsiCo
Trustees
Dawn Burford
InSinkErator (an Emerson Company)
Paul Catalano
ABC Amega
Anna Mantel
A Schulman Inc.
Jackie Mulligan
Proctor & Gamble Distributing LLC
Peter Knox
Nestle USA
Art Tuttle American Greetings
were not a suf cient noti cation under the UCC to cut off the creditors’ setoff rights. In so holding, the court disagreed with a 2003 decision of the United States Bankruptcy Court for the District of Delaware, in the Communication Dynamics case, that a creditor’s receipt of a D&B report disclosing a lender’s security interest was suf cient to cut off the creditor’s setoff rights under the UCC. Interestingly, however, the Communication Dynamics court ultimately held that the creditor could rely on its right of recoupment—which is similar to, yet distinct from, setoff rights—to reduce the amount the creditor owed to its customer, regardless of the fact that the creditor’s setoff rights were wiped out when the creditor had received noti cation of the lender’s security interest.
In light of the inconsistency among the courts regarding what entails suf cient noti cation under UCC Section 9-404, trade creditors weighing their options against a delinquent customer should be aware of the circumstances under which a secured lender might challenge the creditors’ setoff rights. Creditors should also be cognizant of whether they have recoupment rights which would not be defeated by noti cation of a competing security interest.
Overview of a Creditor’s Setoff Rights
Setoff rights are signi cant state and federal law rights that a creditor can use to reduce its exposure on amounts it owes to a  nancially distressed customer. A creditor can assert a setoff when the creditor and its customer sell goods or provide services to each other by netting out the amount its customer owes to the creditor against the amount the creditor owes to its customer. For example, if ABC owes XYZ $1,000 and XYZ also owes ABC $800, then XYZ can net out, or setoff, the amounts owed so that ABC only pays XYZ the net amount of $200. XYZ’s setoff rights are easily understandable and ef cient – they excuse ABC from having to pay XYZ $1,000 and then requiring XYZ to immediately pay $800 back to ABC.
A creditor’s setoff rights are especially valuable if its customer  les for bankruptcy. The creditor can assert its right of setoff to avoid paying the full amount of its indebtedness to its customer when the creditor faces the real risk of the customer’s delayed payment of only a fraction of, or nonpayment of, the creditor’s offsetting claim.
Section 553 of the Bankruptcy Code recognizes a creditor’s setoff rights that already exist under applicable federal or state law. However, the Bankruptcy Code imposes restrictions on a creditor’s setoff rights. Setoff requires that the debtor’s and creditor’s obligations are mutual (they are owed between the same legal entities) and both arose either before or after the bankruptcy  ling. A creditor must also  rst obtain from the bankruptcy court relief from the automatic stay that arises under Section 362 of the Bankruptcy Code to exercise its setoff rights following a debtor’s bankruptcy  ling. Other provisions of Section 553 limit setoff rights that arose within 90 days of the bankruptcy  ling or any setoff during that 90- day period that improved the creditor’s recovery.
Overview of a Creditor’s Recoupment Rights
A creditor’s right of recoupment has the same effect as setoff—allowing the creditor to net out the debt its customer owes against the creditor’s obligations—but it differs from setoff in signi cant ways. Recoupment is narrower than setoff in that recoupment is available only where the mutual debts between the creditor and customer arose out of the same transaction. Courts have de ned “transaction” either broadly or narrowly. Some courts have applied a  exible broad approach to allow recoupment where the debts are logically related. According to this view, recoupment is permissible if the debts are suf ciently interconnected that it would be unfair to insist that one party ful ll its obligation but not require the same of the other party. Other courts, however, narrowly interpret “transaction” and recoupment rights to require that the mutual debts arose from the same contract or even a single transaction under the contract.
Recoupment has several advantages over setoff, especially once a creditor’s customer
has  led for bankruptcy. First, unlike setoff, a creditor usually does not need to obtain relief from the automatic stay to exercise its right of recoupment. Second, Section 553’s limits on setoff rights do not apply to recoupment. Many courts have held that a creditor can recoup its pre-petition claim against its post-petition obligations and vice versa. Third, as discussed
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