Delaware District Court Affirms Decision Holding Triangular Setoffs Are Not Permitted

The United States District Court for the District of Delaware recently affirmed a Delaware bankruptcy court case that held that the mutuality requirement of section 553(a) of the Bankruptcy Code (permitting setoffs) must be strictly construed.¹ The case declined to find mutuality in a triangular setoff between the debtor, a parent entity that owed the debtor money, and that entity’s subsidiary, which was a creditor.²

In our blog post Triangular Setoff Impermissible Under Section 553: No Contracting or Theorizing Around It, Section 553 Requires Mutuality, we examined the bankruptcy court’s In re Orexigen Therapeutics decision and the importance of the mutuality requirement of section 553(a), which aligns with the fundamental bankruptcy policy of ensuring similarly situated creditors receive an equal distribution from the estate.

On appeal, Appellants asked Judge Connolly to disregard a prior decision by the Delaware district court that had interpreted section 553(a) exactly as the Bankruptcy Court did in In re Orexigen Therapeutics.³ Judge Connolly declined to do so, holding that the Bankruptcy Court correctly concluded there is no contractual exception to the mutuality requirement and that mutuality may not be satisfied under a third-party beneficiary theory.

The decision makes clear that at least in Delaware, section 553 requires real mutuality and that parent companies cannot use contractual arrangements with their subsidiary entities to expand their setoff rights (or vice versa).