Establishing the Requirements Necessary in order to Enforce Setoff in Bankruptcy Proceedings

By:  Maria Ehlinger

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Affirming the ruling in the Unites States Bankruptcy Court for the District of Arizona, The United States Bankruptcy Appellate Panel of the Ninth Circuit, in In re RCS Capital Development, LLC, held that a debtor may setoff pre-petition claims against post-petition obligations that it owes because section 558 of the Bankruptcy Code does not contain any restrictive language confining setoffs to pre-petition obligation.[1] The court found that the setoff was valid because all of the requirements of section 558 were met. Specifically, the court found that it was a valid setoff under Nevada law because there was mutuality of claims, debts, and parties, and each party had an enforceable debt against the other.[2] The issue arose after ABC Developmental Learning Centers (U.S.A.), Inc. (“ABC”) filed a proof of claim in the jointly administered chapter 11 bankruptcy cases of RCS Capital Development, LLC (“RCS”) and ACCP LLC (“ACCP”). ABC’s claim was based on an ongoing Nevada lawsuit against ACCP and RCS.[3] RCS objected to ABC’s proof of claim and then moved for summary judgment, arguing that RCS was entitled to set off the post-petition debt it owed to ABC, arising out of the Nevada action, against a debt ABC owed to RCS arising from a separate pre-petition Arizona judgment for breach of contract.[4]  The bankruptcy court granted RCS’s motion, finding that the requirements for setoff were met.[5] On appeal, the BAP affirmed the bankruptcy court and held that the setoff was valid.[6]

A setoff is defined as, “[a] debtor’s right to reduce the amount of a debt by any sum the creditor owes the debtor the counterbalancing sum owed by the creditor.”[7] The Bankruptcy Code has two sections that permit setoff: sections 553 and 558.[8] Section 553 preserves a creditor’s right to setoff debts under state law if (1) the debtor owes a creditor a prepetition debt, (2) the creditor owes the debtor a prepetition debt, and (3) the debts are mutual.[9] For mutuality to exist the debts and claims must be in the same right and between the same parties, standing in the same capacity.[10] Section 553, however, was not applicable in RCS Capital, because RCS, a debtor, was asserting its right to setoff, and section only applies if a creditor is seeking to assert setoff.[11]

Unlike the strict requirements set forth in section 553, section 558 contains broad language that pertains to the situation where a debtor is asserting setoff.[12]  Section 558 provides that the estate shall have the benefit of any defense available to the debtor, including setoff.[13]  Under section 558, the debtor may assert the defense of setoff in an objection to the allowance of a proof of claim.[14] In addition, the lack of restrictive language in section 558 allows debtors to set off prepetition claims against postpetition obligations that it owes.[15] Indeed, the only restriction under section 558 is that the setoff must be valid under state law, which will in turn require that the claims must be mutual.[16]

RCS Capital is significant because the holding distinguished between the requirements for setoff under sections 553 and 558. Section 553 applies strictly to creditors’ setoff rights whereas section 558 addresses the setoff defense available to debtors.  Moreover, section 558, unlike section 553, permits a debtor to setoff a post-petition obligation it owes to a creditor against a prepetition obligation the creditor owes to the debtor.[17] As such, the distinction between pre- and post-petition obligations does not matter for the purpose of determining whether a debtor may assert setoff under section 558.  There are, however, certain similarities between sections 553 and 558.  First, it is important to remember that neither section creates a right of setoff under the Bankruptcy Code.  Rather, each section only preserves the right of setoff if state law provides for such a right.  Second, as RCS Capital demonstrates, both sections 553 and 558 generally require the mutuality between the claim, the debts and the parties.[18]



[1] In re RCS Capital Development, LLC, No. AZ-12-1381, 2013 WL 3618550 1,8 (B.A.P. 9th Cir. July 16, 2013).

[2] In re RCS at 8. See also State Bank of Florence v. Miller (In re Miller), 459 B.R. 657, 675 n. (B.A.P. 6th Cir.  2011).

[3] In re RCSat 1.

[4] Id. at 2 (describing Arizona action where RCS sued ABC Arizona Superior Court breach contract. RCS won jury verdict $47 million, 2012 total amount due excess of $57 million.)

[5] Id. at 6 (citing In re RCS (Bankr. Ariz. 2013) (through RCS’s defacto merger with ACCP it achieved mutuality of claims against ABC).

[6] Id. at 11.

[7] Blacks Law Dictionary 1496 (9th ed. 2009).

[8] Id.  at 8 (“The Bankruptcy Code preserves the right of setoff for creditors under §553”) (“The Code preserves a debtor’s right to effectuate a setoff under §558, as it exists under state law), See also, 11 U.S.C. §553, 11 U.S.C. §558.

[9] See generally, In re Hancock, 137 B.R. 835, 845 (Bankr.N.D.Okla.1922) (explaining that §553 does not define a setoff, that right is established by state courts, and then if it meets the three additional requirements of the bankruptcy code are met the setoff right will be applied to net out claims).

[10] 11 U.S.C. §553,see also Untied States v. Carey (In re Wade Cook Fin. Corp.), 375 B.R. 580, 588 (B.A.P. 9th Cir.  2007).

[11] In re RCS at 8. (“Although RCS is a creditor of ABC, it cannot be using §553 to achieve setoff in its own capacity as a creditor in its own case.”).

[12] 5 Collier on Bankruptcy, ¶ 558, at 558.01 [1][a] (Alan N. Resnick & Henry J. Sommer eds, 16th ed. 2009)  (“ Section 558 deals with all the debtor’s defenses, affirmative as well as negative. It provides the trustee with every defensive weapon available to the debtor.”).

 [13] 11 U.S.C. §558 (“The estate shall have the benefit of any defense available to the debtor as against any entity other than the estate”), see also In re Braniff Airways, Inc., 12 C.B.C.2d 610, 614, 42 B.R. 443.447 (Bankr. N.D. Tex. 1984) (debtor has the right to assert setoff as defense pursuant to section 541(e), even though section 553, governing setoff, refers only to creditor’s right of setoff).

[14] 5 Collier on Bankruptcy, ¶ 558.01, at 558-5 [1][b] (Alan N. Resnick & Henry J. Sommer eds. 16th ed. 2009) (citing, In re Stoecker, 151 B.R. 989 (Bankr. N.D. ill. 1992). See also State Bank of Florence v. Miller (In re Miller), 459 B.R. 657, 675 n. 16 (B.A.P. 6th Cir.  2011) (“Section 558 frequently comes into play when a debtor in bankruptcy objects to a claim filed in the case by a creditor.”).

[15] See State Bank of Florence v. Miller (In re Miller), 459 B.R. 657, 675 n. 16 (B.A.P. 6th Cir.  2011) (Unlike setoff under § 553, setoff under § 558 does not require that the mutual debts both be prepetition obligations. See In re PSA, Inc., 277 B.R. 51, 53 (citing In re Papercraft Corp., 127 B.R. 346, 350) (“we examine only this defensive action by Debtor, invoking §558, to determine whether the postpetition rent may be reduced by amounts owed to Debtor, prepetition, by Lessor.”).

[16] See Camelback Hosp., Inc. v. Buckenmaier (In re Buckenmaier), 127 B.R. 233, 237 ((B.A.P. 9th Cir.  1991) (“[T]he Code does not create or expand the setoff right but instead merely preserves the common-law right under applicable non-bankruptcy law.”). See also In re PSA, Inc., 277 B.R. 51, 54 (Bankr. D. Del. 2002) (“[A] right to setoff must be established under state law so that the debtor then may assert the setoff as a defense reserved by §558.”)

[17] 11 U.S.C. § 553. 5 Collier on Bankruptcy, ¶ 553, at 553.01 [1] (Alan N. Resnick & Henry J. Sommer eds. 16th ed. 2009) (describing that two of the conditions for a creditor to preserve rights of setoff include that the claim against the debtor and the debt it owes to the debtor must have arisen before the commencement of the case).

[18] In re RCS at 9.