Triangular Setoff Rights Again Don't Pass Muster in Bankruptcy

A trade creditor whose financially distressed customer has filed for bankruptcy is frequently looking for ways to maximize recovery on its claim. Setoff is one such risk mitigation tool that allows a creditor to net out its claim against its customer on a dollar- for-dollar basis to reduce the creditor’s indebtedness to that customer.

Triangular setoff expands setoff rights by contract to permit affiliated entities to setoff the obligation of one of the affiliates to a debtor to reduce the debtor’s indebtedness owing to another affiliate. Unfortunately for the creditor, triangular setoff rights are not necessarily enforceable in bankruptcy, despite being enforceable under state law.