Trade Creditors Beware - Debtor’s Setoff Rights Apply to Administrative Expense Claims (Including Claims asserted under 11 U.S.C. § 503(b)(9))
By Natasha M. Songonuga and Mark Conlan, Gibbons P.C.
In a May 5, 2015 decision, Judge Kevin J. Carey of the U.S. Bankruptcy Court for the District of Delaware rejected certain trade creditors’ objections to the joint motion filed by the debtors and the official committee of unsecured creditors in the ADI Liquidation, Inc. (f/k/a AWI Delaware Inc.) chapter 11 cases, jointly administered under Case No. 14-12092 (KJC), seeking authorization to offset trade credits, vendor overpayments and other amounts owed to the debtors against the creditors’ administrative and secured claims (the “Joint Motion”). In granting the Joint Motion, Judge Carey concluded that the Bankruptcy Code (including its underlying policies) and case law provide ample support for allowing the debtors to exercise their discretion in determining to first offset funds owed to the debtors against a creditor’s administrative and/or secured claim (including Bankruptcy Code section 503(b)(9) claims) before applying such setoff rights against the creditor’s general unsecured claims. See Docket No. 2052. The decision highlights the risks trade creditors face in having their administrative priority claims under section 503(b)(9) diluted by a debtor’s setoff rights.
Associated Wholesalers, Inc. (“AWI”), a regional cooperative food distributor, and certain of its subsidiaries each filed voluntary petitions for relief in September 2014. Approximately two months later, substantially all of the debtors’ assets were sold to stalking horse bidder C&S Wholesale Grocers, Inc. (“C&S”) free and clear of all liens, claims and encumbrances, except recoupment rights and other affirmative defenses that any party could assert against the debtors or their estates. Thereafter, numerous trade creditors filed motions and/or proofs of claims asserting in excess of $53 million in administrative section 503(b)(9) claims.
Initially, the relief requested in the Joint Motion was part of another motion filed by the debtors in an attempt to reduce the value of the section 503(b)(9) claims and to resolve a disagreement that had developed between the debtors and C&S regarding post-sale ownership of certain trade credits and vendors overpayments. Due to procedural issues however, the motion was bifurcated and the Joint Motion was filed to have the court determine whether the debtors could offset trade credits and overpayments against the section 503(b)(9) administrative claim amounts owed by the debtors to creditors.
Eigthteen trade creditors filed objections to the Joint Motion asserting, among other things, that: (a) the Joint Motion (i) was premature because the court had yet to determined who owned the credits and overpayments -- the debtors or C&S -- and thus, granting the relief requested in the Joint Motion could lead to the situation where some creditors would be forced to pay the credits and overpayments twice, once to the debtors in the way of a setoff and then again to C&S in the form of an offset by C&S against amounts owed to such creditors by C&S for goods supplied, and (ii) violated the 503(b)(9) claimants’ due process rights to be heard on the reconciliation of their individual claims because the debtors failed to provide specific information about the amount of credits and overpayments at issue for each individual section 503(b)(9) claimant; and (b) allowing the debtors to setoff administrative expense claims like the section 503(b)(9) claims (i) violated section 1129(a)(9)(A) of the Bankruptcy Code, (ii) infringed on a creditor’s right of setoff under section 553 of the Bankruptcy Code, (iii) was inequitable and undermined the legislative history of Bankruptcy Code section 503(b)(9), and (iv) would allow the debtors to use section 558 of the Bankruptcy Code, which expressly preserves a debtor’s estate’s defenses including the right of setoff, as a sword, instead of a shield.
Judge Carey’s Decision
Judge Carey overruled the trade creditors’ objections and granted the relief requested in the Joint Motion. First, the court found that the Joint Motion did not infringe upon any section 503(b)(9) claimant’s due process rights because the Joint Motion did not seek a determination with respect to the value, validity or amount of any particular section 503(b)(9) claim or the amount of any claims of the debtors for setoff or recoupment. Instead, the Joint Motion merely sought a determination as to the debtors’ ability to decide, in their sole discretion, which type of claim -- administrative, secured, or general unsecured claim -- to apply their setoff and recoupment rights. Turning to the core issue at hand -- the debtors’ freedom to set off or recoup the credits and overpayments against the section 503(b)(9) claims -- the court held that unlike section 553 of the Bankruptcy Code, which limits the exercise of a creditor’s rights of setoff to mutual pre-petition obligations between the creditor and the debtor, section 558 of the Bankruptcy Code, which preserves a debtor’s right to effectuate setoffs, contains no such timing restriction and therefore, the debtors may, at their discretion, set off pre-petition amounts owed by a creditor against amounts owed to such creditor, including, but not limited to, administrative expense claims (including section 503(b)(9) claims), secured claims and general unsecured claims.
In support of its ruling, the court noted that the “Bankruptcy Code does not treat a debtor’s and creditor’s right to setoff equally,” and “[t[here is no persuasive reason to conclude that the claimants’ setoff rights should trump the Debtors’ setoff rights. Instead, the differences underlying [section] 558 and [section 553] lead to the opposite conclusion.” The Court further observed that “in evaluating setoff, [the Court] should favor an application that is most likely to result in equal distributions to the Debtors’ creditors as a whole.”
Addressing section 1129(a)(9)(A) argument, that all allowed administrative expense claims must be paid in full on a plan’s effective date (unless the parties agree otherwise), the court held that section 1129(a)(9) does not provide a basis for stripping a debtor’s defenses, including setoff and recoupment, because section 558 specifically preserves a debtor’s defenses without regard to pre-petition or post-petition distinctions. Judge Carey parsed the applicable case law and the relevant Bankruptcy Code sections and concluded that case law, the Bankruptcy Code and the policies underlying the Bankruptcy Code support a debtor’s decision to exercise its setoff rights against administrative claims (including section 503(b)(9) claims), secured claims or general unsecured claims as it sees fit.
The AWI decision highlights the Bankruptcy Code’s distinctions between a creditor’s limited setoff rights under section 553 and a debtor’s more expansive setoff rights under section 558. They are not the same. The AWI decision also alerts trade creditors and practitioners alike that section 503(b)(9) administrative claims may be reduced (or eliminated) by application of a debtor’s setoff rights against those claims.
Natasha M. Songonuga and Mark Conlan, both Directors in the Gibbons P.C. Financial Restructuring & Creditors' Rights Department, co-authored this post. With 220 attorneys and five offices in four states, Gibbons P.C. is ranked among the top 200 law firms in the United States by The American Lawyer. For more information, visit www.gibbonslaw.com.
published: July 2015