Practice Updates

Third Circuit Confirms Triangular Setoffs Do Not Meet Mutuality Requirement of Section 553

In a precedential opinion on March 19, 2021 the Third Circuit Court of Appeals held that the use of a distribution agreement did not create an exception to the mutuality required by Section 553 of the U.S. Bankruptcy Code. The Third Circuit, in agreement with the lower courts, rejected McKesson’s request to set off its $7 million debt obligation by the $9 million amount Orexigen owed McKesson Patient Relationship Solutions (MPRS), a subsidiary of McKesson, which would have reduced MPRS’s claim to approximately $2 million and McKesson’s debt to zero.

In In re Orexigen Therapeutics, Inc., No. 20-1136 (3d Cir. Mar. 19, 2021), the court held that mutuality is a distinct limitation on the right to setoff under §553 of the Bankruptcy Code and that mutuality means only debts owing between two parties, specifically those owing from a creditor directly to the debtor and, in turn, owing from the debtor directly to that creditor and does not include any contractual elaboration on that kind of simple, bilateral relationship, such as triangular setoffs. Finally, the court held that in this case, the parent company could not avoid the mutuality requirement by use of a setoff provision in a distribution agreement its subsidiary had with the Debtor. The court did note that if McKesson wanted to ensure mutuality for the debts in question, it should have “taken on the customer loyalty support that it instead had its subsidiary MPRS handle for Orexigen” or alternatively, “[b]y perfecting a security interest, MPRS may have obtained a priority right to the same amount McKesson now seeks via setoff, which would have had the added benefit of placing Orexigen’s other creditors on advance notice of that priority claim.”