Preserving the right to assert a setoff as a defense does not require filing a proof of claim. Similarly, Bankruptcy Judge Martin Glenn of New York held that discharge following confirmation of a chapter 11 plan does not preclude a defensive right of setoff.

Judge Glenn’s August 2 opinion came from the chapter 11 reorganization of SVB Financial Group, the parent of Silicon Valley Bank, which the Federal Deposit Insurance Corp. took over as receiver in March 2023. At the time of the FDIC takeover, the failed bank had about $2 billion on deposit in a second bank, which the FDIC also took over.

As the owner of the two banks, the debtor filed $2 billion claims in the FDIC receiverships of both banks. The FDIC disallowed both claims.

Evidently not willing to submit to the jurisdiction of the bankruptcy court, the FDIC purposefully did not file a proof of claim in the owner’s chapter 11 case. Presumably, the FDIC could have filed a defensive proof of claim asserting the right of setoff if the FDIC had liability for the $2 billion.

To assert the $2 billion claim, the debtor filed an adversary proceeding in bankruptcy court against the FDIC. On motion, the district court in New York withdrew the reference. The debtor also filed a lawsuit against the FDIC in federal court in California. In both actions in district courts, the FDIC could assert rights of setoff.

The debtor filed a chapter 11 plan, which declared that no one could assert a right of setoff without having filed a proof of claim in the bankruptcy court. In his August 2 opinion, Judge Glenn upheld the FDIC’s objection to confirmation of the plan to the extent it purported to bar defensive setoff absent the filing of a proof of claim.

Standing

The debtor contended that the FDIC did not have standing for filing an objection to confirmation.

Judge Glenn disagreed. He said that cutting off the FDIC’s “defensive setoff rights undoubtedly impacts the [FDIC’s] pecuniary interest as it forecloses one possible avenue for the [FDIC] to reduce its liability.” He held that the FDIC therefore had prudential standing, Article III standing and standing under Section 1109(b).

Setoff Is Defensive

The debtor argued that the FDIC’s rights of setoff were “claims” that went down the drain when the FDIC filed no claim by the bar date for government claims. Parsing the argument, Judge Glenn noted that a “claim” under Section 101(5) is a right to payment or a right to an equitable remedy.

Citing the Tenth Circuit, Judge Glenn said that “courts have noted that a defensive setoff is substantively different from a ‘claim,’” but he also cited a bankruptcy court in Oklahoma for having held “that there is no distinction between asserting a setoff as a claim and asserting setoff as a defense.”

For himself, Judge Glenn saw a “material difference between a defensive claim for setoff and a claim that seeks similar relief on an affirmative basis against a debtor.” He said that the FDIC was “not attempting to affirmatively recover from the Debtor’s estate” but instead was “using the setoff defensively to extinguish or reduce its potential obligation to the Debtor.”

Setoff and Section 553

With exceptions that aren’t applicable, Section 553(a) provides that nothing in the Bankruptcy Code “affect[s] any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case.”

Judge Glenn said that “section 553 does not create a right of setoff, but preserves the right if it exists under applicable non-bankruptcy law.” [Emphasis in original.] He was therefore required to decide whether the FDIC had a right of setoff under applicable law and found it among the rights of the FDIC under 12 U.S.C. § 1822. He also found that the FDIC’s defensive setoff rights satisfied all three requirements in Section 553.

Having decided that the FDIC had defensive setoff rights as an abstract proposition, Judge Glenn turned to the question of whether the FDIC waived those rights by failing to file a claim. He found “case law in this district expressly stat[ing] that a defensive right of setoff can be preserved in the absence of a proof of claim.” He went on to say that “[o]ther courts have also generally agreed that the absence of a proof of claim is not fatal to a right of setoff.”

“Notably,” though, Judge Glenn cited bankruptcy courts in Virginia and Louisiana that “require a creditor to file a proof of claim before the applicable bar date to preserve and exercise its right of setoff.”

Judge Glenn held that the FDIC retained the ability to assert defensive setoff but was careful to add that he was not deciding whether the FDIC could assert setoff successfully.

Setoff and Discharge

The debtor argued that the FDIC’s defensive setoff right would be eradicated by discharge.

For the answer, Judge Glenn referred to Section 1141(d)(1)(A), which says that confirmation “discharges the debtor from any debt that arose before the date of such confirmation,” and to Section 553, which says that nothing in the Bankruptcy Code “affect[s] any right of a creditor to offset a mutual debt.”

Because the FDIC was not required to file a proof of claim to preserve defensive setoff rights, Judge Glenn held that the debtor’s arguments were not “availing” and that the FDIC’s “defensive setoff rights cannot be discharged.”

Judge Glenn sustained the FDIC’s objection to confirmation. The debtor and the official committee are appealing.