Ruling on an important issue in cases of administrative insolvency, Bankruptcy Judge Kevin J. Carey of Delaware concluded that a supplier can offset an unpaid administrative claim against preference liability.
Were the decision otherwise, a supplier in a failed reorganization would be required to pay a preference judgment in full without receiving payment on an allowed administrative claim.
From one point of view, the decision allows unequal treatment among holders of administrative claims. On the other hand, disallowing setoff would discourage a supplier from shipping goods after a chapter 11 filing if the supplier has preference exposure.
The case involved a failed chapter 11 reorganization. The supplier had almost $14 million in preference exposure. After filing, the supplier provided another $2.6 million in goods but was not paid. On motion, the bankruptcy court granted the supplier an allowed $2.6 million administrative claim that was not paid because the debtor was administratively insolvent.
The creditors’ committee sued the supplier for preferences. The supplier denied liability and counterclaimed for the right to offset the unpaid administrative claim against preference liability. The committee filed a motion to dismiss the supplier’s setoff counterclaim. Judge Carey denied the motion in his opinion on July 25, thus allowing setoff.
Judge Carey said that setoff is permitted only when “‘opposing obligations arise on the same side of the . . . bankruptcy petition date.’” Setoff is allowed, he said, because a preference claim does not exist before the filing date.
Judge Carey also rejected the committee’s argument that Section 502(d) prohibits setoff until the preference is paid in full. That section disallows “any claim” until the creditor pays its liability arising from an avoidance action.
“By its terms,” Section 502(d) does not cover administrative expense claims, Judge Carey said. He cited cases holding that administrative claims are given “special treatment” and are not subject to Section 502(d).