On March 10, 2023, the California Department of Financial Protection appointed the FDIC as receiver for Silicon Valley Bank (“SVB”) upon its shutdown.^[3] From March 13 to 16, 2023, Financial Group proceeded to withdraw funds from its $2.1 billion account at Silicon Valley Bridge Bank (“Bridge Bank”) previously transferred from SVB to Bridge Bank by the FDIC.^[4] The FDIC recalled account liability from Bridge Bank on March 15, 2023 to prevent further withdrawal.^[5] In turn, Financial Group filed for chapter 11 bankruptcy on March 17, 2023.^[6] The Court set September 14, 2023 as the deadline for governmental units to file proof of claims against Financial Group. The FDIC did not timely file a proof of claim.^[7]

Financial Group subsequently commenced two actions against the FDIC to recover approximately $1.93 billion left in its Bridge Bank account: (1) an adversary proceeding in its bankruptcy case in the Southern District of New York (“S.D.N.Y.”) on July 9, 2023, and (2) an action in the Northern District of California (“N.D. Cal.”), on March 5, 2024.^[8] On May 30, 2024, Financial Group filed the fifth iteration of the Second Amended Plan of Reorganization under Chapter 11 of the Bankruptcy Code (“Plan”).^[9] On July 8, 2024, the FDIC filed an objection (“Objection”) to the Plan, alleging that section 10.7 of the Plan improperly extinguished its defensive setoff rights in the S.D.N.Y and N.D. Cal. actions due to a lack of proof of claim.^[10] The Court sustained the Objection and ruled in favor of the FDIC.^[11]

The Court ruled that the FDIC's defensive setoff rights were preserved.^[12] The Court differentiated between affirmative and defensive setoff rights, as section 101(5) of the Bankruptcy Code categorizes the former, but not the latter, as “claims.”^[13] Further noting that the FDIC lacked the intent to affirmatively implicate Financial Group’s estate, the Court held that the FDIC's defensive setoff rights are not “claims” and therefore can be asserted past the deadline without a proof of claim.^[14]

The Court further held that the FDIC’s defensive setoff rights are not precluded by section 553(a) of the Bankruptcy Code, which states:

"Except as otherwise provided . . . [Title 11] does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose [pre-petition] . . . against a claim of such creditor against the debtor that arose [pre-petition], except to the extent that—

(1) the claim of such creditor against the debtor is disallowed; . . .

(3) the debt owed to the debtor by such creditor was incurred by such creditor—

(A) after 90 days before the date of the filing of the petition;

(B) while the debtor was insolvent; and

(C) for the purpose of obtaining a right of setoff against the debtor . . . ."^[15]

Additionally, the Court held that while section 553(a) governs a creditor’s right of setoff, it does not independently create such right, but rather preserves pre-existing rights under applicable non-bankruptcy law subject to certain limitations.^[16] The Court found 12 U.S.C. § 1822(d) to be the statutory authorization for FDIC to establish pre-existing setoff rights by withholding payments from depositors to pay off their liabilities.^[17] However, the Court also concluded that section 1822(d) does not contradict the Bankruptcy Code's substantive setoff requirements. Section 1822(d) provides:

"[The FDIC] may withhold payment of such portion of the insured deposit of any depositor in a depository institution in default as may be required to provide for the payment of any liability of such depositor to the depository institution in default or its receiver, which is not offset against a claim due from such depository institution pending the determination and payment of such liability by such depositor or any other person liable therefor."^[18]

The Court thus refocused its analysis on section 553(a) and inquired whether the FDIC satisfied the following statutory criteria: (1) the debtor must owe a debt to the creditor which arose prepetition, (2) the debtor must have a claim against the creditor which arose prepetition, and (3) the debt and claim must be mutual.^[19] The Court found, by operation of 12 U.S.C. § 1821(d)(2)(A)(i), that all three elements were satisfied.^[20] First, Financial Group owed the FDIC a “debt” in the pre-petition period: through section 1821(d)(2)(A)(i), FDIC succeeds “all rights, titles, powers and privileges” of SVB and its stockholders, members, accountholders, depositors, officers, and directors with regarding to its assets as receiver.^[21] FDIC “stands in the shoes” of SVB and, by extension, could bring claims against Financial Group regarding its liabilities.^[22] Second, Financial Group had a claim against the FDIC in the prepetition period caused by the FDIC’s March 15, 2023 recall of the Bridge Bank account liability.^[23] Third, mutuality was preserved between the debt and the claim: the FDIC's March 10, 2023 account transfer from SVB to Bridge Bank and the FDIC's March 15, 2023 account transfer from Bridge Bank to FDIC did not and could not extinguish the FDIC's liability and obligation to Financial under either contract law principles or purposive inquiry.^[24]

Further, the Court ruled that the FDIC’s defensive setoff rights could not be discharged.^[25] Since the FDIC was not required to file a proof of claim to assert defensive setoff rights, the Court concluded that such rights were not subject to section 1141’s discharge provision, which acts as “an injunction against the commencement or continuation of . . . an act, to collect, recover or offset” any debt that arose before the confirmation of the chapter 11 plan.^[26]

The ruling leads to two practical implications for bankruptcy litigation in the Southern District of New York. First, creditors retain the option to defensively setoff past the bar date and without filing a proof of claim as long as the debtor has a claim against the creditor that arose pre-petition. Second, when the setoff rights governed by non-bankruptcy statutes do not modify or contradict section 553(a) (e.g. in receivership cases), defensive setoff rights are directly evaluated under section 553(a) despite the fact that the statute itself does not create any setoff rights.