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Through a preference claim, a debtor or trustee seeks to recover, subject to certain creditor defenses, payments that a trade creditor received within the 90-day period prior to a bankruptcy filing. Preference claims have always been an unfortunate reality for trade creditors.

In its recent decision in In re Orexigen Therapeutics Inc.,[1] the Third Circuit Court of Appeals held that triangular setoffs are not permissible in bankruptcy because they do not satisfy the mutuality requirement of § 553 of the Bankruptcy Code. In doing so, the court categorically rejected the argument that parties can contract around the requirement of strict bilateral mutuality.

Background

In the days leading up to a chapter 11 filing, companies seeking bankruptcy protection commonly ask whether they can continue to pay some of their vendors after the bankruptcy case is filed. On the flip side, in the days following a chapter 11 filing, vendors whose customer recently filed a bankruptcy case have the same question: Can we still get paid?

For the last 25 years, third-party releases in chapter 11 plans were thought to be categorically prohibited in the Ninth Circuit. With its recent decision in Blixseth v. Credit Suisse, however, the Ninth Circuit Court of Appeals walked that prohibition back by affirming confirmation of a plan that released third parties from liability for actions taken during the bankruptcy case.[2] Blixseth may affect where large financially distressed companies located within the Ninth Circuit decide to file for bankruptcy.

One thing that Toys “R” Us, Sears and Forever 21 have in common is that all three cases are administratively insolvent.[1] Vendors who extended credit to the debtor after the petition date in reliance on the debtor’s assurances that it had adequate “DIP” financing to justify new credit terms got stuck a second time when there were inadequate funds to pay the administrative claims of vendors that had supplied the debtor post-petition.