Has the Bell Tolled for Triangular Setoffs?

industry, as in many others, companies routinely find themselves in both a buy and sell relationship with customers operating through multiple legal entities in a single corporate family. As a result, transactions are often linked and provide for the ability to set off opposing obligations not only with the direct legal entity with which business is being conducted but also with any other obligation that may be owed to a customer’s affiliate. This concept, often referred to as triangular or cross-affiliate setoff, has allowed companies to conduct business without requiring their counterparties to post additional credit enhancements, such as cash deposits or letters of credit. Triangular setoffs have also been routinely used in master netting agreements such that only a single net payment is made on a designated day of the month after aggregating all obligations between the parties. All of this has now been called into question through an apparent case of first impression by the United States Bankruptcy Court for the District of Delaware which last week held that “triangular setoff” is impermissible under Section 553 of the Bankruptcy Code in In re SemCrude L.P. Most notably, the court held that parties may not contract out of the “mutual debt” requirement provided by Section 553 through private agreements.

In July 2008, SemGroup L.P., and certain direct and indirect subsidiaries, commenced a Chapter 11 bankruptcy proceeding in Delaware. Prior to filing, Chevron USA Inc. had entered into a series of contracts with three of the debtors, including SemCrude, SemFuel and SemStream, according to the opinion. The contracts all contained identical netting provisions providing that “in the event either party fails to make a timely payment of monies due and owing to the other party, or in the event either party fails to make timely delivery of product or crude oil due and owing to the other party, the other party may offset any deliveries or payments due under this or any other agreement between the parties and their affiliates.” As of the petition date, Chevron owed approximately $1.4 million to SemCrude. Chevron, however, was also owed approximately $10.2 million by SemFuel and $3.3 million by SemStream.