Setoff in Bankruptcy

August 6, 2013

One area of bankruptcy law that can be a surprise to some debtors, especially pro se debtors, is the concept of “setoff”. Section 553 of the Bankruptcy Code allows creditors to offset debts owed to the creditor with debts that the creditor owes back to the debtor. The most common example of this would be a debtor’s bank account at an institution where they carry credit card debt. For example, Joe banks at Federal Bank where he has a checking account. That checking account has $2,500.00 in it the day Joe files bankruptcy. Prior to filing, Joe had a credit card with Federal Bank that he owed $5,000 on. Once Joe files bankruptcy, Federal Bank would be entitled to freeze Joe’s bank account and take his $2,500.00 to “setoff” the debt owed to them.

To enforce a setoff, the creditor has to have the right to do so under state law; Texas happens to be a state that allows setoff.  Once a debtor files bankruptcy, the creditor can administratively freeze any bank account the debtor has with them. Before the creditor can actually “take” the funds in the bank account, the creditor will have to file a Motion to Lift the Automatic Stay.

However, it is important to remember that a setoff only affects PRE-petition debts and PRE-petition credits. Here’s an example: Joe files bankruptcy on Wednesday. At the time of filing, Joe owed Federal Bank $5,000. At the time of filing, Joe did not have any money in his Federal Bank checking account. On Friday, Joe gets his paycheck direct deposited into his account for $2,000. Can Federal Bank take that money? Absolutely not. Joe filed on Wednesday and the money was not in his account until Friday, therefore Federal Bank would not be able to touch that money.

Setoff is a hidden pitfall that debtors can encounter if they don’t have an attorney. It is just one of the many instances where having an attorney can actually end up saving you a great deal of money and frustration. If you’re looking into filing bankruptcy and have questions, contact the knowledgeable attorneys at Fears Nachawati who will set you on the right path.

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