When an insolvent company seeks creditor protection through the courts, all claims against the company are stayed and cannot be pursued. If the company restructures, unsecured creditors will normally see their claims against the debtor sharply reduced and repayment periods extended. If the company is assigned into bankruptcy, unsecured creditors will often receive pennies on the dollar or see their claims go entirely unpaid.
The way around stays
In certain circumstances, however, there may be a way to recover an unsecured debt despite the court-ordered stay of legal proceedings. This is because both the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) confirm that the law of set-off continues to apply in a bankruptcy or restructuring.
When companies conduct regular business together over an extended period, they frequently bill each other for various services or products. At any given time, each may owe the other significant amounts of money and this may provide the basis for a creditor to "set-off" or "net-out" the amount of his or her claim against amounts owing to the insolvent business.
The law of set-off has established three different types of set-off: contractual (where the right to set off is agreed to between the parties to a contract), legal (where debts between the parties are for determined amounts, and are owed exclusively to one another), and equitable (where the debts are sufficiently related such that it would be unfair to allow one debt to be enforced without consideration or credit for the other). Each of these can be available in an insolvency in the right circumstances.
Set-offs - a powerful tool
To assert a set-off claim, it is necessary for the creditor to file a claim with the trustee handling the insolvency proceedings. The creditor must also serve notice that the claim will be applied against amounts owing to the insolvent business by the creditor.
This, of course, only succeeds to the limit of the amount owed by the creditor to the insolvent company. If the creditor owes the insolvent business less than the total of his or her claim, the recovery will be less than the full amount of the claim. However, because a set-off operates on a dollar-for-dollar basis, it will invariably provide a substantially better recovery than whatever compromise other unsecured creditors will face. Any excess amount of the creditor's claim can still be pursued through the insolvency process.
Any creditor who might have a set-off claim against an insolvent party would be wise to consult with experienced insolvency counsel, to ensure a set-off claim is properly asserted and help maximize recovery.