If you owe money to someone, but they also owe you money on some other account, you are entitled to set off the one debt against the other, and only the net difference needs to be paid. This can change in bankruptcy.
When someone becomes bankrupt under the Bankruptcy and Insolvency Act, their assets "vest" in the trustee in bankruptcy and become the property of the trustee and not the bankrupt. This means that, if you have a setoff against someone, you may not continue to have that setoff once that person becomes bankrupt.
In a recent British Columbia decision, Dahl (Re), Colleen Dahl was entitled to a significant gift under her late father-in-law's will. She was also named as executor under his will, and on his death proceeded to pilfer from the estate. Following her bankruptcy, the new executor of the estate argued that the estate could set off what she was owed under her bequest, against what she owed the estate due to her theft.
Ms. Dahl's trustee in bankruptcy opposed this, arguing that there was a third party in the picture - the trustee in bankruptcy - who now owned the right to be paid the bequest, and as a result setoff was not available to the estate following Ms. Dahl's bankruptcy. The court accepted the arguments of the trustee in bankruptcy, and as a result the estate was left to pay the full bequest to the trustee in bankruptcy, and then claim for the loss due to Ms. Dahl's theft as an ordinary creditor in her bankruptcy.
All was not lost, however. The court went on to order that Ms. Dahl's discharge from bankruptcy would not release her from liability to the estate for the amount she had stolen. So, while Ms. Dahl's other debts would be released, her bankruptcy would not free her from her debt to the estate.
Not all claims in bankruptcy are treated equally, and legal advice is recommended to ensure that any bankruptcy claim receives the best possible priority.