In the energy industry, it’s common for oil and gas well operators to “net” unpaid joint interest billings (JIBs) against working interest revenue payments in the ordinary course of business. However, the moment a petition is filed by a debtor under any chapter of the United States Bankruptcy Code, the automatic stay goes into effect which affects the right to “net,” depending upon whether the netting constitutes a setoff or recoupment.

Here are the general rules in the Fifth and Tenth Circuits, which include Texas and Oklahoma: where payables and receivables arise from the same contract or transaction, the practice of netting is called “recoupment,” which may continue without obtaining relief from the automatic stay from the bankruptcy court,1 and may be used to “net” a pre-bankruptcy debt owed by the debtor against a pre- or post-bankruptcy debt owed to the debtor. When the mutual obligations don’t arise out of the same contract or transaction, the practice of netting is called “setoff,” which is subject to the automatic stay and requires prior bankruptcy court approval. Setoff will only be permitted if authorized by the contract or applicable non-bankruptcy (state) law, and even then, only to “net” pre-bankruptcy receivables against pre-bankruptcy payables.2

Recoupment reduces a debt. It’s not a claim in bankruptcy, nor is it subject to the automatic stay or the discharge injunction. Supra, fn. 1; see also Matter of Gaither, 200 B.R. 847, 850 (Bankr. S.D. Ohio 1996). “In recoupment, the elements of the debt may arise either before or after the commencement of the case.” Id. (citation omitted.) “The only real requirement regarding recoupment is that the sum can be reduced only by matters arising out of the same transaction as the original sum.” Id. (citation omitted). “For the purposes of recoupment, a mere logical relationship is not enough: the ‘fact that the same two parties are involved, and that a similar subject matter gave rise to both claims, ... does not mean that the two arose from the ‘same transaction.’ Rather, both debts must arise out of a single integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations.” Commc’n Dynamics, 382 B.R. at 236 Id. (quoting Univ. Med. Ctr. v. Sullivan (In re Univ. Med. Ctr.), 973, F.2d 1065, 1081 (3d Cir. 1992) (additional citations omitted)). “Use of this stricter standard for delineating the bounds of a transaction in the context of recoupment is in accord with the principle that this doctrine, as a non-statutory, equitable exception to the automatic stay, should be narrowly construed.” In re Peterson Distrib., Inc., 82 F.3d 956, 960–61 (10th Cir. 1996) (also quoting Univ. Med. Ctr., supra).

In short, distinguishing recoupment rights from setoff rights means identifying rights to payment and obligations that arise from the same contract or transaction. Doing so isn’t always easy. Note, too, that a single contract is not necessarily required for recoupment to apply. While recoupment is “narrowly construed,” see Peterson Distrib., Inc., 82 F.3d at 959, it’s possible for more than one contract to be part of a “single integrated transaction” to which recoupment will apply.

Finally, also note that the distinction between recoupment and setoff is only relevant to the extent you are owed a pre-bankruptcy debt by the debtor. Assuming the debtor’s bankruptcy is filed under chapter 11, the debtor is required to continue paying its debts incurred after the bankruptcy filing date as they come due. The debtor’s failure to do so is grounds for dismissal of the case or conversion to chapter 7.