UBS terminated its ISDA Master and FX transactions with Lehman Brothers Inc., was obligated to return about $23 million in collateral, wanted to set-off against that $23 million amounts owing by LBI to UBS affiliates as contemplated by the cross-affiliates set-off provision. Judge Peck said no. These types of clauses are enforceable pre-bankruptcy, but not once a proceeding is commenced. Mutuality is a requirement for post-petition set-off. He said, “Contractual provisions that purport to create synthetic mutuality are not a substitute for the real thing.”

Section 553(a) of the U.S. Bankruptcy Code requires mutuality as a condition of preserving a right of set-off. UBS argued that contractual set-off was an exception to the mutuality requirement. Judge Peck disagreed simply on the basis that the statute did not provide for that exception. 

UBS’s argument that the swap agreement safe-harbour could be relied on to permit the set-off also failed for the reasons he gave in the Swedbank case. 

As I pointed out in my brief on the Swedbank case, the result could be the same in Canada. The protection for the “law of set-off” that applies under the Bankruptcy and Insolvency Act and other insolvency statutes, while it contemplates contractual set-off, does not necessarily go so far as to include non-mutual set-off (unless it fits the bill for an equitable set-off). Also, the eligible financial contract safe-harbours by their terms require the set-off to be mutual. 

However, perhaps it’s not correct to analyze the issue as one of set-off. Under Canadian bankruptcy law, a trustee in bankruptcy has no higher right under a contract than had the bankrupt (subject to exceptions such as being able to challenge preferential transfers). If the right to the payment of a sum of money under a contract is subject to a right to deduct amounts owing to affiliates, then why is that not enforceable? There may be stay risk that delays exercise of the right, but on what basis is it not binding on the insolvency representative simply as a matter of contract law? That is an interesting question that the court did not consider in the judgment and which has not received much judicial treatment in Canada either.