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Home New Opinions Bankruptcy Court for Southern District of New York: Pre-Petition Claims May Not Set-Off Against Post-Petition Claims Under Doctrine of Mutuality

Bankruptcy Court for Southern District of New York: Pre-Petition Claims May Not Set-Off Against Post-Petition Claims Under Doctrine of Mutuality


April 23, 2021, Southern District of New York – Debtor Arcapita Bank B.S.C.(c) (“Arcapita”) operated as an investment bank and was a global manager of Shari’a-compliant alternative investments. Defendant BisB is a Bahraini corporation that operates as an Islamic commercial bank and is headquartered in Bahrain. Defendant Tadhamon is a Bahraini corporation and a subsidiary of Tadhamon International Islamic Bank (“TIIB”), a Yemeni bank that offers Shari’a-compliant banking and investment services to customers in Yemen and abroad.

The parties filed cross-motions for summary judgment in the adversary proceeding brought by the Official committee of unsecured creditors in bankruptcy cases of Arcapita Bank and its affiliated debtors. The Official committee of unsecured creditors sought turnover of funds that Arcapita invested with the Defendants in the days before Arcapita’s bankruptcy filing.

The Defendants assert that they have properly exercised their rights under Bahraini law to set off those funds against debts owed to them by Arcapita and that their actions in retaining the funds are further shielded by the safe harbor provisions of the Bankruptcy Code. The Defendants were each party to separate master investment agreements with Arcapita. In addition to investments by the Defendants with Arcapita, Arcapita also made certain investments with the Defendants. Under the arrangement between the parties, Arcapita would transfer funds to the Defendants, which were then used to make certain investment purchases in Arcapita’s name. The Defendants would then repurchase the investments from Arcapita on a deferred payment basis for an amount equal to the original investment plus an agreed-upon return.

The Defendants argued that they are entitled to summary judgment based on a lack of personal jurisdiction. The Court found that the Defendants’ use of New York correspondent bank accounts to receive funds from Arcapita met the threshold of minimum contacts necessary to assert personal jurisdiction.

The Defendants next argued that their retention of the transaction proceeds is appropriate because they exercised a valid right of setoff under Bahraini law. The Court held that the setoff is unenforceable because the debt owed by Arcapita arose pre-petition but the debt owed to Arcapita arose post-petition. Therefore, there is a lack of mutuality of obligations. The Court reasoned that pre-petition debtor and a debtor-in-possession are separate and distinct entities and the post-petition debts may not provide the basis for setoff because mutuality ceases upon the filing of the bankruptcy estate.

Further, the Court held that the Defendants’ setoffs are invalid under Bahraini law because they were superseded by the formal directions that were issued to each Defendant by the regulator of financial institutions in Bahrain, as to these specific transactions.

The Defendants also failed to successfully safeguard the transaction proceeds by the safe harbor provisions of the Bankruptcy Code. The court concluded that the transactions were not “securities contracts” because the financial arrangements between Arcapita and the Defendants consisted of deposit-like instruments based on the Murabaha contractual structure. It did not fulfill the common usage or market practice that could cause them to be considered securities. Further, the transactions also failed to satisfy the elements of “forward contracts” under Section 101(25) of the Bankruptcy Code. The Court also ruled that the transactions were not “swap agreements” under Section 101(53B) of the Bankruptcy Code because they did not provide for the “swap” of financial instruments.

Having concluded that the Defendants’ purported setoffs were invalid and after rejecting the Defendants’ other defenses, the Court found that the Defendants’ failure to remit the transaction proceeds constituted a breach of the applicable agreements. The Court opined that the transaction proceeds were debts that were the property of the estate, were matured, and were subject to turnover under Section 542(b) of the Bankruptcy Code.

The Court granted the Committee’s motions and denied the Defendants’ motions.


Jones & Associates

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