Select Credit Unions May Still Be Able to Setoff a Member's Funds on Deposit Post-Discharge

A question I often encounter from credit unions concerning bankrupt members with delinquent accounts is whether they can setoff the debtor's funds on deposit to apply to unpaid loans. The simplest answer is often “no,” because such an action during an active bankruptcy would be a violation of the stay provisions of 11 U.S.C. § 362, or, if done after the bankruptcy has been discharged, a violation of the discharge provisions of 11 U.S.C. § 727, 11 U.S.C. § 1328, and 11 U.S.C. § 524.

This article focuses on credit union accounts in which there is no agreement securing the loan with money on deposit as collateral. Instead, we'll focus on circumstances in which a credit union has an unsecured account, but pursuant to a contractual agreement, in conjunction with state or federal law, reserves the right to setoff the member's funds on deposit to pay the delinquent account.

11 U.S.C. § 362(a)(7) explicitly states that a bankruptcy petition filed under this title of the code acts as a stay, prohibiting creditors from “the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor.”¹ Once the case is complete and the court has issued the discharge order, the debtor is discharged from all debts that arose prior to the case filing, with the exception of certain non-dischargeable debts enumerated within the code.² A creditor is then barred from the post-discharge collection of the discharged debt.³ 

The aforementioned code provisions may not completely bar a credit union from enforcing some of its contractual rights, even after a bankruptcy case is discharged. 11 U.S.C. § 553(a) of the United States Bankruptcy Code states that “this title does not affect any right of a creditor to offset mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case.”⁴   

11 U.S.C. § 553(a) explicitly preserves the right of setoff by a creditor, but it seems to be in conflict with the provisions of 11 U.S.C. § 524, which prohibits the post-discharge collection of a discharged debt. “The Sixth Circuit has not considered whether setoff may be exercised against discharged debt. Although there is not total agreement on this issue, a majority of courts have held that a creditor's right to setoff survives the bankruptcy court's final discharge of the of the bankrupt's debts, provided that a right to setoff existed at the time the bankruptcy petition was filed.”⁵  

Even though 11 U.S.C. § 553(a) seemingly preserves the credit union's ability to setoff, there must be a right to setoff for this to be enforceable. “Whether the credit union possesses a right of setoff is not a straightforward question. The Bankruptcy Code does not create a right of setoff. The Bankruptcy Code provides that, with certain exceptions not relevant here, whatever right of setoff otherwise exists in state or federal law is preserved in bankruptcy.”⁶ 

Despite the statutory and non-binding case authority in support of this position, a credit union will need to conduct a practical analysis to determine whether they want to try and enforce their right to setoff funds after a bankruptcy is discharged. Since this is an issue without a clear consensus among the courts, attempting a post-discharge setoff will most likely be met with great resistance from debtors and their counsel. The analysis should determine whether the amounts in question are worth the cost of defending such an action, or whether litigating the matter through the federal courts would bring some finality to the issue. Overall, it seems as though the bankruptcy code has some provisions that provide credit unions with additional tools to protect themselves from bankrupt debtors. With proper legal guidance, these provisions can afford credit unions greater power and ability to mitigate their financial loss due to a bankrupt debtor.

For more information, please contact Milos Gvozdenovic, Esq. Mr. Gvozdenovic is an attorney who practices in bankruptcy and is based in the Brooklyn Heights office. Mr. Gvozdenovic is licensed in Ohio, and is admitted to practice before the U.S. District Court for the Northern District of Ohio.