The United States Bankruptcy Court for the Southern District of New York (the Court), has held that section 553(a) of the Bankruptcy Code prohibits a swap counterparty from setting off amounts owed to the debtor against amounts owed by the debtor to affiliates of the counterparty, notwithstanding the safe harbor provision in section 561 of the Bankruptcy Code and language in the ISDA Master Agreement permitting the swap counterparty to effect “triangular” setoffs. In re Lehman Brothers Inc., Case No. 08-01420 (JMP)(SIPA) (Bankr. S.D.N.Y. October 4, 2011).

Section 553(a) of the Bankruptcy Code, which also applies in a proceeding under the Securities Investor Protection Act of 1970 (SIPA), preserves a creditor’s pre-bankruptcy right to setoff “mutual debts.” The term “mutual debts” is understood to mean debts between the same two parties in the same legal capacity. In the bankruptcy context, mutuality also requires that the debts to be setoff both arise prior to the filing of the bankruptcy petition.