First aid in the event of (imminent) bankruptcy of your debtor: how do you offset mutual debts?

Suppose your debtor is at risk of going bankrupt, while you still have mutual debts. In that case, it is advisable to offset these debts through so-called set-off. This mechanism protects your position as a creditor and limits the risk of non-payment. But is set-off always possible, and what changes once bankruptcy threatens or is declared? Attorneys Marlies Janssens and Stijn Berlamont explain when set-off can be applied, which points require attention, and how you can best prepare yourself legally.

What is set-off?

When two parties are mutually debtor and creditor of each other, set-off or compensation causes both debts, under certain conditions, to be extinguished up to the amount of the lower debt.

An example

Suppose: A is a company active in the steel sector and B is a company active in the transport sector. A has sold steel products worth EUR 90,000 to B, and B has provided transport services worth EUR 50,000 to A.

→ Result: A must pay EUR 50,000 to B and B must pay EUR 90,000 to A.

A and B are therefore mutually debtor and creditor. In this example, the mutual claims are not connected, as they arise from separate contracts with different subject matter (see below on the importance of connection). By applying set-off, A’s debt of EUR 50,000 is extinguished and B’s debt is reduced to EUR 40,000 (EUR 90,000 – EUR 50,000).

→ Result: A owes nothing to B and B only has to pay EUR 40,000 to A.

What are the conditions for set-off?

There are two types of set-off: statutory and contractual.

#1. Statutory set-off | Article 5.255 Civil Code

Statutory set-off takes place by operation of law because the following conditions are met:

• There are mutual obligations between the same two parties.
• Both obligations concern the payment of a sum of money or the delivery of a certain quantity of fungible goods of the same kind (for example: a specific raw material).
• Both obligations are certain, liquid and due and payable. “Due and payable” means that the creditor has the right to demand performance of the obligation, for example payment of an (undisputed) invoice whose payment term has expired.

#2. Contractual set-off | Article 5.263 Civil Code

In addition, contractual set-off is also an option. This means that set-off does not occur automatically, but that the parties agree to apply set-off even if the statutory conditions are not (yet) met. Contractually, parties can therefore agree, for example, to offset invoices whose payment term has not yet expired. An agreement on set-off is also known as a netting agreement.

How does set-off help me if my debtor goes bankrupt?

Once your debtor is bankrupt, it is uncertain whether they will still be able to pay their debts. In that case, you improve your position as a creditor by no longer paying your own debts to that debtor up to the amount they still owe you. Set-off is therefore useful because it secures at least part of the amounts owed to you.

An example

In the previous example, B goes bankrupt before paying A’s invoice for the steel products. Without set-off, B’s trustee could require A to pay the transport services worth EUR 50,000 in full into B’s bankruptcy estate, without A having any certainty that it will receive EUR 90,000 from B’s bankruptcy for its steel products. Only after distribution of the estate will it become clear how much A can recover.

A’s position, on the other hand, improves significantly if it can apply set-off: through set-off, A’s debt to B is extinguished, so A does not have to pay EUR 50,000 into B’s bankruptcy. The uncertainty regarding payment from the bankruptcy is thus limited to EUR 40,000 instead of EUR 90,000.

When can I apply set-off in the event of bankruptcy?

In bankruptcy, set-off is usually not possible. The principle in bankruptcy is the concurrence of creditors: from the date of the bankruptcy declaration, the rights of all creditors vis-à-vis the bankrupt are fixed. Concretely, this means, among other things, that from that moment creditors can no longer improve their position by, for example, applying set-off.

Statutory set-off occurs automatically (“by operation of law”) as soon as the statutory conditions are met, without the parties having to do anything and without them even necessarily being aware of it. If, at the time of bankruptcy, the invoices are mutually due and payable, then those invoices have already been set off by operation of law up to the lower amount. However, once one of the parties goes bankrupt, statutory set-off is no longer possible for invoices that are not yet due.

An invoice becomes due when the final payment date expires. If no payment term is agreed for the invoice, a term of thirty days applies between businesses. To make statutory set-off possible in the event of an impending bankruptcy, it is therefore advisable to bring forward the final payment date on the invoice or, if possible, even make the invoice “payable immediately”.

If, in addition, the parties have concluded a valid netting agreement before the concurrence arises, then contractual set-off on the basis of that netting agreement remains possible even after bankruptcy.

In the event of an impending bankruptcy, set-off can make the difference between a manageable risk and a total loss.

My debtor is bankrupt and I have not concluded a (valid) netting agreement, what now?

First of all, there is no problem if you can demonstrate that the mutual claims are connected. This constitutes a statutory exception to the principle that set-off is no longer possible after concurrence. Claims are connected if they show a close economic or legal link or form part of the same economic or commercial transaction. For example: within a single services agreement, an invoice for partially correctly performed services and a claim for damages for the incorrectly performed services. Whether claims are connected is a factual assessment.

If your debtor is already bankrupt, your mutual claims are not connected (as in the example of A and B), and you have not concluded a valid netting agreement, then unfortunately neither statutory nor contractual set-off with respect to non-due invoices is still possible. You will have to await the distribution of the bankruptcy estate.

Set-off in bankruptcy: three practical points of attention

In summary, the following three recommendations can be made:

1. Shorten the payment term on your invoices as soon as you sense trouble. If possible, even make your invoices payable immediately. In the case of immediate payment, the mutual invoices will be due in the event of a later bankruptcy, so that statutory set-off automatically takes place.
2. Conclude a valid netting agreement before your debtor is declared bankrupt. In this way, set-off can also be applied to non-due invoices in the event of a later bankruptcy.
3. If possible, contractually stipulate that your claims are connected.

Do you have further questions or would you like more information about drafting a valid netting agreement? Our attorneys are happy to think along with you. Contact us to make an appointment at our offices in Brussels, Bruges, and Kortrijk.