On May 16, 2012, Judge Brendan Linehan Shannon of the United States Bankruptcy Court for the District of Delaware (the “Court”) denied Zurich American Insurance Company’s (“Zurich”) motion for relief from the automatic stay to exercise its alleged right of setoff because Zurich did not establish cause to lift the stay. In re WL Homes LLC, 2012 WL 1766659, (Bank.D.Del. May. 16, 2012).
Prior to its 2009 bankruptcy filing, Debtor, WL Homes, had taken out a Home Builders Protective Insurance Policy (the “Policy”) with Zurich. . Coverage under the Policy was triggered only after WL Homes had paid a certain amount defined as a “self insured retention” (“SIR”) amount. The Policy obligated WL Homes to pay all defense costs and damages up to the SIR, except that Zurich could elect to pay defense costs notwithstanding the fact that WL Homes had not reached its SIR. Zurich sought stay relief to setoff approximately $2.2 million in insurance premium overpayments belonging to WL Homes, against a contingent claim for defense costs which Zurich could elect to pay under the Policy.
The Court prefaced its analysis by highlighting the Third Circuit’s position that §553 is permissive rather than mandatory and, therefore, left to the sound discretion of the bankruptcy court. In re Bevill, Bresler & Schulman Asset Mgmt. Corp., 896 F.2d 54 (3d Cir. 1990). Turning first to Zurich’s state law setoff rights, the Court found that Zurich had not met its burden that Zurich’s contingent claim could serve as the basis for setoff under applicable California law. The Court also identified reason to doubt the validity of such a position based on its own limited research which concluded that “Ordinarily, when a liability is contingent, and not fixed, it is unavailable as a setoff without the consent of plaintiff…” 16 Cal. Jur. 3d., Counterclaim and Setoff §10 (2012).
The Court also found that Zurich had not met its burden under §553 to show that both the debt and claim arose pre-petition. Zurich’s position that it may elect to fund the SIR post-petition and, in such instance, has the right to setoff that amount against the return premium does not permit setoff which instead “is permitted when, at the time the bankruptcy petition is filed, the debt is absolutely owing but is not presently due, or when definite liability has accrued but is not yet liquidated.” In re Young, 144 B.R. 45, 46-47 (Bankr. N.D. Tex. 1992).