In re Orexigen Therapeutics, Inc.
596 B.R. 9 (2018)
Rule of Law:
A parent corporation cannot assert a triangular setoff in bankruptcy, even if authorized by a prepetition agreement under state law, because the Bankruptcy Code's mutuality requirement mandates that debts be owed between the same two parties in the same capacity, a federal interest that overrides state contract law in this context.
Facts:
- The Debtor was a biopharmaceutical company that manufactured Contrave®, a drug that treats obesity, approved by the United States Food and Drug Administration in 2014.
- On June 9, 2016, the Debtor entered into a Core Distribution Agreement with McKesson Corporation (parent company), which contemplated McKesson would purchase and distribute Contrave®.
- The Distribution Agreement specified that McKesson and its affiliates were authorized to set off amounts owed by McKesson or its affiliates to the Debtor's affiliates against amounts owed by the Debtor or its affiliates to McKesson or its affiliates.
- On July 15, 2016, the Debtor entered into a Master Services Agreement with McKesson Patient Relationship Solutions (MPRS), McKesson's wholly-owned subsidiary, for MPRS to manage the Debtor's LoyaltyScript® program, providing patient price discounts on Contrave®.
- As of the petition date, McKesson owed the Debtor $6,932,816.40 under the Distribution Agreement.
- As of the petition date, the Debtor owed MPRS approximately $9,100,000 under the Services Agreement.
- McKesson and MPRS are undisputed legally distinct entities.
Procedural Posture:
- On March 12, 2018, the Debtor voluntarily filed a petition for relief under Chapter 11 of the Bankruptcy Code with the U.S. Bankruptcy Court for the District of Delaware.
- On April 11, 2018, the U.S. Bankruptcy Court for the District of Delaware entered an order approving a stipulation between the Debtor and MPRS, which, among other things, recognized MPRS's prepetition claim of approximately $9,100,000 against the Debtor.
- On May 18, 2018, the U.S. Bankruptcy Court for the District of Delaware entered an order approving a stipulation between the Debtor, McKesson, and MPRS, noting that McKesson owed the Debtor $6,932,816.40, which McKesson paid off post-petition, but explicitly preserving McKesson's right to offset the entire amount against the debt owed to MPRS.
- On July 20, 2018, the U.S. Bankruptcy Court for the District of Delaware entered an order approving a stipulation between the Debtor, McKesson, and certain Lenders, allowing McKesson to file the Motion at issue and requiring the Debtor to segregate $6,932,816.40 (the 'Disputed Funds') pending resolution of McKesson's motion.
- On July 30, 2018, McKesson filed a Motion for an Order Determining that McKesson is Entitled to the Disputed Funds with the U.S. Bankruptcy Court for the District of Delaware.
- On August 21, 2018, the Noteholders filed their opposition to the Motion, and the Debtor filed its Objection to the Motion, both with the U.S. Bankruptcy Court for the District of Delaware.
- On August 31, 2018, McKesson filed its Reply to the objections with the U.S. Bankruptcy Court for the District of Delaware.
- On October 24, 2018, the U.S. Bankruptcy Court for the District of Delaware heard oral argument from McKesson/MPRS, the Debtor, and the Noteholders on the Motion.
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Issue:
Does a prepetition contractual right under state law that allows a parent corporation to offset its debt to a debtor against the debtor's debt to its subsidiary satisfy the strict mutuality requirement for setoff under Section 553(a) of the Bankruptcy Code?
Opinions:
Majority - Kevin Gross, U.S.B.J.
No, a prepetition contractual right under state law that allows a parent corporation to offset its debt to a debtor against the debtor's debt to its subsidiary does not satisfy the strict mutuality requirement for setoff under Section 553(a) of the Bankruptcy Code because such an arrangement constitutes an impermissible triangular setoff. The court affirmed that Section 553(a) of the Bankruptcy Code recognizes state law setoff rights but imposes its own requirements, most notably strict mutuality. Mutuality in bankruptcy requires that debts be 'due to and from the same persons in the same capacity.' Since McKesson (the parent) and MPRS (the subsidiary) are legally distinct entities, the debt McKesson owed the Debtor and the debt the Debtor owed MPRS were not 'mutual' under this definition; thus, McKesson's proposed setoff was an impermissible 'triangular setoff.' The court acknowledged that the Distribution Agreement, governed by California law, explicitly allowed for such a setoff with affiliates. However, under the Supreme Court's Butner doctrine, state law rights are respected in bankruptcy 'unless some federal interest requires a different result.' The court found such a federal interest in the plain language of Section 553(a) and the fundamental bankruptcy policy of ensuring similarly-situated creditors receive an equal distribution from the debtor's estate. Allowing parties to contractually bypass the mutuality requirement would violate this policy, creating an unfair advantage for one creditor and diluting the estate. The court dismissed McKesson's reliance on Prudential Reinsurance Co. v. Superior Court, noting the cited language was dicta and that California's general definition of mutuality aligns with federal bankruptcy interpretation. Furthermore, the court rejected the argument that MPRS's alleged third-party beneficiary status to the Distribution Agreement created the requisite mutuality, as this doctrine is also contrary to the strict mutuality requirement in Section 553(a).
Analysis:
This case significantly reinforces the strict application of the mutuality requirement in bankruptcy setoffs, particularly in the context of affiliated corporate entities. It clarifies that while state law may define contractual rights, federal bankruptcy policy and statutory language, which prioritize equitable distribution, can override those rights when a 'federal interest' is at stake. The ruling discourages creative contractual arrangements designed to circumvent fundamental bankruptcy principles, such as preventing one creditor from gaining an unfair advantage over others through triangular setoffs. This decision serves as a crucial precedent for creditors and debtors involved in inter-company agreements, emphasizing that the corporate veil, even between a parent and a wholly-owned subsidiary, will not be pierced to satisfy the mutuality requirement of Section 553(a) without extraordinary circumstances.
