Sharing of setoffs: Overview, definition, and example
What is sharing of setoffs?
Sharing of setoffs refers to an agreement where creditors agree to share any amounts recovered through setoff rights. A setoff allows a creditor to deduct what it is owed from amounts it would otherwise have to pay a debtor. In a shared setoff arrangement, multiple creditors agree to distribute any recovered funds among themselves, often in proportion to their outstanding claims.
For example, if a company defaults on loans owed to multiple banks, and one bank recovers funds through a setoff, the agreement may require that bank to share the recovered amount with the other lenders.
Why is sharing of setoffs important?
Sharing of setoffs is important because it ensures fair distribution of recovered funds among multiple creditors, preventing one creditor from gaining an unfair advantage. In syndicated loan agreements or multi-lender financing arrangements, sharing setoffs helps maintain balance among creditors.
For businesses, these provisions affect financial risk and recovery in case of default. Lenders, banks, and financial institutions often include setoff-sharing clauses in loan agreements to protect their interests and ensure equitable repayment.
Understanding sharing of setoffs through an example
Imagine a company borrows $10 million from three banks—Bank A, Bank B, and Bank C—each lending $3.33 million. The company later defaults on its loans, but it holds $2 million in a deposit account with Bank A. Under its loan agreement, Bank A has the right to set off the $2 million against the company’s outstanding debt.
If the loan agreement includes a sharing of setoffs provision, Bank A cannot keep the full $2 million for itself. Instead, it must distribute the funds proportionally among all three lenders, ensuring that Banks B and C also recover part of the defaulted loan.
An example of a sharing of setoffs clause
Here’s how a sharing of setoffs clause might appear in a loan agreement:
“Any Lender that exercises a right of setoff against the Borrower shall share the recovered amount with all other Lenders in proportion to their respective loan interests, ensuring equal treatment among Lenders.”
Conclusion
Sharing of setoffs ensures that when a creditor recovers funds through setoff rights, other creditors with similar claims receive a fair share of the recovery. This provision is commonly used in multi-lender agreements to prevent one party from gaining an unfair advantage.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.