## Facts

- Continental Commodities, Inc. and SMI Industries Corporation were scrap metal dealers that regularly bought and sold to each other on open account, creating mutual running debts.
- Although invoices reflected large gross amounts, the parties’ net balance at any given time was typically small.
- The parties periodically settled by (1) offsetting bookkeeping entries canceling mutual debts or (2) exchanging checks for the outstanding balances, with coordinated, near-simultaneous deposits to ensure clearance.
- In late August 1983, Continental sent SMI 17 checks totaling $273,137.62 for prior invoiced deliveries.
- SMI sent Continental one check for $271,967.20 for Continental’s prior invoiced deliveries.
- Both sides deposited the checks on August 30, 1983.
- Continental filed a Chapter 7 petition on November 18, 1983, within 90 days of the deposits.
- The bankruptcy trustee sued to recover $273,137.62 from SMI as an avoidable preferential transfer.

## Issues

1. Whether Continental’s $273,137.62 check payments to SMI within 90 days of bankruptcy were avoidable preferences under 11 U.S.C. § 547(b).
2. Whether the coordinated exchange of checks should be treated as a setoff of mutual debts preserved by 11 U.S.C. § 553, and whether § 553 or North Carolina law required a particular method to effect a valid setoff.

## Decision

- The Fourth Circuit reversed the district court’s affirmance of the bankruptcy court and remanded.
- The court held the transaction should be analyzed as a setoff of mutual debts, not as a unilateral preferential transfer.
- The court concluded that neither § 553 nor North Carolina law imposed a required method of executing setoff, so effectuating setoff through a coordinated exchange of checks did not invalidate it.

## Legal Principles

- Section 553 does not create a right of setoff; it preserves setoff rights that exist under applicable nonbankruptcy (generally state) law, subject to statutory limitations.
- In assessing preference claims under § 547(b), courts must account for § 553 where the challenged payment is part of a mutual settlement of reciprocal obligations.
- Where state law recognizes setoff for mutual debts and does not mandate a specific form for implementing it, parties may accomplish setoff through synchronized payments (including exchanged checks), and the arrangement may be treated as a setoff rather than an avoidable preference.
- A transaction involving reciprocal obligations should be evaluated in its overall substance when determining whether it is a preference or a permissible setoff.

## Conclusion

The Fourth Circuit held that the coordinated exchange of checks between trading partners with mutual open-account debts constituted a setoff preserved by § 553 under North Carolina law, and the trustee could not avoid the debtor’s gross payment to the creditor as a preference by isolating one side of the reciprocal settlement.


Durham v. SMI Indus. Corp., 882 F.2d 881 (4th Cir. 1989)