Legal Definitions - mutuality of debts

Mutuality of debts is a legal concept, primarily applied in bankruptcy proceedings, that describes a specific condition allowing two parties who owe each other money to "set off" or cancel out those debts. This condition is met when the same two parties owe each other, and they are each acting in the same legal role or capacity regarding both debts. It is important to understand that the debts do not need to be for the same type of goods or services, nor do they need to have originated from the same transaction or agreement.

Here are a few examples to illustrate this concept:

• Example 1: Business-to-Business Transactions

  Imagine "Global Logistics Inc." owes "Office Solutions Corp." $7,000 for a large shipment of new office furniture. Separately, "Office Solutions Corp." had previously hired "Global Logistics Inc." to handle the shipping for a major client and now owes "Global Logistics Inc." $5,000 for those freight services.

  In this scenario, "Global Logistics Inc." and "Office Solutions Corp." are the same two parties. For both debts, they are acting in their capacity as independent businesses. Even though one debt is for physical goods (furniture) and the other is for services (shipping), and they arose from different transactions, the condition of mutuality of debts exists. If one company were to declare bankruptcy, the other might be able to set off the $5,000 debt against the $7,000 debt, reducing the total amount owed.

• Example 2: Individual and Financial Institution

  Consider David, who has a savings account at "Community Credit Union" with a balance of $3,000. Separately, David also has an outstanding personal loan from the very same "Community Credit Union" on which he still owes $2,500.

  Here, David is the same individual, and "Community Credit Union" is the same entity. For the savings account, the credit union owes David money, and for the loan, David owes the credit union money. Both parties are acting in their standard capacities (individual customer and lending institution). Despite the debts being of different types (a deposit versus a loan) and arising from different agreements, the condition of mutuality of debts is present. If David were to file for bankruptcy, the credit union might be able to use the funds in his savings account to reduce the amount he owes on his loan.

• Example 3: Contractor and Subcontractor

  A general contractor, "BuildRight Construction," owes its subcontractor, "Elite Electrical Services," $10,000 for completing the wiring on a new commercial building. Separately, "Elite Electrical Services" had previously rented specialized equipment from "BuildRight Construction" for another project and now owes "BuildRight Construction" $4,000 for that equipment rental.

  In this case, "BuildRight Construction" and "Elite Electrical Services" are the same two parties, and both are acting as businesses in their respective roles as contractor and subcontractor/equipment provider. The debts are for different things (electrical services versus equipment rental) and arose from different agreements. However, because the same parties owe each other in the same capacities, the mutuality of debts exists. This could allow for the debts to be offset if one of the companies faced bankruptcy.