During a liquidation of a company or financial institution, the assets form a common fund. Priority claims from preferential creditors and the expenses of the winding up are paid in full before a statutory trust is formed for the unsecured creditors. Unsecured creditors are for example investors, bond holders and bank deposits above the insured and secured amount. The unsecured creditors file their claims against the free assets of the financial institution, where the pool of assets is distributed on a pari passu basis per level in the creditor hierarchy.
Contractual agreements and several acts and insolvency law allow creditors to offset the debt of a debtor with his assets. The most common example of such a transaction is the mortgage repayment. A default on such a mortgage term or interest payment can be ‘set off’ with a savings account or even other collateral the client holds at the same financial institution. Similar to the transaction between the mortgage payment and the savings- or securities account with the bank can be offsetting of assets with liabilities by the liquidator. For example, nostro accounts with correspondent banks can be set off against the positive and negative balances to remove the debit or credit from the balance sheet. Depending on his mandate, an administrator can set off specific other assets and liabilities. The liquidator is allowed to offset almost any asset with a liability for as long the anti-deprivation rule and the creditor hierarchy in a liquidation is followed.
The right to offset requires a direct relationship between the defaulting party, the assets and the creditor. Since the anti-deprivation rule prevents the removal of assets from an insolvent institution, the offset must be structured properly. Depending on the position during the resolution stage, an administrator or liquidator might need court approval to secure such a transaction to avoid repulsion of the suggested settlement.