Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-azd-2_09-cv-01600/USCOURTS-azd-2_09-cv-01600-0/pdf.json

Nature of Suit Code: 422
Nature of Suit: Bankruptcy Appeals Rule 28 USC 158
Cause of Action: 28:0158 Notice of Appeal re Bankruptcy Matter (BAP)

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WO

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF ARIZONA

In re DAWN PETERSEN, )

) No. CIV 09-1600 PHX RCB

Debtor, )

______________________________) BK 02-01937 - PHX SCC

)

DAVID BIRDSELL, Trustee, ) Adversary No. 02-0576

) 

Appellant, ) BAP No. AZ-09-1210 

)

vs. ) O R D E R

)

DAVID A. PETERSEN, )

)

Appellee. ) )

Introduction

This adversary proceeding is before the court now for the

third time. Once again the broad issue is what funds, if any,

defendant/appellee, David A. Petersen (“defendant”), must turn over

to Trustee/appellant, David Birdsell (“Trustee”), as part of the

bankruptcy estate pursuant to the Bankruptcy Code (“the Code”), 11

Case 2:09-cv-01600-RCB Document 11 Filed 09/27/10 Page 1 of 28
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1 Unless otherwise indicated, all chapter, section and rule references

are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and to the Federal Rules of

Bankruptcy Procedure, Rules 10019037 in effect prior to October 17, 2005, the

effective date of most of the provisions of the Bankruptcy Abuse Prevention and

Consumer Protection Act of 2005, Pub.L. 109-8, April 20, 2005, 119 Stat. 23, as

debtor's case was filed prior to that effective date.

2 In its “conclusion,” however, the bankruptcy court incorrectly noted

“that the bankruptcy estate is entitled to the sum of $27,412.50.” R. (Doc. 4-7)

at 18:22-23. That sum is the amount of setoffs to which the court found defendant

was entitled, however. See id. at 18:13. Evidently the bankruptcy court

inadvertently transposed defendant’s setoffs with the amount which it found he owes

the bankruptcy estate. 

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U.S.C. §542.1 Despite finding community property assets of

$110,881.34, the bankruptcy court found that the bankruptcy estate

and defendant each had a one-half interest in that community

property, i.e., $55,440.62. Id. at 18:2-4. After also allowing

defendant “credits or setoffs” totaling $27,412.50, the bankruptcy

court held that defendant “still owed . . . $28,028.122 . . . to

the bankruptcy estate.” Id. at 18:15-16 (footnote added). Adding

$344.40 in costs, and deducting $14,000.00 which defendant had

previously paid to the Trustee, the bankruptcy court entered a

final judgment against defendant, ordering him to pay $14,372.52 to

the Trustee. R. (Doc. 4-8) at 2, ¶ 1. 

The Trustee argues that judgment should have been entered in

his favor, however, in the full amount of the community property

assets – $110,881.34. Appellant’s Br. (Doc. 3) at 9. Therefore,

he timely filed a Notice of Appeal. R. (Doc. 4-9). Defendant

timely filed a Statement of Election, in accordance with 28 U.S.C.

§ 158(c) and Fed. R. Bank. Pro. 8001(e), electing to have his

appeal heard by this district court rather than by a three-judge

panel of the bankruptcy appellate panel service. Doc. 1. Pursuant

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3 That statute provides in relevant part that “district courts . . .

shall have jurisdiction to hear appeals . . . from final judgments . . . of

bankruptcy judges[.]” 28 U.S.C. § 158(a)(1).

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to 28 U.S.C. § 158(a),3 this district court has jurisdiction to

hear the Trustee’s appeal. No party has requested oral argument

and the court will not require it because “the facts and legal

arguments are adequately presented in the briefs and record and the

decisional process would not be significantly aided by oral

argument.” Fed. R. Bank. Pro. 8012. 

Background

The stipulated facts are simple and straightforward. On April

10, 2000, debtor Dawn L. Petersen served a Petition for Dissolution

of Marriage upon defendant. R. (Doc. 4-3) at 1, ¶ I(A). Nearly

four years later, on February 23, 2004, the Superior Court in

Maricopa County entered a Decree of Dissolution of Marriage. Id.

at 1, ¶ I(C). In the intervening years, prior to the entry of the

Decree of Dissolution, on February 8, 2002, Ms. Petersen filed a

Chapter 7 bankruptcy petition. Id. at 1, ¶ I(B). On June 14,

2002, Ms. Petersen received a discharge of all of her debts. Br.

(Doc. 3) at 1:23-25 (citation omitted). 

On April 12, 2002, the Trustee commenced an adversary

proceeding to recover from defendant the community property

allegedly belonging to the bankruptcy estate. See R. (Doc. 4-2). 

By stipulation, the parties resolved the issue which dominated the

prior two appeals - the community’s interest in the marital

residence. The parties finally agreed, and hence the bankruptcy

court found, that $50,000.00 represents the community’s interest in

the improvements on that residence. R. (Doc. 4-7) at 3:1-13; and 3

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n. 9. Additionally, also pursuant to the parties’ agreement, the

bankruptcy court found that the community held the following

interests:

1. “38[%] of the IRA account” valued at $22,636.48;

2. a “cash management account” valued at $11,778.24; and 

3. a “Wells Fargo Account” valued at $18,034.22.

Id. at 3:17-18 - 4:1 (footnote omitted). Based upon the foregoing

assets, the bankruptcy court found that “the interests in community

property to be taken into consideration” totaled “$110,881.34.” 

Id. at 17:19-20; and 18:1. 

The bankruptcy court “technically agree[d] with the Trustee[]”

that pursuant to 11 U.S.C. § 541(a)(2) the “bankruptcy estate

includes,” inter alia, “all of the community property of the Debtor

and [the defendant], . . . , as of the time of the filing of the

bankruptcy petition on February 8, 2002[,]” i.e., $110,881.34. Id.

at 9:14-16 (footnote omitted). Nevertheless, the bankruptcy court

“allocate[d] one-half of the value of the community assets to [the

defendant],” and the other half to the bankruptcy estate. Id.

at 9:17-18; and at 18:3-4. The bankruptcy court apportioned the

community property assets in that way relying upon Arizona statutes

governing division of community property in a dissolution

proceedings, as more fully discussed herein. The bankruptcy court

further relied upon what it perceived to be the “inequit[y]” which

would arise from “allow[ing] the bankruptcy estate to retain a 100

percent interest in the community assets.” Id. at 13:2-3. 

Concomitantly, the bankruptcy court found that defendant

“shall receive . . . credits or setoffs” of $27,412.50 against the

amount he owes to the bankruptcy estate. The bankruptcy court

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offered two reasons for allowing those setoffs. First, it found

that defendant met the three criteria for a setoff pursuant to

section 553 of the Code. 

Second, invoking the equitable doctrine of recoupment, the

bankruptcy court allowed “the setoff of mutual debts.” Id. at

16:8-9. When the bankruptcy court did that, as just noted, it

allowed $27,412.50 in setoffs, and found that defendant still owed

the bankruptcy estate $28,028.12. Id. at 18:12-14. 

The Trustee’s appeal presents two fairly narrow legal 

issues. Did the bankruptcy court commit “reversible error” by: 

(1) “failing to order the Defendant to turn over the full value of

the community property to the [T]rustee[;]” and (2) “allowing the

defendant to assert offsets against property of the bankruptcy

estate[.]” Appellant’s Br. (Doc. 3) at 1:11-16. The court will

address these issues in turn. 

Discussion

I. Standards of Review

In reviewing the bankruptcy court’s decision, “[t]he

applicable standard of review is identical to that employed by

circuit courts of appeal in reviewing district court decisions.” 

Brooks v. Brooks, 2010 WL 1416702, at *2 (E.D.Cal. April 5, 2010)

(citing Ford v. Baroff (In re Baroff), 105 F.3d 439, 441 (9th Cir.

1997)). A bankruptcy court’s “factual findings are reviewed for

clear error.” Ormsby v. First Am. Title Co. of Nev., 591 F.3d

1199, 1205 n. 2 (9th Cir. 2010) (citation and internal quotation

marks omitted). However, “a bankruptcy court’s legal conclusions,

including its interpretation of the bankruptcy code and state law,”

are subject to “de novo[]” review. Heilman v. Heilman, 430 B.R.

Case 2:09-cv-01600-RCB Document 11 Filed 09/27/10 Page 5 of 28
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213, 216 (9th Cir. BAP 2010) (citation omitted). Mixed questions of

law and fact are, likewise, subject to de novo review. In re

Cerchione, 414 B.R. 540, 545 (9th Cir. BAP 2009). “Such issues are

reviewed de novo because they require consideration of legal

concepts and the exercise of judgment about the values that animate

legal principles.” Id. (citation and internal quotation marks

omitted). 

This court “may affirm, modify, or reverse [the] bankruptcy

judge’s judgment, order, or decree or remand with instructions for

further proceedings.” Fed. R. Bank. P. 8013. An affirmance “may”

be based “on any ground supported by the record, even if it differs

from the bankruptcy court’s stated rationale.” Cerchione, 414 B.R.

at 545 (citation omitted). 

On this appeal the Trustee is challenging the bankruptcy

court’s determination that the bankruptcy estate is entitled to

one-half the value of community assets, as opposed to “retain[ing]

a 100 percent interest in th[os]e assets.” R. (Doc. 4-7) at 13:3. 

The issue of “[w]hether property is property of the [bankruptcy]

estate is a question of law reviewed de novo.” In re Mwangi, 2010

2723204, at *3 (9th Cir. BAP June 30, 2010) (citation omitted). “De

novo means review is independent, with no deference given to the

trial court’s conclusion.” Id. (citation omitted). 

The Trustee also challenges the bankruptcy court’s allowance

of certain setoffs to defendant based upon section 553 of the Code.

Decisions to allow or disallow setoffs under that section are

subject to review for abuse of discretion. Brown & Cole Stores,

LLC v. Associated Grocers, Inc. (In re Brown & Cole Stores, LLC),

375 B.R. 873, 877 (9th Cir. BAP 2007) (citations omitted). Reversal

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on abuse of discretion grounds is not proper “unless [the court]

ha[s] a definite and firm conviction that the bankruptcy court

committed a clear error of judgment in the conclusion it reached

after weighing the relevant factors.” In re Gould, 401 B.R. 415,

429 (9th Cir. BAP 2009) (citation omitted), aff’d on other grounds,

603 F.3d 1100 (9th Cir. 2010). By the same token though, “a

bankruptcy court necessarily abuses its discretion if it bases its

decision on an erroneous view of the law or clearly erroneous

factual findings.” Id. (citation omitted). “Absent such abuse,”

the court “will not set aside the disallowance[,]” or, conversely,

the allowance. See United States v. Carey (In re Wade Cook Fin.

Corp.), 375 B.R. 580, 588 (9th Cir. BAP 2007) (citation omitted).

In according setoffs to defendant, alternatively, the

bankruptcy court relied upon the equitable doctrine of recoupment.

The Trustee did not explicitly address the bankruptcy court’s

reliance upon recoupment. Regardless, as with the decision to

allow setoffs under section 553, a bankruptcy court’s “use” of

recoupment is “reviewed for an abuse of discretion.” Aalfs v.

Wirum (In re Straightline Invs., Inc.), 525 F.3d 870, 882 (9th Cir.

2008) (citations and internal quotation marks omitted). With these

standards of review firmly in mind, the court will examine the

Trustee’s two issues on appeal. 

II. Issues on Appeal

A. Bankruptcy Estate’s Entitlement to Community Property 

Because the bankruptcy court required defendant to turn over

to the Trustee only one half of the community property assets in

his possession, the Trustee charges that court with “confus[ing]

its responsibilities in the bankruptcy proceeding with the

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4 Defendant further contends that the “Trustee has failed to establish

that any marital property in this case falls within § 541(a)(2)(B).” Resp. Br.

(Doc. 8) at 3, § III (A)(1) (emphasis added). The Trustee’s reply brief makes

clear, however, that he is relying only upon section 541(a)(2)(A). Thus, there is

no need for the court to, and it will not, consider the potential applicability of

section 541(a)(2)(B) here.

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responsibilities of the Arizona divorce courts in dissolution

proceedings.” Appellant’s Br. (Doc. 3) at 4:3-5. Essentially the

Trustee contends that the bankruptcy court committed “legal error”

when it relied upon “equitable principals [sic][,]” and “state law

presumptions that apply to the division of community property in a

divorce case” to justify its decision to require the defendant to

“turn over to the trustee only half of the community assets in his

possession[.]” Id. at 5:19; 4:20; 4:22-23; and 5:17-18. 

 Defendant counters that “[a]fter the filing of a petition for

dissolution, Arizona marital property does not fall within” the

ambit of section 541(a)(2)(A).4 Resp. Br. (Doc. 8) at 3. 

Defendant posits that A.R.S. §§ 25-214 and 25-315, “sever[] the

spouse’s rights to independently manage, control and dispose of

community property[.]” Id. at 5. Absent that statutory right to

independently manage and control community property, defendant

asserts that after the filing of a dissolution petition in Arizona,

community property “does not come into the bankruptcy estate under

§541(a)(2)(A).” Id. at 6. 

The Trustee replies, first of all, that the defendant 

waived the “defense” that A.R.S. §§ 25-214(C)(3) and 25-315

“‘sever[ed]’ the community property of the Petersens such that 

the community property which was being litigated before the

bankruptcy court never came ‘into the bankruptcy estate under 11

U.S.C. § 541(a)(2)(A).’” Reply Br. (Doc. 9) at 2:12-15 (quoting

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Resp. Br. (Doc. 8) at 5). That defense has been waived, the

Trustee argues, because it is being raised for the first time on

this appeal. Turning to the merits, the Trust contends that

A.R.S. § 25-214(B), which, inter alia, gives spouses “equal

management, control and disposition rights over their community

property[,]” when read in conjunction with section 541(a)(2)(A),

“make[s] it clear that community property in Arizona is property of

the bankruptcy estate.” Id. at 3:23-24. Lastly, the Trustee

strenuously disagrees with the defendant that he was entitled to

certain setoffs, as the bankruptcy court allowed, as part of an

“equitable distribution of marital assets[.]” See Resp. Br. (Doc.

8) at 8. 1. Waiver

 Preliminarily, the court must address the fact that the

Trustee is raising the waiver argument for the first time in his

reply brief. Ordinarily, that “is improper . . . because the other

party does not have a chance to respond.” See A.D. v. California

Highway Patrol, 2009 WL 733872, at *9 (N.D.Cal. March 17, 2009)

(citing, inter alia, Lentini v. Cal. Ctr. for the Arts, 349 F.3d

608, 614 n.2 (9th Cir. 2003)). In the present case, however, the

Trustee cannot be faulted for not having raised this waiver

argument sooner because, as explained below, the defendant did not

make the argument which the Trustee claims has been waived, until

the filing of the defendant’s response brief on this appeal. 

Moreover, addressing the Trustee’s waiver argument does not result

in any prejudice to the defendant because, as will be seen, the

court finds no waiver here. 

The bankruptcy court did not address defendant’s argument that

he is entitled to one-half of the community property assets because

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in Arizona, “after the petition for dissolution is filed,”

community property “does not come into the bankruptcy estate under

§ 541(a)(2)(A).” Resp. Br. (Doc. 8) at 5-6. Understandably, the

bankruptcy court did not address that argument because, as the

record shows, there is no mention of that argument anywhere in

defendant’s bankruptcy court brief. See R. (Doc. 4-4). 

Consequently, the court could find, as the Trustee maintains, that

the defendant has waived this argument because defendant is making

it for the first time on appeal. See Sigma Micro Corp. v.

Healthcentral.com (In re Healthcentral.com), 504 F.3d 775, 789 (9th

Cir. 2007) (citation omitted) (declining to consider and deeming

“waived” arguments made on appeal which a party did not “assert[]”

before the bankruptcy court, and hence that court did not

consider); see also Levitt v. Levitt, 2007 WL 1651062, at *4

(E.D.Cal. June 5, 2007) (declining to “consider theories asserted

for the first time on appeal” which “were never directly or

properly raised at the bankruptcy court level[]”), aff’d unpub’d

opinion, Levitt v. Maxwell-Stratton, 310 Fed.Appx. 127, 128 (9th

Cir. 2009) (citation omitted) (“district court properly declined to

consider the other issues raised by Mr. Levitt because he did not

raise them before the bankruptcy court[]”). 

As with most legal rules, there are exceptions to the waiver

rule. One exception is that a court may consider an issue raised

for the first time on appeal “when the issue is one of law and does

not depend on the factual record, or the record has been fully

developed.” Countrywide Home Loans, Inc. v. Hoopai (In re Hoopai),

581 F.3d 1090, 1096 (9th Cir. 2009) (citations and internal

quotation marks omitted). Here, the issue of whether the filing of

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a petition for dissolution under Arizona law takes community

property outside the scope of the bankruptcy estate under section

541(a)(2)(A) is one of law. Resolution of that issue involves

primarily statutory interpretation, as the parties argue it. 

There is no need to resort to the factual record or for further

development of that record. Having found that the defendant did

not waive his argument that Arizona domestic relations law removes

community property from the bankruptcy estates as section

541(a)(2)(A) defines it, the court will turn to the merits of that

argument.

2. Merits

When, as in the present case, “a chapter 7 bankruptcy petition

is filed, an estate automatically is created that comprises

essentially all property owned by the debtor.” In re Mwangi, 2010

WL 2723204, at *3 (citing, inter alia, § 541(a)); see also Rooz v.

Kimmel (In re Kimmel), 378 B.R. 630, 638 (9th Cir. BAP 2007) 

(“Section 541 is self effectuating.”) With limited exceptions not

relevant here, that bankruptcy estate includes “all legal or

equitable interests of the debtor in property as of the

commencement of the case.” 11 U.S.C. § 541(a)(1). A bankruptcy

estate under section 541 also includes, among other things, “[a]ll

interests of the debtor and the debtor's spouse in community

property as of the commencement of the case that is– . . . under

the sole, equal or joint management and control of the debtor[.]” 

11 U.S.C. § 541(a)(2)(A). Thus, “[i]n a non-dissolving marriage,

community property is property of the [bankruptcy] estate.” In re

Keller, 185 B.R. 796, 799 (9th Cir. BAP 1995) (citations omitted). 

Likewise, “[w]hen,” as here, “a bankruptcy petition is filed

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prior to the final disposition of property between divorcing

spouses, the community property comes within the jurisdiction of

the bankruptcy court[.]” Id. The underlying rationale is that it

permits the bankruptcy court to “assure fairness to the creditors

of the individual spouses and the marital estate.” Id. Consistent

with the foregoing, the Ninth Circuit recognizes that “[f]or

purposes of § 541(a)(2), all community property not yet divided by

a state court at the time of the bankruptcy filing is property of

the bankruptcy estate.” Dumas v. Mantle (In re Mantle), 153 F.3d

1081, 1085 (9th Cir. 1998); see also In re Bauer, 2005 WL 4705284,

at *3 (Bankr. D. Idaho Aug. 22, 2005) (“In the event a divorce

action is pending, so long as a state court has not yet divided the

couple’s property, all community property of the spouses becomes

property of the bankruptcy estate of the first spouse to file a

petition.”) (citation omitted).

There is no dispute in the present case that the debtor’s

filing of her bankruptcy petition preceded final dissolution of her

marriage to the defendant. There also is no dispute, as the

bankruptcy court pointed out, that “the parties . . . chose to

litigate the issue of the recovery of community property assets by

the bankruptcy estate in th[at] [bankruptcy] [c]ourt.” R. (Doc. 4-

7) at 12:4-5. In fact, the bankruptcy court expressly acknowledged

that “any community property owned by the parties, as of the filing

of the Debtor’s bankruptcy petition, would have become property of

the bankruptcy estate.” R. (Doc. 4-7) at 10:18-20 (citing, inter

alia, In re Kimmel, 378 B.R. 360). 

Despite accurately reciting the applicable rule of law, the

bankruptcy court chose to disregard it. Instead, the bankruptcy

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court relied upon general principles of equitable distribution

under Arizona’s domestic relations law. In so doing, the

bankruptcy court faulted the Trustee for not “present[ing] [any]

evidence which would allow the bankruptcy estate to retain a 100

percent interest in the community assets, when the presumption

under Arizona law is to divide the assets, each spouse to receive

one-half of the value of the community assets.” Id. at 12:21-23. 

Further, the bankruptcy court found that it would be “inequitable

to . . . allow the bankruptcy estate to retain a 100 percent

interest in the community assets.” Id. at 13:2-3. From the

bankruptcy court’s viewpoint, that inequity arose from “the posture

of th[e] case,” in that for “many years . . . the parties have

[been] pursu[ing] their rights and remedies, at the trial-court and

appellate level[.]” Id. at 13:1-2.

In light of the well-settled legal principles outlined above,

however, the court agrees with the Trustee that the bankruptcy

court’s decision to apply Arizona domestic relations law pertaining

to equitable distribution of community property was legal error. 

The bankruptcy court must be “guided by the dictates of the

Bankruptcy Code and not by supposition as to what actions the state

court might have taken to ensure an equitable distribution of

community property between the” debtor and defendant. See In re

Entz, 44 B.R. 483, 484 (Bankr. D. Ariz. 1984). 

Defendant attempts, in two ways, to justify the bankruptcy

court’s erroneous legal conclusion, and refute the Trustee’s

argument that community property is part of the bankruptcy estate

under section 541. First, he argues that the cases to which the

Trustee cites, In re Kimmel, 378 B.R. 630, In re Maynard, 264 B.R.

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209 (9th Cir. BAP 2001); and In re Teel, 34 B.R. 762 (9th Cir. BAP

1983), are distinguishable. In Maynard and Teel, notwithstanding 

pending marital dissolution proceedings, upon the debtor/spouse’s

filing of a bankruptcy petition, the Bankruptcy Appellate Panel

(“BAP”) held that community property, including that of the nondebtor spouse, became part of the bankruptcy estate under section

541. The defendant correctly notes that as a basis for bringing

the non-debtor spouse’s community property within the bankruptcy

estate under section 541, in both Teel and Maynard the BAP did rely

upon California statutes providing that each spouse has equal

rights of management and control of community property. See Teel,

34 B.R. at 765 (citations omitted); See Maynard, 264 B.R. at 214

(citation omitted). Defendant unsuccessfully attempts to

distinguish those cases from the present one because the courts

relied upon California community property law, which defendant

baldly asserts “differ[s]” from Arizona law. See Resp. Br. (Doc.

8) at 4. 

California and Arizona law are nearly identical on the

fundamental issue of spousal control over community property

though. As in California, in Arizona “[t]he spouses have equal

management, control and disposition rights over their community

property[.]” A.R.S. § 25-214(B). Moreover, the Ninth Circuit BAP

has expressly recognized that “[t]he jurisdiction of the bankruptcy

court is exclusive because the initiation of divorce or dissolution

proceedings does not terminate either spouses [sic] management and

control over community property by placing the community property

in custodia legis of the divorce court.” In re Keller, 185 B.R. at

799 (citations and internal quotation marks omitted). 

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Consequently, there is no merit to defendant’s suggestion that this

court should disregard Teel and Maynard because those cases “arise

out of California.” See Resp. Br. (Doc. 8) at 4. 

Similarly unavailing is defendant’s argument that A.R.S. 

§§ 25-214(C)(3) and 25-315 “sever[] the spouse’s rights to

independently manage, control and dispose of community property[]”

so that “after the petition for dissolution is filed” in Arizona,

community property “does not come into the bankruptcy estate under

§ 541(a)(2)(A).” See id. at 5 and 6. Section 25-214(C)(3) does

limit a spouse’s ability to “bind the community . . . after service

of a petition for dissolution . . . if th[at] petition results in a

decree of dissolution[.]” A.R.S. § 25-214(C)(3). Further, A.R.S. 

§ 25-315 authorizes entry of a “temporary order or preliminary

injunction” in dissolution proceedings which prohibits, inter alia,

both spouses from “transferring, encumbering, concealing, selling

or otherwise disposing of any of the . . . , community property of

the parties.” A.R.S. § 25-315(A)(1)(a). Nothing in the plain

language of those statutes supports defendant’s interpretation that

they take community property outside the ambit of the bankruptcy

estate under section 541, however. 

Despite defendant’s assertion to the contrary, A.R.S. §§ 25-

214(C)(3) and 25-315 do not “sever[],” “divest[],” Resp. Br. (Doc.

8) at 5, or in any way impair, impede or defeat the “equal

management and control” which A.R.S. § 25-214(B) explicitly allows. 

In fact, one bankruptcy court within this District has found that

sections 541(a)(2)(A) and (B) “are generally satisfied with respect

to Arizona community property,” and hence “‘the community property

of both spouses becomes property of the estate when one spouse

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files a bankruptcy petition.’” In re Monroe, 282 B.R. 219, 222

(Bankr. D. Ariz. 2002) (quoting Maynard, 264 B.R. at 214). 

That is certainly the case here. A plain reading of section

541 of the Code and A.R.S. § 25-214(B) readily shows, as discussed

earlier, that in the present case, the bankruptcy estate includes

defendant’s interests in community property as of the date the

debtor filed her chapter 7 bankruptcy petition, i.e., February 8,

2002. Moreover, even if there is a conflict between Arizona law

regarding division of community property and the Bankruptcy Code,

the latter would “control under the supremacy clause, Article VI,

Clause 2, of the United States Constitution.” See Teel, 34 B.R. at

764 (citations omitted). 

As the foregoing discussion shows, the bankruptcy court erred

in “award[ing] [defendant] a one-half interest in th[e] community

property[,]” and in holding that “the bankruptcy estate has an

interest in the community property equal to one-half of

$110,881.34, or the amount of $55,440.62.” See R. (Doc. 4-7) at

18:2-4. Hence, this court vacates that aspect of the bankruptcy

court’s decision finding that “the bankruptcy estate has an

interest in the community property equal to one-half of

$110.881.32, or the amount of $55,440.62.” See id. at 18:3-4. 

B. “Setoffs”

Next, the court will address the Trustee’s argument that

contrary to the bankruptcy court’s holding, “the defendant is not

entitled to ‘offsets’ against [the bankruptcy] estate property.” 

Appellant’s Br. (Doc. 3) at 5:22-23 (emphasis omitted). The

bankruptcy court held that defendant “shall receive” $27,412.50 in

setoffs against the amount that it held defendant “still owed . . .

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to the bankruptcy estate.” R. (Doc. 4-7) at 18:5; and 18:15-16. 

Pursuant to section 553 of the Code, the bankruptcy court found

that defendant was entitled to setoffs totaling $27,412.50. 

Alternatively, the bankruptcy court relied upon the equitable

doctrine of recoupment as a “legal theory” for allowing setoffs in

that amount. See id. at 16:8-9. The bankruptcy court arrived at

that $27,412.50 figure based upon the following undisputed facts. 

First, the bankruptcy court allowed defendant a setoff of

$24,000.00, representing one-half of his interest in the total

proceeds ($48,000.00) from the sale of debtor’s insurance business. 

Id. at 4:6-9 (footnote omitted). Debtor started that business

during her marriage to defendant. Id. at 4:6-7. The court

observes, as did the bankruptcy court, that “[t]he parties have not

questioned this factual finding.” See id. at 4:25-26, n. 12. 

The second setoff which the bankruptcy court allowed is based

upon a pre-petition state court order of distribution of community

funds. Defendant presented evidence that on June 25, 2000, he paid

debtor $2,000.00 of the $4,000.00 which the state court had

previously ordered him to pay her. See id. at 5:6-7 (footnote

omitted). However, because defendant “was only able to show that

he paid $2,000 of th[at] $4,000[,]” the bankruptcy court permitted

him a setoff of “only . . . $2,000.00.” Id. at 5:13-15. 

Third, despite proof before the bankruptcy court that the

“Debtor withdrew funds [in the amount of $2,825.00] from [a]

deposit account just prior to commencing the domestic relations

proceedings against [defendant][,]” the bankruptcy court found that

the defendant did not provide “the requisite evidence that the

funds in that account were . . . his sole and separate property.” 

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Id. at 5:20-21 (footnote omitted); and 6:2-3. Further, the

bankruptcy court stressed that the state court “[m]inute [e]ntry

reflects that th[at] . . . Court believed that whatever funds were

left in the deposit account were community funds, since it ordered

. . . [defendant] [to] provide one-half of the funds on deposit to

the Debtor.” Id. at 6:4-6 (footnote omitted). Thus, “[g]iven the

timing of the Debtor’s withdrawal of the funds and the apparent

lack of notice of such action by the [State] Court[,]” the

bankruptcy court “allow[ed] [defendant] a credit for one-half of

the funds that the Debtor withdrew just prior to the divorce

proceedings[,]” i.e., $1,412.50. Id. at 6:6-9 (footnote omitted). 

The Trustee contends that the bankruptcy court’s setoff

“analysis was fundamentally flawed[]” because from his perspective

“[t]his case is not about a right of setoff under 11 U.S.C. § 533.” 

Appellant’s Br. (Doc. 3) at 6:4 and 7:24. So instead of discussing

the bankruptcy court’s section 553 analysis, the Trustee singularly

focused on what he contends was the sole issue for the bankruptcy

court – “to determine the community assets [which] existed on the

date of the bankruptcy filing.” Id. at 6:18-19. Because the

parties stipulated and the bankruptcy court found that those assets

totaled $110,881.34, the Trustee argues that “[t]h[at] . . . court

improperly allowed the Defendant to offset his ‘divorce court’

claims against estate property.” Id. at 8:9-10. In sum, the

Trustee strenuously maintains that the entire $110,881.34 should be

turned over to the bankruptcy estate. Therefore, he is seeking an

order to set aside the judgment and to “remand this matter . . .

with instructions to deny the offsets asserted by the Defendant.” 

Id. at 8:11-12. 

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Somewhat surprisingly, the defendant did not adopt one or both

of the bankruptcy court’s reasons - section 553 or recoupment – for

allowing him $27,412.50 in setoffs. Rather, without offering any

legal support, the defendant maintains that “the Bankruptcy Court

was to apportion and recover the bankruptcy estate’s interest in

the parties’ community assets[]” in accordance with state law. See

Resp. Br. (Doc. 8) at 8. That task of “equitable distribution”

fell to the bankruptcy court, explains defendant, because it “had

not been completed by the state court[.]” Id. Defendant contends

that adopting the Trustee’s position would impermissibly “tie the

hands of the Bankruptcy Court . . . forc[ing] a decision for

turnover without consider[ing] the parties’ relative rights and the

equities of the case.” Id. at 9. Thus, the defendant seeks to

have this court affirm the judgment of the bankruptcy court, which

allowed him certain setoffs. 

 Disagreeing with the defendant’s apportionment theory, the

Trustee emphasizes that the plain language of section 541(a)(2)(A)

provides in relevant part that “‘all interests of the debtor and

the debtor’s spouse in community property’ is property of the

bankruptcy estate.” Reply Br. (Doc. 9) at 11-13 (emphasis added by

Trustee) (quoting 11 U.S.C. § 541(a)(2)(A)). After “identify[ing]

[the] community property,” which the bankruptcy court did, the

Trustee asserts that pursuant to section 541(a)(2)(A), all of that

property became part of the bankruptcy estate, i.e., $110,881.34,

and should be turned over to him in accordance with section 542 of

the Code. Id. at 6:5. The Trustee is adamant that the defendant

“does not get to keep all or some portion of that property ahead of

creditors.” Id. at 6:7-8. 

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5 Despite sometimes being used interchangeably, recoupment and section

553 of the Code are two distinct, albeit related, concepts. Thus, a party “is

allowed to assert that certain mutual claims extinguish one another . . . in spite

of the fact that they could not be ‘setoff’ under 11 U.S.C. § 553.” Madigan, 270

B.R. at 754 (citation and internal quotation marks omitted). 

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Perhaps because he realizes the futility of arguing that the

bankruptcy court erred in applying the doctrine of recoupment here,

the Trustee does not mention that doctrine anywhere in his appeal. 

Similarly, the defendant did not mention recoupment, as noted

earlier. Nonetheless, given the Trustee’s broad assertion that

“[t]he offset is unsupportable under bankruptcy law[,]” Reply Br.

(Doc. 9) at 5:17 (emphasis omitted), and because recoupment has

been “preserved through judicial decisions” in the bankruptcy

context, Aetna U.S. Healthcare, Inc. v. Madigan (In re Madigan),

270 B.R. 749, 753 (B.A.P. 9th Cir. 2001), the court will consider

whether the bankruptcy court properly relied upon recoupment as a

basis for allowing $27,412.50 in setoffs to defendant. 

Assuming arguendo that setoff pursuant to section 553 is not

available to defendant,5 this court will consider whether, as the

bankruptcy court found, the defendant should be allowed setoffs

based upon the doctrine of recoupment. Before turning to the

merits of that court’s recoupment analysis, there is a preliminary

procedural issue which this court must address. “Under recoupment,

a defendant may meet a plaintiff’s claim with a countervailing

claim that arose out of the same occurrence or transaction as the

plaintiff’s claim.” Wade Cook, 375 B.R. at 601 (citation omitted). 

“For this reason, recoupment has been analogized to both compulsory

counterclaims and affirmative defenses.” Id. (citations and

internal quotation marks omitted). 

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In the present case, defendant did assert a counterclaim in

his answer to the Trustee’s complaint. Defendant couches that

counterclaim as one for “setoff[,]” but he does not mention section

553; nor does he mention recoupment as a possible basis for that

counterclaim. See Answer (Doc. 3-2) at 2:9. Federal Rules of

Civil Procedure 13(a), governing compulsory counterclaims,

“requires the defendant to assert a counterclaim in its responsive

pleading or otherwise lose that counterclaim forever.” Wade Cook,

375 B.R. at 601 (citation omitted) (emphasis added). 

Bankruptcy Rule 7013 “incorporates” Fed. R. Civ. P. 13(a)

“with a few variations[]” however. Id. (citation omitted). Of

particular importance here is that “Rule 7013 differs from FRCP

13(a) in that “a party sued by a trustee or debtor in possession

need not state as a counterclaim any claim that the party has

against the debtor, the debtor's property, or the estate, unless

the claim arose after the entry of an order for relief.” Id.

(emphasis added) (internal quotation marks and citations omitted). 

“Thus, if a trustee initiates an adversary proceeding against a

creditor, who has a prepetition claim against the debtor, that

creditor does not need to assert that claim as a counterclaim in

its answer to the trustee's complaint.” Id. (citation omitted). 

Obviously, in the present case the Trustee initiated an

adversary proceeding against defendant. Further, given the Code’s

broad definition of a creditor, it is equally clear that the

Trustee is pursuing this action against defendant as a creditor. 

Pursuant to the Code, a creditor is an “entity that has a claim

against the debtor that arose at the time of or before the order

for relief concerning the debtor[.]” 11 U.S.C. § 101(10)(A)

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(emphasis added). In turn, the Code defines the term entity to

“include[] [a] person[.]” 11 U.S.C. § 101(15). Pursuant to the

Code, “[t]he term ‘claim’ means – right to payment, whether or not

such right is reduced to judgment, liquidated, unliquidated, fixed,

contingent, mature, unmatured, disputed, undisputed, legal,

equitable, secured, or unsecured[.]” 11 U.S.C. §101(5)(A). Indeed,

the “breadth of th[a]t definition ensures that all legal

obligations of the debtor, no matter how remote or contingent will

be able to be dealt with in the bankruptcy case.” Heilman, 430

B.R. at 218 n. 7 (citations and internal quotation marks omitted). 

In his counterclaim defendant asserts, inter alia, a “right to

receive half of the proceeds from the sale of debtor’s business, a

community property asset, believed to be worth $24,000.00.” Answer

(Doc. 3-2) at 2:13-14. As already discussed, that asserted “right”

is based upon 2000 state court divorce proceedings. Therefore,

that “right” arose pre-petition. Thus, because defendant has a

pre-petition claim against the debtor, the fact that he did not

explicitly assert recoupment in his counterclaim does not preclude

him from obtaining relief under that doctrine if he is otherwise

entitled. Similarly, the fact that defendant did not specifically

mention the $2,000 “Deposit Account Credit” and the $1,412.50

“Credit for one-half the amount withdrawn by Debtor at [the] time

of [the] divorce proceedings[,]” does not preclude him from

asserting a counterclaim based upon those claimed “credits.” See

R. (Doc. 4-7) at 18:8-11. 

Lastly, recognizing that “[u]nder the Federal Rules of Civil

Procedure and Bankruptcy Rules, all pleadings are to be construed

so as to do substantial justice[,]” In re California Canners and

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Growers, 62 B.R. 18, 22 (9th Cir. BAP 1986) (Elliott, J.,

concurring) (citation omitted), defendant’s failure to explicitly

refer to recoupment in its counterclaim is not a sufficient reason

for the court to disregard that theory. See id. (citations

omitted) (whether recoupment is “viewed as an affirmative defense

or a counterclaim, . . . [d]istributors[’] failure to label their

well pleaded claim as a ‘recoupment’ was an insufficient reason for

the court to ignore the argument[]”). Having found that there is

no procedural bar to recoupment, the court will turn to the issue

of whether the bankruptcy court properly invoked that doctrine

here.

 “Recoupment is an equitable doctrine, similar to setoff, that

has been recognized in bankruptcy proceedings.” In re Miller, 2009

WL 2868441, at *5 (Bankr. D. Idaho Aug. 28, 2009) (citing Sims v.

U.S. Dept. of Health and Human Servs. (In re TLC Hosps. Inc.), 224

F.3d at 1001). Basically, recoupment “involves a netting out of

debt arising from a single transaction.” Straightline, 525 F.3d at

882 (citation and internal quotations omitted). In other words, 

“recoupment is the setting up of a demand arising from the same

transaction as the plaintiff’s claim or cause of action, strictly

for the purpose of abatement or reduction of such claim.” Wade

Cook, 375 B.R. at 600 (citations and internal quotation marks

omitted) (emphasis in original). Thus, recoupment is “only a

challenge to the validity and extent of the plaintiff’s claim, and

no affirmative recovery is permitted.” In re Conrad, 2007 WL

3273441, at *4 (Bankr. W.D. Wash. Nov. 2, 2007) (citations and

internal quotation marks omitted). The underlying theory of 

recoupment is that “‘the defendant should be entitled to show that

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because of matters arising out of the transaction sued on, he or

she is not liable in full for the plaintiff’s claim.’” Newbery, 95

F.3d at 1401 (quoting Collier ¶ 553.03, at 553-17)). In this

respect, “[t]he common-law claim for recoupment is analogous to a

compulsory counterclaim interposed solely to defeat or diminish

plaintiff’s recovery.” Madigan, 270 B.R. at 755 (citation and

internal quotation marks omitted). 

In the Ninth Circuit, “[f]or recoupment to apply, the

competing claims must arise out of the same transaction or

occurrence.” In re Coast Grain Co., 317 B.R. 796, 807 (Bankr.

E.D.Cal. 2004) (citations and internal quotation marks omitted). 

“[T]he crucial factor in determining whether two events are part of

the same transaction[,]” according to the Ninth Circuit, is whether

there “is [a] ‘logical relationship’ between the two.” TLC Hosps.,

224 F.3d at 1012 (citation omitted). “The word ‘transaction’ is

given both a liberal and flexible construction[]” under that

standard. Conrad, 2007 WL 3273441, at *5 (citing Madigan, 270 B.R.

at 755). Consequently, “a ‘transaction’ may include ‘a series of

many occurrences, depending not so much upon the immediateness of

their connection as upon their logical relationship.’” TLC Hosps.,

224 F.3d at 1012 (quoting Moore v. New York Cotton Exch., 270 U.S.

593, 610, 46 S.Ct. 367, 70 L.Ed. 750 (1926)). Therefore, “[c]ourts

applying this standard ‘have permitted a variety of obligations to

be recouped against each other, requiring only that the obligations

be sufficiently interconnected so that it would be unjust to insist

that one party fulfill its obligation without requiring the same of

the other party.’” In re Coast Grain Co., 317 B.R. at 807 (quoting

Madigan, 270 B.R. at 755 (other citation omitted)). So although

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“[r]ecoupment often arises in contract cases, it is not limited to

contractual obligations, nor must the amount to be recouped be

liquidated in order for the right to apply.” Id. at 806 (emphasis

added). 

“The recoupment doctrine draws its authority from principles

of equity[,]” as stated at the outset, “and is thereby subject to

the facts in each individual case.” Coast Grain, 317 B.R. at 807. 

In this case, applying the “logical relationship” test, the

bankruptcy court made several factual findings. First, it found

that “the Debtor filed for a dissolution of marriage, but then

waited almost two years before filing her bankruptcy petition.” 

R. (Doc. 407) at 17:7-8. Second, the bankruptcy court found that

during that interim “the Superior Court entered various orders[,]”

including some pertaining to the distribution of community assets. 

Id. at 17:8-9. Also during that interim period, debtor and

defendant “continued to hold community and separate property

acquired before marriage and after the petition for dissolution was

filed.” Id. at 17:11-13. Based upon the foregoing, the bankruptcy

court reasoned that “this matter should be treated as if the

parties were engaged in one transaction, with the various expenses

of the Defendant to be netted from the final amount that he must

pay the bankruptcy estate.” Id. at 17:13-15. Thus, despite using

the terms “credits and setoffs[,]” the bankruptcy court effectively

held that defendant was entitled to recoup a total of $27,412.50

from the amount that court found he still owes the bankruptcy

estate. See id. at 18:5-16. 

After undertaking the requisite de novo review, this court

affirms the bankruptcy court’s use of the recoupment doctrine. 

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There is ample support in the record for the bankruptcy court’s

factual findings in that regard, and the Trustee does not suggest

otherwise. Plainly, those factual findings are not clearly

erroneous. 

Additionally, the bankruptcy court soundly found that there is

a logical relationship between the debtor’s bankruptcy and the

debtor and defendant’s divorce proceeding, so as to justify

allowing defendant to recoup certain monies. Clearly, the debtor’s

and defendant’s state court imposed obligations logically relate to

their obligations arising from debtor’s subsequent bankruptcy

petition. Those mutual obligations are “sufficiently

interconnected so that it would be unjust to insist that one party

fulfill its obligation without requiring the same of the other

party.” See Madigan, 270 B.R. at 755 (citation omitted). More

specifically, it would be unjust to insist that the defendant

fulfill his obligation to turn over all community property in his

possession to the bankruptcy estate without also recognizing that

the state court previously determined that debtor was required to

“turn over” certain community property assets to defendant, i.e., 

half the proceeds from the sale of debtor’s business. 

Moreover, the bankruptcy court did not abuse its discretion in

applying the doctrine of recoupment to the facts before it. This

court cannot reverse on abuse of discretion grounds, as earlier

discussed, “unless [it] ha[s] a definite and firm conviction that

the bankruptcy court committed a clear error of judgment in the

conclusion it reached after weighing the relevant factors.” In re

Gould, 401 B.R. at 429 (citation omitted). There is simply no

basis for finding that the bankruptcy court abused its discretion

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in allowing recoupment here. 

The court is keenly aware that recoupment is only available

when the equities of the situation permit it. See Straightline,

525 F.3d at 882. Those equities, as discussed herein, readily

support that court’s conclusion that defendant be allowed to recoup

$27,412.50 from the amount which he still owes the bankruptcy

estate. Indeed, it would be inherently inequitable to require that

all community property here become part of the bankruptcy estate,

including that of the non-debtor/defendant spouse, while

simultaneously disallowing him to recoup monies which the state

court previously found he was entitled to during debtor’s divorce

from defendant. 

Several other aspects of recoupment convince this court of the

propriety of relying upon the recoupment doctrine under the

somewhat unique facts of the present case. The first is that

because “recoupment is neither a claim nor a debt, it is unaffected

by either the automatic stay or the debtor’s discharge.” Madigan,

270 B.R. at 754 (citations omitted). So, despite the Trustee’s

suggestion to the contrary, the debtor’s discharge does not mean

that defendant’s “setoffs or claim would have been discharged as

well.” See R. (Doc. 4-7) at 13:16. Additionally, allowing

defendant to recoup certain monies is in keeping with the settled

rule that “[t]he bankruptcy trustee takes property subject to the

rights of recoupment.” See Madigan, 270 B.R. at 754 (citations

omitted) (emphasis added). Lastly, because defendant is recouping

some community property assets, which were divided by the state

court prior to the filing of debtor’s bankruptcy petition, those

assets are not part of the bankruptcy estate for purposes of

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section 541(a)(2) of the Code. See In re Mantle, 153 F.3d at 1085. 

In sum, allowing recoupment here, as did the bankruptcy court,

clearly serves the purpose of that doctrine “which is to do justice

viewing one transaction as a whole.” See In re National Audit

Defense Network, 332 B.R. 896, 913 (Bankr. D. Nev. 2005) (citations

and internal quotation marks omitted). The court thus affirms that

aspect of the bankruptcy court’s decision allowing defendant to

recoup $27,412.50 from the amount he still owes the bankruptcy

estate. 

For all of these reasons, although this court AFFIRMS the

bankruptcy court’s decision allowing defendant to recoup

$27,412.50, it REVERSES and VACATES that decision insofar as that

court awarded defendant a one-half interest in the community

property. As explained herein, the bankruptcy estate is entitled

to 100 percent of the community property, $110,881.34, in

defendant’s possession at the filing of debtor’s bankruptcy

petition. The bankruptcy court is thus ordered to vacate its prior

judgment and enter judgment in accordance herewith. 

DATED this 27th day of September, 2010.

Copies to counsel of record

Case 2:09-cv-01600-RCB Document 11 Filed 09/27/10 Page 28 of 28