1998 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

1-20-1998

In Re: Continental

Precedential or Non-Precedential:

Docket 97-7109

Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_1998

This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova

University School of Law Digital Repository. It has been accepted for inclusion in 1998 Decisions by an authorized administrator of Villanova

University School of Law Digital Repository. For more information, please contact Benjamin.Carlson@law.villanova.edu.

Recommended Citation

"In Re: Continental" (1998). 1998 Decisions. Paper 15.

http://digitalcommons.law.villanova.edu/thirdcircuit_1998/15
Filed January 20, 1998 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

No. 97-7109 

IN RE: CONTINENTAL AIRLINES, 

 Debtor 

UNITED STATES OF AMERICA, 

 Appellant 

v. 

CONTINENTAL AIRLINES 

 THOMAS E. ROSS, 

 Trustee 

An Appeal from the United States District Court 

for the District of Delaware 

Civil Action No. 93-cv-00485 

Argued December 2, 1997 

Before: COWEN, McKEE and ROSENN, Circuit Judges. 

(Opinion Filed January 20, 1998) 

 Robert M. Loeb (Argued) 

 Room 3617 Main 

 United States Department of Justice 

 Civil Division, Appellate Staff 

 10th & Pennsylvania Avenue, N.W. 

 Washington, D.C. 20530-0001 

 Counsel for Appellant 
 Gordon B. Conn, Jr. (Argued) 

 Laura D. Jones 

 Robert S. Brady 

 Young, Conaway, Stargatt & Taylor 

 P.O. Box 391 

 Rodney Square North, 11th Floor 

 Wilmington, DE 19899-0391 

 Counsel for Appellee 

OPINION OF THE COURT 

ROSENN, Circuit Judge. 

This appeal presents an issue pertaining to the right of 

set-off by a pre-bankruptcy creditor after a plan of 

reorganization has been approved by the bankruptcy court. 

Continental Airlines and its affiliates (Continental or 

Debtors) filed petitions for reorganization under Chapter 11 

of the Bankruptcy Code. In April, 1990, the Bankruptcy 

Court confirmed the Debtors' Joint Plan of Reorganization. 

In addition to ten federal government agencies that had 

timely filed proofs of claim, the General Services 

Administration of the United States (GSA or Government) 

filed an amended proof of claim on May 25, 1993, after the 

confirmation of the plan, and specifically asserted a right of 

set-off for the first time. The Bankruptcy Court held that 

the Government could not exercise set-off rights with 

respect to $4.8 million due the Debtor and ordered it to pay 

the sum to the Debtors. The Government appealed to the 

United States District Court for the District of Delaware 

which affirmed. The Government then timely appealed to 

this court.1 We also affirm. 

_________________________________________________________________ 

1. The bankruptcy court had jurisdiction over this matter pursuant to 28 

U.S.C. S 157(b). The district court had jurisdiction to review the 

bankruptcy court's decision pursuant to 28 U.S.C.S 158(a). This Court 

has appellate jurisdiction of the district court's order pursuant to 28 

U.S.C. S 1291. 

 2 
I. 

On December 3, 1990, Continental filed for Chapter 11 

reorganization in the United States Bankruptcy Court for 

the District of Delaware. Subsequently, each of ten agencies 

of the United States Government filed separate proofs of 

claim with the bankruptcy court for monies owed to them 

by Continental, which in aggregate totaled approximately 

$14.5 million. Continental submitted its revisedfinal 

reorganization plan to the bankruptcy court on January 13, 

1993. Although the court resolved several objections by the 

various agencies to Continental's proposed plan, no

government agency sought to amend its proofs of claim to 

assert any additional claims, including a right to set-off the 

$4.8 million owed by GSA. Accordingly, the bankruptcy 

court entered its order confirming the plan on April 16, 

1993 without any objection from the Government. 

Under the confirmed plan, the federal agencies were

treated as general unsecured creditors, and were entitled to 

recover approximately 4.8% of their total claims. The 

Government did not appeal the confirmation order. 

Meanwhile, in August 1992, in a suit unrelated to 

Continental's bankruptcy petition, the United States 

District Court for the District of Columbia ordered GSA to 

return money it had wrongfully withheld from several 

airlines, including approximately $4.8 million withheld from 

Continental.2 The Government sought a stay of the district 

court's order in the United States Court of Appeals for the 

Federal Circuit. On April 12, 1993, the Federal Circuit 

issued an order denying the Government's request for a 

stay, but instead permitted it to deposit the disputed sum 

into the registry of the bankruptcy court while the

Government attempted to set-off the $4.8 million it owed 

against the $14.5 million in claims due its agencies. 

Subsequently, on May 28, 1993, the GSA filed a motion 

with the bankruptcy court seeking to set-off its claim 

against the funds deposited in the bankruptcy court's 

registry. On September 30, 1993, the bankruptcy court 

_________________________________________________________________ 

2. Alaska Airlines, Inc. v. Austin, 801 F. Supp. 760 (D. D.C. 1992). The 

facts of Alaska Airlines, Inc. v. Austin are not relevant to the issues 

raised on this appeal. 

 3 
denied the Government's motion, ruling that the 

Government could not exercise its set-off rights with 

respect to the $4.8 million and ordered it to pay the money 

to the Debtor. After the Government appealed, the District 

Court for the District of Delaware affirmed the bankruptcy 

court's ruling. 

II. 

This Court's review of a district court's disposition of a 

bankruptcy appeal is plenary. The Court of Appeals 

exercises "the same review of the district court's decision as 

that exercised by the district court. The bankruptcy court's 

findings of fact are reviewable only for clear error. Legal 

determinations are subject to plenary review." In re 

Continental Airlines, 125 F.3d 120, 128 (3d Cir. 1997) 

(internal citations omitted); accord In re Engel, 124 F.3d 

567, 571 (3d Cir. 1997). 

The Government argues that the $4.8 million it deposited 

into the registry of the bankruptcy court and which the 

Government alleged it was entitled to set-off3 against the 

$14.5 million owed by Continental were not "property of 

the [bankruptcy] estate." The Government contends that 

the bankruptcy court's confirmation of Continental's 

reorganization plan did not extinguish its right of set-off 

vis-a-vis the $4.8 million held in the court's registry.4 The 

Government principally bases its argument on Citizens 

Bank of Maryland v. Strumpf, 116 S. Ct. 286 (1995), which 

it argues overrules this Court's holding in United States v. 

_________________________________________________________________ 

3. 11 U.S.C. S 553 which governs set-offs does not define the term. The 

right of set-off, as generally understood, simply means that "the debts of 

two persons who are mutually indebted may be set off against each 

other." Brian A. Blum, Bankruptcy and Debtor/Creditor S 22.2, at 348 

(1993). "Its central premise is an ancient one well-grounded in practical 

logic: If A is indebted to B, and B is likewise indebted to A, it makes 

sense simply to apply one debt in satisfaction of the other rather than 

require A and B to satisfy their mutual liabilities separately." 5 Collier 

on 

Bankruptcy P 553.01 (Lawrence P. King ed., 15th rev. ed. 1997). 

4. For purposes of this discussion it is unnecessary to determine 

whether the Government did have a valid right of set-off; thus, the right 

will be assumed. 

 4 
Norton, 717 F.2d 767 (3d Cir. 1983), heavily relied on by 

the bankruptcy court and the district court. 

Norton held that a creditor's withholding of funds subject 

to a set-off violated the Bankruptcy Code's automatic stay 

provision,5 and also adopted the viewpoint that set-off is 

not permitted after confirmation of a bankruptcy plan of 

reorganization. In Norton, under facts similar to those 

presented on this appeal, this court held that the 

Government could not offset an outstanding tax refund 

against an outstanding tax liability after confirmation of the 

debtor's plan. In their plan, as here, the debtors made no 

provision for set-off. Emphasizing that the Government 

never objected to the plan, we concluded that it would be 

unreasonable for the Government to retain the tax refund 

as security for the debtors' obligation. Instead, we require 

the Government to pay over the refund and accept 

treatment under the plan as an unsecured creditor. 

The Government primarily contends that this case is

closely analogous to and governed by the recent decision of 

the United States Supreme Court in Strumpf and thus is 

not controlled by Norton. In Strumpf, the Supreme Court 

merely held that a bank's pre-confirmation temporary 

withholding of a debt that it owed a depositor who was in 

bankruptcy, in order to protect its set-off rights, did not 

violate the automatic stay. The Court explained that the 

bank's "temporary refusal to pay was neither a taking of 

possession of [the depositor/debtor's] property nor an 

exercising of control over it, but merely a refusal to perform 

its promise." Id. at 290. Norton, therefore, is only 

overturned to the extent that it held that "state law . . . 

determine[s] when a set-off has occurred." 717 F.2d at 772 

(emphasis added). Today, under Strumpf,"the question 

whether a set-off . . . has occurred is [now] a matter of 

federal law;" a bank's temporary withholding of funds on 

_________________________________________________________________ 

5. The automatic stay, 11 U.S.C. S 362(a), is "an injunction that arises 

by 

operation of law immediately upon the commencement of the bankruptcy 

case. . . . Its effect is to impose a wide-ranging prohibition on all 

activity 

outside the bankruptcy forum to collect pre-petition debts from the 

debtor or to assert or enforce claims against the debtor's pre-petition 

property or estate property." Blum, Bankruptcy and Debtor/Creditor 

S 16.1, at 231. 

 5 
deposit subject to a set-off does not violate the automatic 

stay. 116 S. Ct. at 289 (emphasis added). The 

Government's position, in this case, mischaracterizes and 

overemphasizes both the relevance and importance of

Strumpf. It reaches this conclusion by incorrectly arguing 

that pursuant to Strumpf, because the $4.8 million was still 

held in the registry of the court at the time Continental's 

reorganization plan was confirmed, "the funds plainly were 

not `property of the estate' at that time." Thus, the 

Government's argument continues, when the court 

confirmed the plan, the funds did not vest "free and clear" 

in Continental as property of the bankruptcy estate. 

Building on this premise, the Government concludes that 

the April 16, 1993 confirmation of Continental's plan did 

not extinguish GSA's right to set-off the $4.8 million owed 

to Continental against its $14.5 million in claims due its 

agencies. 

As Continental points out, however, the Supreme Court 

in Strumpf expressly refused to address the issue of the 

effect of confirmation on set-offs, which is dispositive to the 

resolution of this appeal. In a footnote in Strumpf, the 

Supreme Court unequivocally "decline[d] to address [the] 

contention . . . that the confirmation of [a bankruptcy 

reorganization plan] preclude[s] [the] exercise of [a] set-off 

right." 116 S. Ct. at 290 n.**. This case, therefore, is not 

controlled by Strumpf because the Government here filed its 

motion to exercise its alleged set-off in the bankruptcy 

court almost six weeks after confirmation of Continental's 

reorganization plan (and over nine months after the district 

court held the Government liable to Continental for the 

$4.8 million in the Alaska Airlines case). 

Finally, the Government's contention that the Norton 

court "incorrectly considered the funds held by the creditor 

to be property of the estate" which led to its"erroneous 

ruling that confirmation of the plan extinguishes a

creditor's set-off rights" is without merit. (citing 11 U.S.C. 

SS 1141(b), 1327 and Norton, 717 at 774). The 

Government's argument makes two critical mistakes and 

thus misses the cumulative effect of the Norton and Strumpf 

holdings. First, although Norton implicitly held that the 

funds withheld by the creditor subject to set-off were 

 6 
"property of the estate," today under Strumpf, the relevant 

"property of the estate" is instead the bankrupt debtor's 

claim to the funds as opposed to the possession of the 

physical funds themselves. 

Second, the relevant funds at issue in this case are 

clearly distinguishable from those in both Norton and 

Strumpf. In both of those cases, the creditor retained 

possession of the funds; here the Government deposited the 

$4.8 million into the registry of the court pending an 

appeal. As this Court has noted, such deposits are 

comparable to the res of a trust. The "court acts as trustee 

and is charged with the duty of determining the 

beneficiaries pursuant to the appeal. . . . [T]he 

[Government] has no beneficial interest (in the deposit[ ]) 

[while the court] holds the money as . . . trustee for the 

rightful owners when and if they are determined by the 

court." Mid-Jersey Nat'l Bank v. Fidelity-Mortgage Investors, 

518 F.2d 640, 643-44 (3d Cir. 1975). Thus, contrary to the 

Government's assertion, its set-off rights in the funds did 

not remain unaffected by confirmation of the plan because 

the Government no longer retained an interest in them; 

under Norton, its set-off right was extinguished by the 

confirmation of the plan. Although the actual funds

themselves may not have passed as property of the estate, 

upon confirmation of the plan, Continental did acquire a 

claim or interest in them subject only to final resolution of 

the Government's appeal. Norton continues to have vitality 

and survives Strumpf. 

The Government argues before us, however, that to the 

extent that Norton may control and hold that the 

confirmation of the plan extinguishes all set-off rights not 

provided for in the plan, it was wrongly decided. The 

Government asserts that the Bankruptcy Code's set-off 

provision in S 553 states in the clearest of terms that the 

rest of the Bankruptcy Code "does not affect" a creditor's 

right to set-off provided that the obligations between 

creditor and debtor are mutual and that both obligations 

arose prior to the commencement of the reorganization 

proceedings. Relying on 11 U.S.C. S 553(a), the 

Government, in effect, maintains that a pre-petition 

creditor's right to set-off may be exercised without regard to 

 7 
the status of the bankruptcy proceedings and the 

confirmation of the debtor's reorganization plan. The 

Government argues that In re De Laurentiis Entertainment 

Group, Inc., 963 F.2d 1269 (9th Cir. 1992), supports its 

position. In De Laurentiis, the court considered the tension 

between 11 U.S.C. S 553 and 11 U.S.C. S 1141 of the

Bankruptcy Code. Section 1141 provides for the discharge 

of pre-petition debts after completion of a bankruptcy 

proceeding.6 It also provides that any assets retained under 

the administration of reorganization are free and clear of 

any pre-petition debts. 11 U.S.C. S 5537 protects the right 

of a creditor to offset a mutual debt. After analyzing the 

statutory sections and the applicable cases in other 

jurisdictions, the De Laurentiis court concluded that S 553 

must take precedence over S 1141. Although uncertain, it 

also believed that the language of S 553 "seems intended to 

control notwithstanding any other provisions of the

Bankruptcy Code." 963 F.2d at 1276-77. The court, 

however, predicated its decision upon the particular facts in 

_________________________________________________________________ 

6. 11 U.S.C. S 1141 provides in pertinent part: 

 (a) Except as provided in subsections (d)(2) and (d)(3) of this 

section, 

 the provisions of a confirmed plan bind . . . any creditor . . . 

whether 

 or not such creditor . . . has accepted the plan. 

 . . . 

 (c) Except as provided in subsections (d)(2) and (d)(3) of this 

section 

 and except as otherwise provided in the plan or in the order 

 confirming the plan, after confirmation of a plan, the property 

dealt 

 with by the plan is free and clear of all claims and interests of 

 creditors. . . . 

 (d)(1) Except as otherwise provided in this subsection, in the 

plan, 

 or in the order confirming the plan, the confirmation of a plan -- 

 (A) discharges the debtor from any debt that arose before the date 

 of such confirmation . . . . (emphasis added). 

7. 11 U.S.C. S 553 provides in pertinent part: 

 (a) Except as otherwise provided in this section and in sections 

362 

 and 363 of this title, this title does not affect any right of a 

creditor 

 to offset a mutual debt owing by such creditor to the debtor that 
 arose before the commencement of the case under this title against 

 a claim of such creditor against the debtor that arose before the 

 commencement of the case . . . . (emphasis added). 

 8 
the case before it, including the creditor's diligent pursuit of 

its set-off claim before the bankruptcy court "during the 

entire period the reorganization plan was being considered." 

Id. at 1277. The court noted that the creditor, NBC, had 

filed a proof of claim and petition for relief from stay. 

We believe that the material facts in De Laurentiis

distinguish it from the case before us. We recognize that a 

right of set-off is preserved under S 553 in a bankruptcy 

proceeding but we believe that the right must be exercised 

by the creditor in timely fashion and appropriately asserted 

in accordance with other provisions of the Bankruptcy 

Code. Unlike the Government in this case, NBC, the 

creditor in De Laurentiis, timely filed its proof of claim in 

the bankruptcy court and claimed its right of set-off against 

its debt to the Debtor. NBC also filed a motion for relief 

from the automatic stay prior to confirmation of the plan. 

The Government did neither of these in this case. In the 

instant case, the plan of reorganization proceeded on the 

justifiable assumption that the reorganized debtor faced no 

set-off claim. On the other hand, in De Laurentiis, the 

bankruptcy court converted NBC's set-off claim into an 

adversary proceeding and NBC "pursued its claim diligently 

before the bankruptcy court at all times." Id. at 1271. There 

was no adversary proceeding here prior to plan 

confirmation, and the facts in both cases are materially 

different. 

The Government also cites to In re Davidovich, 901 F.2d 

1533 (10th Cir. 1990) and two bankruptcy court cases. 

Davidovich involved an arbitration debt to the debtor from 

his former law partner, and the debtor, under the facts of 

the case, had notice of the set-off claim. The court, 

however, only discussed the right of set-off under S 553 but 

made no analysis of the provisions of S 1141 of the

Bankruptcy Code. As to the bankruptcy court cases, In Re 

Weigand, 199 B.R. 639, (Bankr. W.D. Mich. 1996) relies 

largely on De Laurentiis only, and the facts of In re 

Womack, 188 B.R. 259 (Bankr. E.D. Ark. 1995) are 

distinguishable. Womack, unlike this case, involved a 

secured debt of the Government, income tax liability, 

payment of which was provided by the confirmed plan. The 

debtors had a refund due from the Government for an

 9 
overpayment on a subsequent tax year. After the 

confirmation of the plan, the Government sought to set-off 

the refund against the debt due it under the plan and the 

bankruptcy court permitted it. The bankruptcy court

concluded that the set-off might in fact be of benefit to the 

debtors and to some of the creditors because the reduction 

of the claim of the United States under the plan will permit 

acceleration of payment to other creditors. Id. at 262. 

Because the plan provided for the ultimate payment of the 

debt due the Government, allowing the set-off merely 

accelerated its payment, and there was no need to discuss 

the conflict between S 553 and S 1141 of the Bankruptcy 

Code. 

Thus, we are not persuaded by the cases relied on by the 

Government that S 1141 may be disregarded when a set-off 

is asserted. Norton did not extinguish non-secured set-off 

claims, nor do we, provided they are timely asserted. In the 

instant case, the Government would have the court treat a 

non-secured claim as a secured claim to the disadvantage 

of all other general creditors. The Government here has no 

statutory secured claims as it did in Womack for income tax 

liability. Furthermore, allowing the Government under the 

facts of this case to come forward after the plan of 

reorganization has been confirmed and sua sponte decide 

that it has a valid set-off without timely filing a proof of 

claim and asserting the set-off in the reorganization 

proceedings, has a probability of disrupting the plan of 

reorganization. It may also unnecessarily protract the 

bankruptcy proceedings and consume judicial resources. 

Furthermore, it is unfair to other creditors and the debtor, 

and can conceivably undermine the plan of reorganization 

and the objectives and structure of the Bankruptcy Code. 

Thus, because the Government attempted to exercise its 

set-off right after confirmation of the plan, the 

Government's remaining arguments are unpersuasive. 

Norton still controls in this Circuit and precludes the 

Government's exercise of any set-off right it may have had 

once Continental's plan was approved. As the Government 

correctly notes, "a panel of this court is bound to follow the 

holdings of published opinions of prior panels of this court 

unless overruled by the court en banc or the holding is 

 10 

undermined by a subsequent Supreme Court case." 

Nationwide Ins. Co. v. Patterson, 953 F.2d 44, 46 (3d Cir. 

1991). 

III. 

To summarize, we reaffirm the ruling in Norton and hold 

that the right of a creditor to set-off in a bankruptcy 

reorganization proceeding must be duly exercised in the 

bankruptcy court before the plan of reorganization is 

confirmed; the failure to do so extinguishes the claim. 

Accordingly, the judgment of the district court upholding 

the bankruptcy court's ruling that the Government's set-off 

rights, if any, were extinguished upon confirmation of 

Continental's Plan of Reorganization will be affirmed. Costs 

taxed against the appellant. 

A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 

 for the Third Circuit 

 11