United States Bankruptcy Appellate Panel

FOR THE EIGHTH CIRCUIT 

______ 

No. 10-6058 

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In re: Joseph Warren Terry, * 

 * 

Debtor. * 

 * 

Joseph Warren Terry, * Appeal from the United States 

 * Bankruptcy Court for the Western 

Plaintiff – Appellee, * District of Missouri 

 * 

v. * 

 * 

Standard Insurance Company, * 

 * 

 Defendant – Appellant; * 

 * 

Norman E. Rouse, Trustee, * 

 * 

Defendant. * 

______ 

Submitted: January 11, 2011 

Filed: January 28, 2011 (Corrected January 28, 2011) 

______ 

Before KRESSEL, Chief Judge, SALADINO and NAIL, Bankruptcy Judges. 

______ 

KRESSEL, Chief Judge. 

1 
The Standard Insurance Company appeals1

 from an order of the bankruptcy 

court granting the debtor’s complaint for a declaratory judgment. The court 

determined that Standard may not recoup $45,316.54 of disability insurance 

“overpayments” from the debtor’s future disability payments. For the reasons 

below, we reverse and remand.

BACKGROUND 

The facts were established by stipulation of the parties and are not in 

dispute. The debtor, Joseph Terry, was employed by the state of Missouri. He 

received a group long term disability policy through the Missouri State Employees’ 

Retirement System (MOSERS), which provides monthly long term disability 

benefits for certain disabled MOSERS employees. Terry became disabled on 

December 6, 2005. He filed a claim under the policy and Standard began sending 

Terry’s benefits in August of 2006. Two years later, in May of 2008, Terry was 

awarded Social Security Disability benefits, including a retroactive payment of 

$45,316.54 for a period going back to June 1, 2006. 

Terry’s disability policy through Standard provided that his long term 

disability insurance benefits would be reduced by the amount of any Social 

Security payments he received and that Standard would be entitled to be 

reimbursed from his future Standard benefits for any previous “overpayments.” 

Standard determined that it had the right to the debtor’s retroactive award of 

$45,316.54 in SSDI. The policy provides that Standard will reduce its monthly 

benefit payment to the beneficiary by the amount of the beneficiary’s deductible 

income. The policy defines deductible income as including “Any amount you [the 

beneficiary] may receive or are eligible to receive because of your disability or 

retirement under: a. The Federal Social Security Act.” The policy provides rules 

                                                            1

 Although Norman Rouse is named as a defendant, the bankruptcy 

court dismissed him from this adversary proceeding, and he is not a party to this 

appeal. 

2 
for deductible income, including the following: “We will not deduct pending 

Deductible Income until it becomes payable. You must notify us of the amount of 

the Deductible Income when it is approved. You must repay us for the resulting 

overpayment of your claim” and “We will notify you of the amount of any 

overpayment of your claim [. . .]. You must immediately repay us. You will not 

receive any LTD Benefits until we have been repaid in full. In the meantime, any 

LTD Benefits paid, including the Minimum LTD Benefit, will be applied to reduce 

the amount of the overpayment.” On that basis, Terry repaid $45,316.54 to 

Standard from his deposit account on July 24, 2008.2

 Terry filed a chapter 7 petition on July 31, 2008, one week after Standard 

had debited his account to reimburse itself for the overpayment. On October 29, 

2008, the debtor received his chapter 7 discharge. On April 20, 2009, the trustee, 

Norman E. Rouse, sent a preference demand letter to Standard. The trustee 

demanded that Standard return the overpayment that it had received from the 

debtor on July 24, 2008. In response, Standard immediately sent the money to the 

trustee. Standard then reinstated Terry’s obligations for the overpayment and 

began to deduct the overpayment from Terry’s post-petition long term disability 

benefits. After the bankruptcy court noted its concern that Standard might not be 

entitled to take that action against the debtor, Standard ceased the deductions 

pending the court’s determination regarding the various parties’ rights to the funds. 

 On July 30, 2009, Terry commenced this adversary proceeding against 

Rouse and Standard, seeking: 1) judgment declaring the rights, duties, and legal 

relationships between the plaintiff and the defendants; 2) judgment in favor of 

Terry and against the trustee for turnover of the $45,316.54; and 3) judgment in 

favor of Terry and against Standard requiring Standard to pay his monthly 

disability payments lawfully withheld retroactive to April 2009 and requiring 

payment of all future disability benefits as provided under the MOSER’S deferred 

compensation plan. 

                                                            2

 Standard withdrew the funds from Terry’s bank account pursuant to a 

pre-authorization that Terry executed when he made a claim under the policy.

3 
 On October 23, 2009, Terry amended his schedules to claim an exemption in 

his entire future monthly disability benefit from Standard. No party objected to 

Terry’s claimed exemption. On March 23, 2010, the court ruled that the debtor 

could not claim as exempt the $45,316.54 that he had previously paid to Standard. 

The court therefore treated that issue as moot and dismissed Terry’s claims against 

the trustee. The only issue determined by the court in the order on appeal was 

whether Standard may exercise the equitable right of recoupment post-bankruptcy 

to recover from the debtor the money that Standard turned over to the trustee. 

Because the bankruptcy court determined that Standard was not entitled to 

recoupment solely on the basis of 11 U.S.C. § 502(h), it did not address the merits 

of Standard’s recoupment defense and made no findings regarding equitability. 

Standard of Review 

The interpretation of 11 U.S.C. § 502(h) is a legal conclusion, which we 

review de novo. The CIT Group/Equipment Financing, Inc. v. M & S Grading, 

Inc. (In re M & S Grading, Inc.), 307 F.3d 898, 899 (8th Cir. 2006); Bankr. R. 

8013. 

Discussion 

 

When Standard turned over to the trustee the $45,316.54 that Terry had 

repaid it, the debtor’s satisfaction was undone and Standard’s right to be 

reimbursed by the debtor for the overpayment was revived. Hutchinson v. Otis, 

Wilcox & Co., 190 U.S. 552, 554, 23 S.Ct. 778, 779 (1903) (“When Otis, Wilcox, 

& Co. paid the debts out of which they had received satisfaction, they undid the 

satisfaction, and the trustee in bankruptcy knew it. We see no sufficient ground on 

which he can deny the consequence that the right to prove revived.”). Standard’s 

right to be reimbursed for the overpayment is a claim. 11 U.S.C. § 101(5). As 

such, Standard’s claim is entitled to be paid as a general claim as allowed under 11 

U.S.C. § 502(h). 

4 
Contrary to the bankruptcy court’s holding and the debtor’s arguments, 

nothing in § 502(h) limits Standard to a claim against the estate or eliminates 

Standards rights against the debtor. Section 502(h) assumes the existence of a 

prepetition claim and instructs the court on how such a claim is to be allowed in 

the case- nothing more. It does not create claims or confer priority and most 

importantly for our purposes, it does not purport to limit Standard’s rights to 

recovery. 11 U.S.C. § 502(h); Busseto Foods, Inc. v. Laizure (In re Laizure), 548 

F.3d 693, 698 (9th Cir. 2008) (holding that after trustee avoided a preference, the 

preference recipient’s claim against the debtor was reinstated and § 502(h) did not 

change the nature of the underlying claim). Although it is clear that Standard had a 

general unsecured claim and it is undisputed that it had notice of the case, it did not 

file a proof of claim, so its claim was not allowed. As a result, it was not entitled 

to any distribution in the case, which would have had the effect of reducing or even 

eliminating the amount it is trying to recover from the debtor. Its claim was also 

discharged. 11 U.S.C. § 727(b) (“a discharge under subsection (a) of this section 

discharges the debtor from all debts that arose before the date of the order for relief 

under this chapter”); Fed. R. Bankr. P. 3002(a). 

 Although Terry’s debt to Standard for the overpayment was discharged, 

Standard’s recoupment defense survived. The equitable defense3

 of recoupment 

entitles Standard to defend against demands by the debtor under the contract by 

withholding payment in order to essentially repay itself for the overpayment, if the 

elements are satisfied. Williams v. Neely, 134 F. 1 (8th Cir. 1904) (Recoupment is 

an equitable defense, which “crept from courts of chancery into the practice at law 

to enable courts of law to avoid the expense of suits in equity, to prevent circuity of 

action, and to obtain its benefit.”). “Recoupment is the keeping back of something 

that is due because there is an equitable reason for holding it.” Id. It “presents no 

affirmative cause of action for a recovery.” Id. See also 4 Norton Bankr. L. & 

Prac. 3d § 73:2 (2010) (“The matters raised by a claim of recoupment directly 

reduce the amount of damages to which a plaintiff is entitled. No affirmative 

                                                            3

 While often referred to as a claim, we think recoupment is more 

properly characterized as a defense.

5 
judgment is allowed.”). The Supreme Court has commented that it is well-settled 

“that a bankruptcy defendant can meet a plaintiff-debtor’s claim with a 

counterclaim arising out of the same transaction, at least to the extent that the 

defendant merely seeks recoupment.” Reiter v. Cooper, 507 U.S. 258, 265 n. 2, 

113 S. Ct. 1213, 1218 n. 2, 122 L. Ed. 2d 604 (1993). See also Bird v. Carl’s 

Grocery Co. (In re NWFX, Inc.), 864 F.2d 593, 596-97 (8th Cir. 1989) (“The 

common law doctrine of recoupment is still important in bankruptcy. Where it is 

applicable, recoupment may be used to afford a creditor preferential treatment. For 

recoupment to apply, however, the creditor must have a claim against the debtor 

that arises from the same transaction as the debtor’s claim against the creditor.”) 

(citing In re B & L Oil Co., 782 F.2d 155, 157 (10th Cir. 1986)). Although 

Standard can no longer collect the overpayment affirmatively, it may seek to 

exercise its right of recoupment under the contract. 

 

The parties disagree about the application of the Eighth Circuit’s decision in 

Dewey. U.S. Postal Serv. v. Dewey Freight Systems, Inc., 31 F.3d 620, 623 (8th 

Cir. 1994). Dewey was a chapter 11 case involving recoupment of damages 

following the rejection of an executory contract. The Eighth Circuit cited a 

number of cases where recoupment was allowed in the bankruptcy context, and 

stated: 

These cases suggest that USPS could recoup, for example, claims for 

overpayment or damage-in-transit arising from Dewey’s pre-petition 

trucking services against Debtor’s claims for post-petition services 

under the same contracts. But USPS’s Claim here is different- it 

stems from Debtor’s failure to perform its future contractual 

commitments, a failure that is inextricably tied to its status as a 

chapter 11 debtor. 

Id. In this case, the debtor’s obligation is not “inextricably tied to its status” as a 

debtor in bankruptcy. The facts of this case are more like the cases distinguished 

by the court in Dewey that involved claims for overpayment, whereas in Dewey the 

creditor sought to reduce post-petition payments based on damages created by the 

6 
debtor-in-possession’s rejection of their executory contract. Standard is not 

prohibited from asserting a recoupment defense against the debtor. 

In order for recoupment to be permitted in bankruptcy cases, “‘both debts 

must arise out of a single integrated transaction so that it would be inequitable for 

the debtor to enjoy the benefits of that transaction without also meeting its 

obligations.’” Dewey at 623 (quoting In re Univ. Med. Ctr., 973 F.2d 1065, 1081 

(3d Cir. 1992)). Although the debtor argues that the contract does not satisfy the 

same transaction test, we disagree. It is undisputed that both parties’ rights and 

obligations arise out of a single contract, and the debtor has not persuaded us that 

some basis exists to view their mutual obligations as arising out of separate 

transactions. 

However, recoupment is only allowed where it would be “inequitable for the 

debtor to enjoy the benefits of that transaction without also meeting its 

obligations,’” and recoupment should be narrowly construed in bankruptcy. 

Dewey at 623. Standard’s rights are not absolute, and the equities must be 

weighed. Because the bankruptcy court did not reach the question of whether the 

equities favor allowing recoupment, we must remand. There are a number of 

considerations that the bankruptcy court might weigh. For instance, if the court 

were to allow recoupment, Terry would be required to repay the funds a second 

time, which the debtor argues would be a particularly inequitable result for a 

permanently disabled debtor. In addition, allowing recoupment might compromise 

the debtor’s fresh start. We also note that Standard did not defend itself against the 

trustee’s preference demand. Although we express no opinion on the merits of the 

trustee’s claim or any defenses Standard might have had, in some cases, the failure 

to defend a preference demand would be relevant. 

CONCLUSION 

We hold that 11 U.S.C. § 502(h) does not operate to limit Standard’s rights 

to a claim against the bankruptcy estate. We reverse and remand to the bankruptcy 

7 
court to determine whether the equities favor allowing Standard to recoup the 

debtor’s overpayment from the debtor’s post-petition benefits. 

SALADINO, Bankruptcy Judge, dissenting. 

 Although I agree with most of what is stated in the majority opinion, 

including the conclusion that § 502(h) does not, standing alone, operate to limit 

Standard’s ability to assert a recoupment defense, I would affirm. Instead of 

focusing on a de novo review of the legal issues surrounding § 502(h), I believe the 

bankruptcy court’s order denying an equitable remedy should be reviewed from an 

abuse of discretion standard. C.T. Development Corp. v. Barnes (In re Oxford 

Development, Ltd.), 67 F.3d 683, 685 (8th Cir. 1995). 

 The bankruptcy court expressly recognized that recoupment is an equitable 

doctrine and that it should apply only where it would be inequitable to allow the 

debtor to enjoy the benefits of the transaction without also meeting its obligations. 

In United States v. Dewey Freight System, 31 F.3d 620 (8th Cir. 1994), the Eighth 

Circuit Court of Appeals engaged in an extensive review of how recoupment has 

been applied in bankruptcy. The Dewey court never expressly said it was weighing 

the equities, but it did look at the recoupment issue “from the perspective of the 

Bankruptcy Code’s treatment of executory contracts.” In other words, it looked at 

how the claims arose (under § 365(g)(1) and § 502(g)) and the impact recoupment 

would have on the bankruptcy estate: 

However, once the contracts were rejected, any damages 

caused by rejection, such as those asserted by USPS in 

this case, are treated as pre-petition unsecured creditor 

claims. In these circumstances, it would frustrate the 

basic purpose of § 365 in a Chapter 11 proceeding to 

allow USPS to reduce the amount it owes to Debtor for 

post-petition services by offsetting claims that § 365 has 

explicitly removed from the post-petition scene. 

“The fundamental purpose of reorganization is to prevent 

a debtor from going into liquidation, with an attendant 

8 
loss of jobs and possible misuse of economic resources.” 

Bildisco, 465 U.S. at 528, 104 S. Ct. at 1197. We may 

not construe the equitable doctrine of recoupment so as to 

frustrate both the specific commands of § 365(g)(1) and § 

502(g), and this overriding purpose of Chapter 11. 

Id. at 625. Similarly, the bankruptcy court here correctly recognized that the 

recoupment analysis was impacted by the trustee’s preference demand and § 

502(h). Although its conclusion that § 502(h) alone precludes recoupment is 

certainly debatable, the bankruptcy court did note that recoupment should be 

narrowly construed, there is a general hesitancy to apply recoupment in bankruptcy 

cases, and that it would be inimical to the purpose of equal distribution among 

creditors “to interpret § 502(h) in such a way that would permit that creditor to 

once again obtain preference over other creditors by use of the doctrine of 

recoupment.” That is the same sort of “equitable” analysis conducted by the 

Eighth Circuit in Dewey. 

 I note that the majority pointed out additional equitable factors4

 that are 

certainly relevant, were raised on appeal, and clearly support denial of recoupment 

in this case. Even though the bankruptcy court did not mention those same factors 

in its order, they are in the record and the parties stipulated to the underlying facts. 

In any event, the bankruptcy court had the discretion to deny the equitable claim of 

recoupment and, based on the record, did not abuse that discretion. Accordingly, 

although I get there by a slightly different path (as did the court in Dewey), I think 

the bankruptcy court correctly denied recoupment. 

                                                            4

 The majority noted that if recoupment were allowed, the permanently 

disabled debtor would effectively be repaying the overpayment a second time, 

which would impair the debtor’s fresh start. Further, Standard failed to defend or 

even question the preference demand.

9