Opinion ID: 755246
Heading Depth: 2
Heading Rank: 2

Heading: MARAD's Claim to the Tax Refund.

Text: 23 There is no question that MARAD had a valid right of setoff. This issue was decided by the bankruptcy court on February 12, 1988 and was affirmed by the district court on March 29, 1989. The parties never appealed this issue to this court. Therefore, the only issue before us is whether MARAD validly exercised its right of setoff or whether it lost that right as a result of the IRS' inadvertent payment of the tax refund to the Trustee. 24 The Supreme Court has held that to effectuate a right of setoff, a party must manifest an intent to permanently settle accounts. Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 19, 116 S.Ct. 286, 133 L.Ed.2d 258 (1995). Generally, a party must take the following three steps: 25 (1) Make a decision to effectuate a setoff; 26 (2) Take some action accomplishing the setoff; and 27 (3) Record the setoff. 28 Id. 29 In the instant case, MARAD clearly manifested an intent to settle accounts with the Original Debtors and acted on that intent when it sought a determination in the Original Debtors' bankruptcy proceeding that it had sufficient mutuality with the IRS to pursue a private, common law right of setoff against a tax refund owed by the IRS to the Original Debtors. The bankruptcy court ultimately determined that MARAD did have sufficient mutuality with the IRS to pursue a setoff. This decision was rendered while the tax refund was still in the IRS' possession. MARAD subsequently contacted an agent of the IRS to give the IRS notice of its right of setoff. MARAD followed up with a letter to the IRS which included the memorandum of decision and the final judgment of the bankruptcy court and an address to which the tax refund should be sent. When the Trustee and NBA appealed the decision of the bankruptcy court to the district court, MARAD reaffirmed its intent to exercise its right of setoff in defending the bankruptcy court's judgment. The district court rendered its judgment of affirmance after the date the Plan was confirmed and the automatic stay was lifted. However, MARAD could not yet collect the refund from the IRS because the IRS had not yet determined the value of the available tax refund. 30 Later, on January 2, 1995, after UMSI filed for Chapter 11 bankruptcy and the case was converted to Chapter 7, the IRS did determine the value of the tax refund and disbursed the full amount of the tax refund to the Trustee after deducting overdue withholding taxes. MARAD presented uncontradicted evidence at trial that the IRS inadvertently disbursed the tax refund instead of honoring MARAD's entitlement to the refund. 31 Notwithstanding, the Trustee and NBA now argue that MARAD has lost its right of setoff. The Trustee argues that MARAD waived its right of setoff when the IRS inadvertently disbursed the funds to the Trustee on behalf of the bankruptcy estate. NBA asserts that a setoff cannot be accomplished because MARAD lost possession of the funds before the setoff was effectuated. Both of these arguments amount to the same thing. The possessory fund argument merely states the result of the application of the waiver doctrine. Once a creditor waives its right to assert a setoff by voluntarily releasing funds, it loses possession of the funds. 32 After reviewing the relevant case law, we hold that the doctrine of waiver may not be applied to extinguish MARAD's right of setoff absent proof that the government's disbursement of the tax refund to the Trustee was a voluntary or intentional relinquishment of MARAD's right of setoff. See In re Lanny Jones Welding & Repair, 106 B.R. 446 (Bankr.E.D.Va.1988); In re Krieger Steel Sections, Inc., 103 F.Supp. 351 (E.D.N.Y.1951), aff'd sub nom. Chassen v. United States, 207 F.2d 83 (2nd Cir.1953), and In re Tilston Roberts Corp., 75 B.R. 76, 79 (S.D.N.Y.1987). The bankruptcy court in this case clearly found that the IRS's disbursement of the tax refund to the Trustee was a mistake. The Trustee and NBA failed to contest this finding in the bankruptcy court or the district court, and thus, should not be permitted to challenge this finding on appeal to this court. Because we find no other evidence in the record supporting a finding that MARAD voluntarily or intentionally relinquished its right of setoff, we conclude that the district court did not err in granting summary judgment in favor of MARAD. 33 None of the cases cited by the NBA or the Trustee require a different result. In all of those cases, the court found a waiver of the creditor's right of setoff only because the creditor released the funds against which the setoff could be made before asserting any right of setoff, in court or otherwise. See In re Gehrke, 158 B.R. 465 (Bkrtcy.N.D.Iowa 1993)(holding bank's failure to assert right of setoff at time of turning over proceeds of debtor's bank accounts to the Trustee barred bank from asserting a right of setoff a year and a half later); In re Cloverleaf Farmers Co-Operative, 114 B.R. 1010 (Bkrtcy.D.S.D.1990)(denying SBA right of offset against funds disbursed to the debtor by the Agricultural Stabilization and Conservation Service because the action for offset was brought in court after funds had been released); In re Wilson, 49 B.R. 19 (Bkrtcy.N.D.Tex.1985) (holding SBA waived any claim it might have had to a setoff by not asserting a setoff right until after the IRS had disbursed the funds to the Trustee); and In re Royal Crown Bottling Co. of Boaz, Inc., 29 B.R. 52 (Bkrtcy.N.D.Ala.1981) (holding bank's right of setoff was extinguished because bank failed to assert its right of setoff before voluntarily disbursing debtor's account balance to the Trustee). 3 34 In this case, by contrast, MARAD asserted its right of setoff in court and gave notice to the IRS of its right of setoff well before the IRS ever disbursed the tax refund to the Trustee. Since asserting its right of setoff, MARAD has not taken any affirmative action inconsistent with its right of setoff. See In re Holder, 182 B.R. 770 (Bkrtcy.M.D.Tenn.1995)(holding that by affirmatively entering into agreed order with Chapter 11 trustee settling its claims, the United States Custom Service acted inconsistently with its right of setoff and thereby waived its right of setoff against a tax refund owed by the IRS to the debtor). Accordingly, we hold that the IRS' inadvertent release of the tax refund to the Trustee does not preclude MARAD from asserting its right of setoff. The Trustee, having mistakenly received the tax refund, is now liable ex acquo et bono to return it to the government. DiSilvestro v. United States, 405 F.2d 150, 155 (2nd Cir.1968). 4 35