Opinion ID: 2998766
Heading Depth: 2
Heading Rank: 1

Heading: U.S. Bank Matter

Text: We review a bankruptcy court’s disposition of crossmotions for summary judgment de novo, with all facts and inferences viewed in a light most favorable to the respective nonmoving parties. Hoseman v. Weinschneider, 322 F.3d 468, 473 (7th Cir. 2003). An award of summary judgment is proper when “there is no genuine issue as to any material fact and [ ] the moving party is entitled to a judgment as a matter of law.” FED. R. CIV P. 56 (c); Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). U.S. Bank asserts that the bankruptcy and district courts erred in concluding that it had a nondiscretionary duty to make disbursements to United from the construction fund upon United’s request. U.S. Bank further contends that even if such an obligation did exist, any obligation to perform such a duty would be contingent upon United’s repayments of interest and principal. U.S. Bank also contends that regardless, the bankruptcy court erred in applying an equitable maxim codified in California law to a contractual breach, and, finally, that its perfected security interest in the construction funds survived because it maintained possession. A critical question in this case is how the underlying agreements bind the parties to one another. While it is true, as U.S. Bank points out, that separate agreements govern, the reality is that the agreements form the basis of a single relationship: the reimbursement arrangement underlying the financing of the LAX terminal. The structure of the relationship is such that one agreement cannot be understood in isolation from its counterpart. California law instructs that, in circumstances such as these, interrelated documents should be read together for purposes of interpretation. CAL. CIVIL CODE § 1642 (2005) (“Several contracts relating to the same matter, between the same parties, and Nos. 05-1752 & 05-1814 9 made as parts of substantially the same transaction, are to be taken together.”); Versaci v. Superior Court, 26 Cal Rptr. 3d 92, 97-98 (Ct. App. 2005); Heston v. Farmers Ins. Group, 206 Cal. Rptr. 585, 594 (Ct. App. 1984). This discussion leads directly into the important question of duty—what duty, if any, does U.S. Bank owe to United? U.S. Bank contends that it owes United no duty because their two signatures never appeared on the same document. By the terms of the 2001 Trust Agreement, U.S. Bank reasons, the only duty it owes anyone is the fiduciary duty it owes the bondholders. Again, however, these arguments are flawed in that they misapprehend the essentially unified nature of the Trust and Bond Agreements. The parties understood from the beginning that United would receive the bond money upon its request. These contracts, then, were made for United’s benefit, as well as that of the bondholders. It is well settled under California law that when a contract is made expressly for the benefit of another, that other party is a third-party beneficiary. E.g., Johnson v. Superior Court, 95 Cal Rptr. 2d 864, 873 (Ct. App. 2000); Principal Mut. Life Ins. Co. v. Vars, Pave, McCord & Freedman, 77 Cal. Rptr. 2d 479, 488-89 (Ct. App. 1998); Harper v. Wausau Ins. Co., 66 Cal. Rptr. 2d 64, 68 (Ct. App. 1997); COAC, Inc. v. Kennedy Eng’rs, 136 Cal. Rptr. 890, 892 (Ct. App. 1977). Because United is a thirdparty beneficiary, U.S. Bank owes United the duty of good faith and fair dealing. E.g., Walker v. Truck Ins. Exch., Inc., 900 P.2d 619, 639 (Cal. 1995); CalFarm Ins. Co. v. Krusiewicz, 31 Cal. Rptr. 3d 619, 628 (Ct. App. 2005).1 1 U.S. Bank’s argument is curious on the point of duty. The fulcrum of its overall argument is that equity is inappropriate because this case is contractual. But on the issue of duty, U.S. Bank turns to the Restatement (Third) of Trusts to conclude that (continued...) 10 Nos. 05-1752 & 05-1814 What we have, then, are competing obligations of duty on the part of U.S. Bank; U.S. Bank owes the bondholders a fiduciary duty and United the duty of good faith and fair dealing. It is inevitable, especially in a situation such as this one, that these duties will sometimes conflict. The question then becomes how to resolve the conflicts in a manner fairest to the parties and to the terms of the agreements. It is possible, of course, to conclude that one duty trumps the other.2 U.S. Bank makes essentially this point, arguing that its fiduciary duty to the bondholders prevented it from paying out to a financially strapped United. But this resolution is rather arbitrary, and it is strange to contend that one’s fiduciary duty to a party requires it to violate the terms of the agreement creating that fiduciary relationship. We suppose it is possible to create such an arrangement, but that certainly is not the case here. Moreover, this argument places the burden following resolution squarely on one of the parties to whom a duty is owed, which seems inappropriate. The better resolution, we think, is to balance the duties. Balancing is both more sensible and more just, and it remains truer to the agreement among all interested parties. Thus, we conclude that while U.S. Bank’s fiduciary duty to the bondholders is important and must be considered, it does not erase United’s claim to duty as a third-party beneficiary. 1 (...continued) “a person who merely benefits from the performance of a trust is not a beneficiary.” While that may be true, United remains a third-party beneficiary under California contract law. 2 The dissent appears to assert that the fiduciary duty must prevail under the particular circumstances here, but without citing any authority for this conclusion. The fiduciary relationship to the bondholders is the product of the same contract that creates the duty to United. Nos. 05-1752 & 05-1814 11 Since U.S. Bank owes United the duty of good faith and fair dealing, it must face the elephant in the room: United’s bankruptcy, which was imminent in December 2002 and of which U.S. Bank rather implausibly denied anticipation at oral argument. There, U.S. Bank asserted that it had no idea United was nearing bankruptcy in December 2002. A cursory glance at the major newspapers of the day makes it hard to believe that even laypersons were unaware of the airline’s impending bankruptcy.3 Surely a major bank in a 3 E.g., Edmund L. Andrews, No Help for United, N.Y. TIMES, Dec. 8, 2002, §, at 1 (“The Bush administration refused to give United Airlines . . . a $1.8 billion loan guarantee, almost certainly pushing it to bankruptcy court.”); Greg Griffin, United Board Weighs Filing; Bankruptcy Move Could Come Today, DENVER POST, Dec. 8, 2002, at A-1 (“United Airlines’ board of directors met by teleconference Saturday afternoon to consider how to proceed with a bankruptcy filing in the next two days.”); Matthew Brelis, US Rebuffs United Airlines on $1.8B Loan Guarantees; Bankruptcy Filing Looks Likely, BOSTON GLOBE, Dec. 5, 2002, at A1 (“United Airlines . . . will almost certainly be forced to file for bankruptcy protection after the federal Air Transportation Stabilization Board yesterday evening rejected its application for $1.8 billion in federal loan guarantees.”); Greg Burns, Bitter Bankruptcy Feared, Workers, Travelers Would Lose, Rivals Stand to Gain, CHI. TRIB., Dec. 5, 2002, at 1 (“United is running out of options besides bankruptcy”); Editorial, United: An End, and a Beginning, CHI. TRIB., Dec. 5, 2002, at 28 (“Given the overwhelming liabilities United faces and the fact that it is burning through cash at a startling rate, the [$1.8 billion loan guarantee] decision almost certainly means the financially struggling airline will be forced to reorganize under bankruptcy protection.”); Simon English, United Airlines on Brink of Collapse, DAILY TELEGRAPH (London), Dec. 5, 2002, at 34 (“United warned earlier this week that it was down to its last $1 billion and repeated its threat that bankruptcy looked hard to avoid, even with a loan.”); What United’s Up Against, CHI. TRIB., Dec. 4, 2002, at 6 (“But many (continued...) 12 Nos. 05-1752 & 05-1814 lending relationship with United understood the airline’s dire financial situation, especially a bank that has in this 3 (...continued) airline analysts say bankruptcy is inevitable.”); Keith L. Alexander, Frequent Fliers Look Ahead to United Filing, WASH. POST, at E01; James Flanigan, United is a Poor Model for Employee Ownership, L.A. TIMES, Dec. 4, 2002, at 3:1 (“It would be easy to look at what’s happening at United Airlines, now on the brink of bankruptcy, and conclude that the concept of employee ownership in America has fallen into a tailspin.”); Russell Grantham, Delta’s Status Better than United, Observers Say, ATLANTA J.-CONST., Dec. 4, 2002, at 1D (“United will almost certainly seek Chapter 11 protection from creditors, said [an analyst], if Machinists union members don’t approve an amended $700 million concession package this week.”); Greg Griffin, United, Union Set New Vote; Airline Defers Bond Payment, Though Another Comes Due in Solvency Fight, DENVER POST, Dec. 3, 2002, at A-01 (“Without ratification of the 7 percent pay cut by the mechanics, cashstrapped United could file for bankruptcy immediately because it will have no chance of receiving a loan guarantee from the government. . . . United also is preparing for the possibility of Chapter 11, trying to line up $1.5 billion in emergency financing to fund its operations while in court, according to published reports.”); John Schmeltzer, CHI. TRIB., Dec. 3, 2002, at N1 (“Hedging its bets, United also is working with private lenders to finance the company’s operations should it file for court protection. ‘You don’t arrange bankruptcy financing unless you think you’re going to file for bankruptcy,’ [an analyst] said. ‘If they don’t file, I would be surprised.’ ”); Air NZ Unfazed As United Teeters on the Edge of Bankruptcy, N.Z. HERALD, Dec. 2, 2002 (“United is likely to file for bankruptcy within the next two weeks unless it can soon get a new wage-cut deal from reluctant mechanics and a crucial federal guarantee of a US$1.8 billion . . . loan, sources familiar with the matter said.”); John Schmeltzer, United, Mechanics Return to the Table; Flight Attendants OK Wage Cuts, CHI. TRIB., Dec. 1, 2002, at C1 (“United doesn’t have much more time before a bankruptcy filing will be its only alternative.”). Nos. 05-1752 & 05-1814 13 case repeatedly asserted the need for due diligence.4 This understanding implicates critically important policy questions: is it appropriate to imbue trustees with virtually unfettered discretion to disburse funds so that they can punish debtors on the verge of bankruptcy? Should we extend such a power even in the face of agreements that plainly create a nondiscretionary duty to disburse funds? We think not. Our answer may have been different in a factual setting with different underlying agreements. But the reality here is that the parties negotiated agreements that afford U.S. Bank no discretion in disbursing the funds. Under California law, a trustee’s duties and obligations are strictly defined by and limited to the terms of the underlying agreement, particularly in relationships involving indenture trustees. Bryson v. Bryson, 216 P. 391, 393 (Cal. Dist. Ct. App. 1923). The agreements here provide that once United completes the work and once United submits a reimbursement request, U.S. Bank must pay. (2001 Payment Agreement § 3.3(a) (“Each of the payments referred to . . . shall be made upon receipt by the Trustee of a Written Request of the Corporation.”).) Moreover, the Agreements exclude the need for due diligence by stating that written requests conforming to certain procedures “shall be sufficient evidence” that the items are properly reimbursable. Reading a “reasonable time to perform due diligence” clause into the agreements ignores their plain text and the course of 4 U.S. Bank’s denial is rendered all the more implausible by its assertion in its opening brief to this Court that “[w]ithholding reimbursements to United when it is expected that United will not honor its contractual obligations under the [2001] Payment Agreement was simply an action U.S. Bank deemed necessary with respect to enforcing United’s obligations under the Payment Agreement.” (Pet’r Br. at 15-16) (footnote omitted.) The agreements do not afford U.S. Bank this discretion. 14 Nos. 05-1752 & 05-1814 dealing between the parties. Thus, we conclude, as did the bankruptcy and district courts, that U.S. Bank had a nondiscretionary duty to disburse funds upon an appropriate request from United. These conclusions permit us to resolve the first step in adjudicating these claims: who is entitled to the money in absence of setoff (an issue to which we will return)? Since the terms of the agreements clearly state that once a request is properly filed, U.S. Bank must reimburse, it follows that United was entitled to the funds covered by the Category III Claims on December 5, 2002, and the funds subject to the Category II Claims on December 13, 2002. Under California law as preserved in the Bankruptcy Code, mutual debts arising before the commencement of a bankruptcy proceeding may be offset, subject to certain exceptions not relevant here. “The right of setoff (also called ‘offset’) allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding the ‘absurdity of making A pay B when B owes A.’ ” Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 18 (1995) (quoting Studley v. Boylston Nat’l Bank of Boston, 229 U.S. 523, 528 (1913)). Section 553(a) “generally permit[s] a creditor to offset, on a dollar-for-dollar basis, a debt it owes to the bankrupt party on a pre-commencement debt that the bankrupt owed to the creditor.” United States v. Maxwell, 157 F.3d 1099, 1100 (7th Cir. 1998); see also CAL CIV. PRO. CODE § 431.70 (2005); Harrison v. Adams, 128 P.2d 9, 11 (Cal. 1942); Plut v. Fireman’s Fund Ins. Co., 102 Cal. Rptr. 2d 36, 42 (Ct. App. 2000). Setoff is appropriate against the Category II Claims because, under the 2001 Agreements, United owed U.S. Bank and the bondholders repayments of principal and interest. Once United entered bankruptcy, all debts were therefore subject to setoff. United’s primary defense against setoff is that the debts are not mutual. California law and Nos. 05-1752 & 05-1814 15 § 553(a) require that, for setoff to apply, debts be between the same parties and that both arise before the filing of the bankruptcy petition. Meyer Med. Physicians Group, Ltd. v. Health Care Serv. Corp., 385 F.3d 1039, 1041 (7th Cir. 2004); In re Doctors Hosp. of Hyde Park, Inc., 337 F.3d 951, 955 (7th Cir. 2003); Harrison, 128 P.2d at 11-12. United argues that since, as we have concluded, U.S. Bank’s obligation to pay does not arise until United submits a request, U.S. Bank’s debt to United is not prepetition and therefore enjoys no mutuality with United’s debt to repay principal and interest. In order for this argument by United to succeed, we would need to read each reimbursement request as a separate act that obligates U.S. Bank. That is, we would need to conclude that U.S. Bank is bound to pay only after United submits a reimbursement request, and once that request has been paid out, U.S. Bank’s obligation ceases. But that is not the arrangement here. Although United was not entitled to this money until it filed its request, U.S. Bank bound itself to pay, subject to request, when it entered the agreements in 2001. We have already explained that we are not willing to view the arrangement as a series of piecemeal agreements; it is improper to view the 2001 Trust Agreement and the 2001 Payment Agreement as two separate agreements because together they form a single framework of provisions governing the financing arrangement, and it not possible to understand one without reference to the other. Likewise, it is improper to treat each interaction in this arrangement as a separate transaction. Accordingly, this debt arose prepetition. Moreover, these funds are not, as United contends, special purpose funds exempt from setoff. See In re Ben Franklin Retail Store, Inc., 202 B.R. 955, 957 (Bankr. N.D. Ill. 1996). This exemption applies when a debtor deposits funds for some special purpose, which are thereby held in trust for the debtor. Id. A typical example of a special purpose fund 16 Nos. 05-1752 & 05-1814 is collateral pledged to satisfy obligations to third parties in the event of a draw on a letter of credit. Id. Here, however, the bondholders deposited the funds—not United. These funds are not earmarked in any way that imposes a special purpose on them, nor are they pledged for any third-party purpose (that is, some purpose outside the LAX project). Thus, these debts are mutual, ordinary purpose funds subject to setoff. We next confront the issue of default. Section 6.1(c) of the 2001 Payment Agreement identifies filing a bankruptcy petition as an event of default.5 United argues that this provision is an ipso facto default term, which 11 U.S.C. §§ 363(1), 365(e)(1), and 541(c)(1)(B) prohibit. United reasons that the default provision of the 2001 Payment Agreement provide U.S. Bank with its only avenue to setoff, which means that the default provision modifies United’s interest in property. Authority supporting this proposition is slim and not quite on point. Indeed, the only case directly on point brought to our attention—an unpublished disposition at that—limits its holding to situations where debtors are not otherwise in default. Reloeb Co. v. LTV Corp. (In re Chateaugay Corp.), 1993 WL 159969, at  (S.D.N.Y. May 10, 1993). United, on the other hand, is in default for reasons extending beyond the bankruptcy filing; the airline has not made a required payment of principal and interest since October 2002. Even if we were to determine that the ipso facto default provisions are unenforceable, United’s nonpayment remains a default under Section 6.1 of the 2001 Payment Agreement (which is parallel to Section 7.01 of the 2001 Trust Agreement). United contends that these nonpayments ought not count as defaults, because the 5 Nothing, however, indicates that anticipation of bankruptcy is cause to withhold payment. Nos. 05-1752 & 05-1814 17 Bankruptcy Code prohibits these types of payments while it remains in bankruptcy. The Code may well prohibit such payments, but the agreements—the sole authority governing this relationship—provide no basis to avoid setoff on this ground. United must be held to the deal it made, just as U.S. Bank must be held to the payment obligations it made. In addition, United’s ipso facto argument is not particularly relevant here. Section 553(a) expressly preserves creditors’ setoff rights that are protected under state law. California law expressly extends setoff rights to bankruptcy filings in situations where the creditor and the debtor share a mutual debt. Thus, because the Category II Claims satisfy the requirements for setoff as outlined in California law and preserved in § 553(a), the claims are subject to setoff. Now, having resolved the Category II Claims and explored some aspects of setoff, we can move on to the Category III Claims. As we have demonstrated, United was entitled to the claimed funds upon making its reimbursement request—that is, on December 5, 2002. Because U.S. Bank had a nondiscretionary duty to reimburse, it wrongfully withheld these funds. In the absence of bankruptcy, we could simply order U.S. Bank to pay United now and the issue of damages would be resolved. But the bankruptcy filing, which United is only just now overcoming, complicates the matter. For if we were simply to award United its damages effective today, the money would be subject to the bankruptcy filing and would be disbursable to creditors. The purpose of damages would not be served; United would not be compensated for the damages it suffered, nor would the construction funds be available for their intended purpose. See, e.g., Avery v. Fredericksen & Westbrook, 154 P.2d 41, 42 (Cal. Dist. Ct. App. 1944); Mente & Co. v. Fresno Compress & Warehouse Co., 298 P. 126, 128 (Cal. Dist. Ct. App. 1931). In addition, U.S. Bank would be rewarded for speculating on United’s bankruptcy, which surely would 18 Nos. 05-1752 & 05-1814 increase the incidence of such behavior in the future. The question, then, is whether California law contains a remedy that will make United whole. The bankruptcy court, as we have discussed, believed that equity provided the necessary remedy. While the maxim—that which ought to be done is deemed as having been done—is codified under California law and certainly makes sense, it may seem to be a tight fit here. First, equity is generally unavailable in breach of contract cases, although the courts are willing to turn to equity where damages at law are inadequate. Wilkison v. Wiederkehr, 124 Cal. Rptr. 2d 631, 638 (Ct. App. 2002). Second, and perhaps more fundamentally, applying the maxim in this context may appear to be reaching beyond the bounds of this case to force a result. That appearance, however, is deceptive. The California courts, like courts of other jurisdictions, rely on a number of equitable doctrines in different situations to provide the relief required to redress a plaintiff’s injuries when the law is unable to do so. See, e.g., Cortez v. Purolator Air Filtration Prods. Co., 999 P.2d 706, 716-17 (Cal. 2000); Poultry Producers of Cent. Cal., Inc. v. Nilsson, 197 Cal. 245, 253-55 (Cal. 1925); Portuguese Am. Bank v. Schultz, 193 P. 806, 807 (Cal. Dist. Ct. App. 1920). One doctrine rooted in equity with particular analogic value here is the doctrine of constructive receipt. The doctrine of constructive receipt—an income tax doctrine—has the same basic thrust as the equitable maxim that the bankruptcy court relied upon.6 The constructive 6 Despite the dissent’s suggestions to the contrary, we do not directly rely on the doctrine of constructive receipt to decide this case. The doctrine only represents an apt analogy; it, like this case, directs that context and timing are relevant even in (continued...) Nos. 05-1752 & 05-1814 19 receipt doctrine provides that cash and receipts in kind are reportable as income either when they are actually received or when they are constructively received. Income is constructively received when, although a taxpayer has the power to receive income, she chooses not to do so—generally to obtain favorable tax treatment. E.g., Corliss v. Bowers, 281 U.S. 376, 376-77 (1930); Hornung v. Comm’r, 47 T.C. 428, 433-34 (1967). The constructive receipt doctrine, then, addresses issues of timing, specifically to preclude taxpayers from manipulating the timing of income receipt for their own benefit. In the case before us, the problem is to preclude the lender from manipulating the timing of payment to the detriment of the borrower. Quite clearly, then, the policy underlying the constructive receipt doctrine is appropriately responsive to the issues in this case. A key policy issue here is that a trustee should not be rewarded for speculating on the bankruptcy of a debtor. But the legal redress for such an injury is insufficient. The common thread between this case and ordinary applications of the constructive receipt doctrine is the idea that parties in a position to control disbursements may not manipulate the system to avoid the consequences of controlling requirements (e.g., the Internal Revenue Code or the Trust Agreements). U.S. Bank withheld reimbursement, predicting—accurately, it turned out—that United would enter bankruptcy. It is as improper for U.S. Bank to withhold the Category III Claims to obtain a financial advantage as it is for a taxpayer to defer the receipt of 6 (...continued) cases involving comprehensive codes. See also In re Payne, 431 F.3d 1055, 1057-58 (7th Cir. 2005) (Posner, J.) (holding that the definition of an income tax “return” in both the Bankruptcy Code and the Internal Revenue Code depends, in part, on context). Contrary to the dissent, nothing precludes appellate courts from seeking apt analogies, whether or not suggested by the parties. 20 Nos. 05-1752 & 05-1814 income to avoid a realization event to reduce taxes.7 The California courts are willing to apply extralegal remedies in situations where the equities demand it. E.g., Cortez, 999 P.2d at 716-17 (applying equitable considerations to a disposition under unfair competition law); Poultry Producers of Cent. Cal., Inc., 197 Cal. at 255-56 (awarding specific performance and damages for breach of contract); see also Hirshfield v. Schwartz, 110 Cal. Rptr. 2d 861, 876 (Ct. App. 2001) (“ ‘Equity or chancery law has its origin in the necessity for exceptions to the application of rules of law in those cases where the law, by reason of its universality, would create injustice in the affairs of men.’ ” (quoting Estate of Lankershim, 58 P.2d 1282, 1284 (Cal. 1936)). In this case, application of an equitable remedy is appropriate to ensure that the parties are made whole for the breach. And, under the particular circumstances present here, U.S. Bank’s fiduciary duty to the bondholders does not, as we have earlier noted, extinguish its contractual obligation of good faith and fair dealing with respect to United. U.S. Bank may not breach its agreements in a purported effort to observe its fiduciary duty. Finally, U.S. Bank’s point about holding a perfected security interest fails because as of December 5, 2002, the effective date of this transfer, no debt existed that such an interest might secure. United was current in its payments, and nothing had occurred to trigger application of the security interest. Accordingly, United is entitled to the full amount of the Category III Claims free from setoff. 7 U.S. Bank argues that its delay was not to procure advantage but instead to conduct due diligence. The terms of the agreements and the course of dealing expose this argument as merely a post hoc rationalization. In any event, whether or not U.S. Bank improperly withheld payment in anticipation of bankruptcy here, the dissent would provide an incentive for lenders in these circumstances to do so in the future. Nos. 05-1752 & 05-1814 21 U.S. Bank argues that the decisions below will wreak havoc with commercial law. It believes that the bankruptcy and district courts have so blurred the lines drawn in the Bankruptcy Code as to render the Code unworkable. It argues that our affirmance would undermine well-established principles of both bankruptcy and general commercial law. Those doomsday fears, however, are overstated. We have done nothing to blur the operation of the Bankruptcy Code. Our decision today stands for the simple propositions that parties will be held to their deals and that one party may not manipulate the timing of its payments to exploit the vulnerabilities of the other. U.S. Bank’s characterization of recourse to equity as some rogue remedy is baseless. Courts consistently rely on equitable remedies where damages at law are insufficient. More fundamentally, this type of remedy is appropriate and applicable in cases where one party shirks its obligations in order to obtain benefits at the expense of the other. Moreover, if any position is likely to upend well-settled law, it is U.S. Bank’s position. Despite its assertions to the contrary at oral argument, U.S. Bank conceded in briefing that it deemed it necessary to withhold payment to United because U.S. Bank believed United was nearing bankruptcy. This type of speculation is not permitted by the agreement the parties made, which once again directs that when United incurs expenses and properly requests reimbursement, U.S. Bank must pay and promptly. Sanctioning that speculation here would create incentives for future lenders to withhold funds when it appears that their borrowers are in financial trouble, regardless of their bargain.