Opinion ID: 3051920
Heading Depth: 3
Heading Rank: 4

Heading: Defenses Asserted by Aalfs

Text: Aalfs raises the defenses of earmarking and recoupment. For the reasons hereafter stated, he is not entitled to either defense.
[15] “[T]he earmarking doctrine applies ‘when a third party lends money to a debtor for the specific purpose of paying a selected creditor.’ ” In re Superior Stamp & Coin Co., Inc., 223 F.3d at 1008 (quoting Hansen v. MacDonald Meat Co. (In re Kemp Pac. Fisheries, Inc.), 16 F.3d 313, 316 (9th Cir. 1994)). [T]he earmarking doctrine requires: “(1) the existence of an agreement between the new lender and the debtor that the new funds will be used to pay a specified antecedent debt; (2) performance of that agreement according to its terms; (3) the transaction viewed as a whole . . . does not result in any diminu- tion of the estate.” Id. (quoting McCuskey v. Nat’l Bank of Waterloo (In re Bohlen Enters., Ltd.), 859 F.2d 561, 566 (8th Cir. 1988)). [16] Here, Aalfs paid money to Straightline in exchange for Straighline’s accounts receivable. Aalfs contends he was not a “lender,” but even if he were, the money he paid was not paid under any agreement that it would be used to pay a specific debt. Nor was there any showing as to how the money Aalfs paid was used by Straightline. And, as previously stated, there arguably was a diminution in the value of Straightline’s estate because of the discount at which its receivables were sold to Aalfs. 5078 IN RE STRAIGHTLINE INVESTMENTS, INC. [17] Because the requirements of the earmarking doctrine are not satisfied, the defense of earmarking does not apply.
“The doctrine[ ] of . . . recoupment [is] equitable in nature, and [its] use by the bankruptcy court is permissive [and] reviewed for an abuse of discretion.” Oregon v. Harmon (In re Harmon), 188 B.R. 421, 424 (B.A.P. 9th Cir. 1995) (citing Pieri v. Lysenko (In re Pieri), 86 B.R. 208, 210 (B.A.P. 9th Cir. 1988)). [18] “Recoupment . . . involves a netting out of debt arising from a single transaction.” Id. at 425. “ ‘Its function is to reduce the amount demanded, but only to the extent of the plaintiff’s claim.’ ” Id. (quoting Long Term Disability Plan of Hoffman-La Roche, Inc. v. Hiler (In re Hiler), 99 B.R. 238, 243 (Bankr. D.N.J. 1989)). “[R]ecoupment ‘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.’ ” Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 1392, 1399 (9th Cir. 1996) (quoting 5 Collier on Bankruptcy ¶ 553.03, at 553-15 (15th ed. 1984)). Aalfs paid $186,455 for receivables having a face value of approximately $200,600. Aalfs argues that the trustee’s recovery in this case should be subject to his right to recoup the $186,455 he paid for the accounts in the first place. In Aalfs’s opinion, in keeping with the equitable principle of recoupment, the trustee should recover nothing because the amount the estate already received is greater than the dollar amount of damages the bankruptcy court awarded to the trustee. [19] The doctrine of recoupment does not apply here, however, because it is an equitable remedy and equitable remedies may not be invoked to compensate someone who has engaged in inequitable conduct. Aalfs and Galt essentially effected a IN RE STRAIGHTLINE INVESTMENTS, INC. 5079 transfer of Straightline’s accounts receivable to Aalfs in contravention of the bankruptcy court’s order prohibiting such a transfer. They contend that the transaction was a sale in the ordinary course of business, notwithstanding that Aalfs advanced the money to Straightline for the accounts under an agreement with Galt that he would be repaid in full. That was a disguised loan which the bankruptcy court had precluded, yet Aalfs went ahead with it anyway. Aalfs engaged in inequitable conduct, and he is not entitled to the equitable remedy of recoupment. See United States v. Arkison (In re Cascade Rds., Inc.), 34 F.3d 756, 762 (9th Cir. 1994) (affirming bankruptcy court’s conclusion that equitable principle was not available to party who engaged in inequitable conduct). E. Appropriate Measure of Recovery Under 11 U.S.C. § 550 “The bankruptcy court’s choice of remedies is reviewed for an abuse of discretion.” Bankr. Receivables Mgmt. v. Lopez (In re Lopez), 345 F.3d 701, 705 (9th Cir. 2003) (citing Stone v. San Francisco, 968 F.2d 850, 861 (9th Cir. 1992)). Section 550(a) of the Bankruptcy Code provides that “to the extent that a transfer is avoided under section . . . 549 . . . , the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from— (1) the initial transferee of such transfer . . . .” 11 U.S.C. § 550(a) (West 2004). The bankruptcy court entered judgment against Aalfs in the amount of $163,007 — the amount he collected from the accounts receivables — plus interest, costs, and the return of the remainder of the uncollected accounts. Aalfs contends this resulted in a windfall to the Debtor’s estate because the Debtor had already received the $186,455 that Aalfs paid for the accounts. [20] Section 550 provides for recovery of the property transferred and avoided under § 549 or for recovery of the 5080 IN RE STRAIGHTLINE INVESTMENTS, INC. value of that property. Id. By awarding the trustee the sum of what Aalfs collected on the accounts plus the uncollected accounts, the bankruptcy court ordered a monetary recovery for part of the value of the improperly transferred property and ordered the return of the remainder of the uncollected accounts.3 The BAP affirmed this award, but the dissenting BAP judge believed the trustee should only have been allowed to recover the amount to which Straightline’s estate was damaged — the difference between the $200,600 face value of accounts receivable transferred to Aalfs and the $186,455 Straightline received from Aalfs. [21] Generally, the purpose of § 550(a) is “ ‘to restore the estate to the financial condition it would have enjoyed if the transfer had not occurred.’ ” Acequia, Inc. v. Clinton (In re Acequia, Inc.), 34 F.3d 800, 812 (quoting Morris v. Kan. Drywall Supply Co. (In re Classic Drywall, Inc.), 127 B.R. 874,