Court Opinion

ID: 9685700
Source: CourtListenerOpinion
Date Created: 2023-08-24 14:57:37.958249+00
Date Added: 2024-06-11T18:18:09.585716
License: Public Domain

ELLIOTT, Bankruptcy Judge,
concurring.
I concur with the majority’s result, but not their reasoning. This adversary proceeding began when California Canners and Growers (“Canners”), the debtor in possession, filed an objection to Military Distributors of Virginia, Inc.’s (“Distributors”) proof of claim and, concurrently, a complaint against Distributors. See Bankr.R. 3007. As explained by the majority, Distributors’ claim was based on Can-ners’ failure to reimburse Distributors for the cost of certain goods it delivered prior to Canners’ bankruptcy and for the related drayage fees. Canners’ complaint was based on Distributors’ failure to reimburse Canners for goods delivered after the commencement of Canners’ bankruptcy case.
Distributors’ answer restated the grounds for its claim and, in response to the complaint, alleged that it was entitled to either a “setoff” or a “credit” of the amount due it from Canners against its admitted liability to Canners.
Canners moved for summary judgment arguing that 11 U.S.C. § 553(a) prohibited setoff of Distributors’ prepetition claim against Canners’ postpetition claim. Distributors countered that it was entitled to a recoupment, rather than a setoff, because its claim and Canners’ claim arose from the same transaction rather than independent transactions. Canners replied that the claims did not arise from the same transaction and that Distributors’ failure to plead recoupment resulted in either the waiver or bar of that argument.
The bankruptcy court entered judgment for Canners finding that the only defense raised was setoff and that setoff was barred by 11 U.S.C. § 553. It noted jurisdiction to enter final judgment under 28 U.S.C. § 157(b)(2). On appeal, Distributors admits that 11 U.S.C. § 553(a) precludes setoff of the prepetition and postpetition claims at issue. Distributors contends, however, that the bankruptcy court erred by not addressing its recoupment argument and by granting summary judgment when a material issue of fact existed as to whether the daims arose from the same transaction.
I.
I agree with the bankruptcy court that it had jurisdiction to enter a final judgment regarding Canners’ complaint, 28 U.S.C. § 157(b)(2)(C) (“counterclaims by the estate against persons filing claims against the estate” — although Canners styled its action as a “complaint,” I believe that it is best characterized as a counterclaim to Distributors’ proof of claim).
Canners’ motion for summary judgment only requested relief regarding its complaint and that is the extent of relief granted. The judgment does not dispose of Can-ners’ concurrent objection to Distributors’ proof of claim. Therefore, it may be considered an interlocutory order rather than a final judgment. See Fed.R.Civ.P. 56(d). The notice of appeal would then have to be construed as a motion for leave to appeal, Bankr.R. 8003(c), and this panel would need to grant leave in order to assert appellate jurisdiction, 28 U.S.C. § 158(a), (b). In any event, further proceedings concerning the claim objection are necessary. Appellee has not raised the point and the panel has entertained the appeal. Therefore, we are deemed to have granted leave to appeal.
II.
The bankruptcy court concluded that Distributors raised only the defense of setoff. In support of that conclusion, Canners asserts that Distributors, by labelling its claim a “credit” or “setoff,” either waived the recoupment argument or is barred from asserting it.
In determining whether Canners was entitled to summary judgment, the bankrupt*22cy court should have considered, and both the majority and I do consider by way of this de novo review, Distributors' recoupment argument. Whether that argument is viewed as an affirmative defense or a counterclaim, see 2A Moore’s Federal Practice ¶ 8.27[3] (2d ed. 1985) (noting usage of common law recoupment as both a compulsory counterclaim and an affirmative defense under the Federal Rules of Civil Procedure), Distributors failure to label their well pleaded claim as a “recoupment” was an insufficient reason for the court to ignore the argument. Cf. Fed.R.Civ.P. 8(c) (when a party mistakenly designates a counterclaim as a defense or a defense as a counterclaim, the court shall treat the pleading as if there had been a proper designation if justice so requires); Alexander v. Unification Church of America, 634 F.2d 673, 678 (2d Cir.1980) (dismissal of mislabelled count of complaint improper under the liberal rules of federal pleading). Under the Federal Rules of Civil Procedure and Bankruptcy Rules, all pleadings are to be construed so as to do substantial justice. Fed.R.Civ.P. 8(f). “The Federal Rules reject the approach that pleading is a game of skill in which one misstep by counsel may be decisive to the outcome and accept the principle that the purpose of pleading is to facilitate a proper decision on the merits.” Conley v. Gibson, 355 U.S. 41, 48, 78 S.Ct. 99, 103, 2 L.Ed.2d 80 (1957).
III.
In contrast to the majority, I find it unnecessary to determine if a question of fact exists regarding the availability of recoupment. In my view Quittner v. Los Angeles Steel Casting Co., 202 F.2d 814 (9th Cir.1953) prohibits Distributors’ proposed use of recoupment.
In Quittner, a purchaser advanced $15,-000 to pay for scrap already delivered and to be delivered by a corporation. Prior to the seller’s assignment for the benefit of creditors, $6,202.44 worth of scrap had been delivered to the purchaser. After the assignment, the assignee made two shipments of scrap worth $3,011.76. The corporation was subsequently adjudicated an involuntary bankrupt. The bankruptcy trustee then sued the purchaser for the value of the two shipments worth $3,011.76. The purchaser made a “cross-claim” for the balance of the $15,000 advance and prevailed at trial.
The Ninth Circuit reversed. It concluded that this was a matter of recoupment and not a setoff governed by former Section 68 of the Bankruptcy Act of 1898. Given the purchaser’s status as a general creditor, the Ninth Circuit stated:
Scrap was eventually shipped to [the purchaser] by the assignee, but by this time the $15,000 advance had, as a legal effect of the assignment, lost its identity in the common fund for the benefit of all general creditors which was being administered by the assignee. Under these circumstances we think an assignee for the benefit of creditors stands for the purposes here involved in the same position as a court appointed receiver or trustee in bankruptcy. To accept appel-lee’s contentions would in effect grant to it a preference and prevent the other creditors from obtaining a fair and ratable distribution of the debtor’s assets.
Appellee complains that, if the theory of the trustee in bankruptcy be accepted, it will be forced to “pay twice” for the same goods. This is not quite correct. It pays once for the scrap but, because of circumstances, the money which it originally intended to use in payment has lost its identity as such by operation of law and has become part of a general fund to be administered by the trustee in bankruptcy in the interest of all creditors.
Quittner, 202 F.2d at 817 (emphasis added).
I read Quittner as establishing the rule that a general creditor’s claim which arises prior to an assignment for the benefit of creditors or the appointment of a receiver or a bankruptcy trustee cannot be used to recoup a claim of the assignee, receiver, or bankruptcy trustee brought against the general creditor. Since a debtor in possession essentially performs the same role as a trustee, see 11 U.S.C. § 1107(a), the Quittner rule also applies to creditors’ *23claims arising before the debtor in possession’s creation upon the filing of the bankruptcy petition, see 11 U.S.C. §§ 101(12), 1101(1).
To allow recoupment of a prepetition claim against the claim of the trustee or debtor in possession would enable the recouping general creditor to receive full payment on the creditor’s claim up to the amount of the trustee’s or debtor in possession’s claim. Recoupment does not allow affirmative assertion of the recouping party’s claim above the amount of the opposing party’s claim. Frederick v. United States, 386 F.2d 481, 487 (5th Cir.1967). Full payment of all or part of a claim would be a preference over other general creditors who, unless given special treatment under the Bankruptcy Code, would typically be paid less than 100% on their claim through a Chapter 7 liquidation or a Chapter 11 or 13 plan. But c.f. 4 Collier on Bankruptcy ¶ 553.03 (15th ed. 1985) (“There is no element of preference ... or of an independent claim to be offset [in recoupment], but merely an arrival at just and proper liability on the main issue.” Collier’s appears to be referring to preference in the technical sense of an avoidable preference under 11 U.S.C. § 547 rather than to the general preference in distribution described in Quittner.)
Thus, even assuming Distributors is correct in arguing that a question of fact exists as to whether its claim and Canners’ claim arose under the same contract and thus from the same transaction, Quittner makes the question immaterial because it prohibits Distributor’s attempted use of re-coupment.
I recognize that other courts addressing the issue have not similarly curbed the use of recoupment. See Ashland Petroleum v. Appel (In re B & L Oil), 782 F.2d 155 (10th Cir.1986) (allowing recoupment of a creditor’s prepetition claim against a trustee’s claim and collecting similar cases).
It has been said that “[t]he justification for the recoupment doctrine is that where the creditor’s claim against the debtor arises from the same transaction as the debtor’s claim, it is essentially a defense to the debtor’s claim against the creditor rather than a mutual obligation, and application of the limitations on setoff [now found in 11 U.S.C. § 553] would be inequitable.” Lee v. Schweiker, 739 F.2d 870, 875 (3d Cir.1984).
I find this justification unpersuasive. To support its statement the Lee court cited In re Monongahela Rye Liquors, 141 F.2d 864 (3d Cir.1944), which noted that the right to recoupment did not arise from the setoff provisions of former Section 68. However, in Monongahela Rye Liquors the bankruptcy trustee attempted to recoup against the claim of the Commonwealth of Pennsylvania in order to avoid the bar of sovereign immunity and there was no problem of preferential distribution to a creditor. Equality of distribution among creditors of the debtor is one of the primary goals of the bankruptcy laws. E.g., Joint Industry Board of the Electrical Industry v. United States, 391 U.S. 224, 228, 88 S.Ct. 1491, 1493, 20 L.Ed.2d 546 (1968); 4 Collier on Bankruptcy ¶ 547.03[1] (15th ed. 1985). To say that it would be inequitable to apply 11 U.S.C. § 553’s limitations on setoff to recoupment is to fail to understand that Congress has carved out a limited exception to the rule of equal distribution by allowing setoff in the first place. See 4 Collier on Bankruptcy ¶ 553.02 (15th ed. 1985). Inferring that Congress intended to allow a general creditor to recoup his claims unconstrained even by the limits on setoff simply because recoupment, by definition, is not a setoff cuts directly against the equal distribution policy of the bankruptcy laws. I think the inference is incorrect. As the Supreme Court has noted, “ ‘The broad purpose of the Bankruptcy Act is to bring about an equitable distribution of the bankrupt’s estate....’ Kothe v. R.C. Taylor Trust, 280 U.S. 224, 227, 74 L.Ed. 382, 385, 50 S.Ct. 142 [143], and ‘... if one claimant is to be preferred over others, the purpose should be clear from the statute.’ Nathanson v. NLRB, 344 U.S. 25, 29, 97 L.Ed. 23, 29, 73 S.Ct. 80 [83].” United States v. Embassy Restaurant, 359 U.S. 29, 31, 79 S.Ct. 554, 555, 3 L.Ed.2d 601 (1959); accord County Sanitation District No. 2 v. Lor*24ber Industries of California, 675 F.2d 1062, 1065-66 (9th Cir.1982). That rule applies equally under the Bankruptcy Code. I am unable to find any statutory authorization for granting preferential treatment to a general creditor solely because that creditor’s claim arose from the same transaction as the trustee’s or debtor in possession’s claim.
Recoupment has already been justified by analogy to the treatment of executory contracts in bankruptcy. Ashland Petroleum Co. 782 F.2d at 157. The theory advanced is that if the debtor takes advantage of the favorable aspects of the contract postpetition then the debtor must bear the unfavorable prepetition burdens of the contract. United States v. Midwest Service and Supply (In re Midwest Service and Supply), 44 B.R. 262 (D.Utah 1983); In re Yonkers Hamilton Sanitarium Inc., 22 B.R. 427 (Bankr.S.D.N.Y.1982), aff'd, Sapir v. Blue Cross/Blue Shield (In re Yonkers Hamilton Sanitarium), 34 B.R. 385 (S.D.N.Y.1983).
I disagree with these cases to the extent that they hold that the debtor’s continuance of a business relationship with the creditor justifies statutory, contractual, or common law recoupment of prepetition contract claims in the absence of court approved assumption of the contract. Congress has clearly authorized full satisfaction of valid prepetition claims for defaults by the debtor under an executory contract when the contract is assumed. 11 U.S.C. § 365(b)(1). I find no congressional authorization for preferential treatment of a contracting party’s prepetition claims in the absence of court approved assumption of the contract. Another shortcoming of the executory contract analogy is that recoupment is not limited to executory contracts or contracts at all for that matter. See 29 AmJur2d Counterclaim, Recoupment, Etc. § 17 (2d ed. 1965).
I believe that a creditor’s right to recovery of prepetition contract overpayments, which was the problem faced in Ashland Petroleum Co., Midwest Service and Supply, and Sapir, could be handled in a fashion consistent with the purposes of the Bankruptcy Code by application of constructive trust principles, see, e.g., N.S. Garrott & Sons v. Union Planters National Bank (In re N.S. Garrott & Sons), 772 F.2d 462 (8th Cir.1985) (discussing the role of constructive trusts in bankruptcy), in the event the contract is not assumed.
Finally, I note that it does not appear that Quittner would allow a creditor to assert a recoupment defense even when setoff of mutual prepetition claims, between a creditor and the estate would be permissible under 11 U.S.C. § 553. It seems inequitable to prohibit recoupment in that situation solely because of the fortuitous circumstance that the claims arose from the same transaction rather than separate transactions. Here, we are not faced with that unfairness because Distributors cannot setoff its prepetition claim against Canners’ postpetition claim. 11 U.S.C. § 553(a). The harder case will be decided another day.
For the reasons stated, I would affirm the bankruptcy court’s judgment.