Arbitration Provision Enforcement
State Law Setoff Right Subject to "Mutuality"
In re New Haven Foundry Inc., 285 B.R. 646 (Bankr. E.D. Mich. 2002), Chief Bankruptcy Judge Steven W. Rhodes addressed an interesting twist on the right of setoff. State law governs the substance of the right of setoff claims. However, the state law right of setoff is subject to the bankruptcy requirement of "mutuality," which mandates that the debts must be owed between the same parties acting in the same capacity but, as the court noted, not necessarily the same character. In this case, the debtor's obligation to a creditor originated as a debt owed by the debtor to its subsidiary. Pre-petition, the debt owed to the subsidiary had been assigned to the creditor as part of an assignment of the debtor's accounts. The creditor filed a motion for relief from stay to exercise the right of setoff of the assigned debt against a debt that the creditor owed to the debtor. A third party creditor asserted that it had a perfected security interest in all inventory, accounts, contract rights and accounts receivable, including the amounts owed to the debtor by the creditor requesting the right of setoff. The secured creditor unsuccessfully contended that because its lien was "paramount," any asserted interest of the creditor seeking the right of setoff should be denied. The secured creditor also unsuccessfully argued that the mutuality requirement was not satisfied. The court found that under the applicable version of the UCC, a right of setoff prevails over perfected security interests unless the account debtor had actual notice of the security interest before the setoff right arose.
Breach of Contract Claim Against Insurer a Pre-petition Claim
In In re Roberds Inc., 285 B.R. 651 (Bankr. S.D. Ohio 2002), Bankruptcy Judge Thomas F. Waldron addressed another issue related to the right of setoff. The court held that a debtor's breach of contract claim against an insurer for refusing to pay a claim under a pre-petition insurance contract arising from an alleged pre-petition theft by debtor's employees was a "pre-petition claim" for purposes of setoff in bankruptcy, although the debtor did not file a proof of claim of loss until after the bankruptcy. Since the claim was not made until after the bankruptcy petition was filed, the insurer did not deny claim until after the commencement of the chapter 11 case. The insurer was held to have the right to setoff indemnification claims against its alleged contract liability on the insurance policy.
Dischargeability Objection to Corporate Officers' Bankruptcies
In In re Ridsdale, 286 B.R. 225 (Bankr. W.D.N.Y. 2002), Bankruptcy Judge Michael Kaplan considered an objection to dischargeability in corporate officers' individual bankruptcy cases. Corporate funds were used for personal expenses, including payments on a truck owned by an officer, work on that officer's house, payments on a mortgage and payments on another officer's race car trailer. There was evidence that one of the debtors was aware of the other officers' "abuse" and that it was "okay" with him. The court also found that one debtor "shrewdly assuaged—defused—the concerns of other officers in order to facilitate diversion of this company's assets and value." During this relevant time period, the officers/debtors formed a separate corporation in Florida, and significant amounts of equipment and vehicles went to Florida to be used by the new Florida corporation. The corporation whose equipment and funds were improperly used never actually filed bankruptcy. The objection to dischargeability was on the grounds of willful and malicious injury to a creditor of the corporation. The court noted that there is no comparative negligence or assumption of the risk in a case of willful and malicious injury since "virtually by definition, one never assumes the risk of willful and malicious injury." The court noted that the fiduciary duty of the principals to the creditors of insolvent corporation is clear. Relying on the Supreme Court decision of In re Geiger, 523 U.S. 57 (1998), the court found that after the plaintiff/creditor acquired a lien on the assets of the corporation, there was an intentional diversion of the assets of that corporation to the personal benefit of debtors/defendants/ officers. The diversion constituted an injury to "property" in which the plaintiff/creditor had an interest. The court noted that there are a number of ways to cause willful and malicious injury to "another entity," including trespassing, vandalizing equipment, interfering with contracts, defaming, doing bodily injury or using economic power to start a competing business, or using political or other influence to see that contracts were not awarded or instigate labor unrest. The court held that the "means may be [a] combination of facts that individually might be lawful and might not injure any of the properties, or injure any of the property interests, but collectively are 'wrongful' and thus non-dischargeable. This is because the statute does not say 'by unlawful means,' does not say 'by means of intentional tort' and does not require an injury to property."
Unexpired Leases Can Be Sold
In re Ames Department Stores Inc., 287 B.R. 112 (Bankr. S.D.N.Y. 2002), relates to a motion to approve the sale of "designation rights" that were described as "the right to direct the debtors to assume and assign unexpired leases to third parties qualifying under the Bankruptcy Code, after such non-end users locate ultimate purchasers of the unexpired leases." After a discussion and analysis under §§363(b) and 541(a)(1), the court held that the "designation rights" were valuable property rights of the estate that could be sold. Further, the sale of such rights would not result in an exemption from the requirements of §365 of proposed assignment of the leases, and if applicable, the assumption of a particular lease. The court noted that it had been provided with 15 orders in other cases around the country approving the sale of "designation rights." While this was in no way determinative of the court's analysis, the court did recognize it as persuasive value. The court reviewed extensively what it referred to as "the only two reported decisions that have addressed the matter:" In re Ernst Home Ctr. Inc., 209 B.R. 974 (Bankr. W.D. Wash. 1997), appeal dismissed, BC Brickyard Assoc. Ltd. vs. Ernst Home Ctr. Inc. (In re Ernst Home Ctr. Inc.), 221 B.R. 243 (9th Cir. BAP 1998); Ernst-B.A.P., 221 B.R. at 248-256 (Russell, J. concurring). The court found that the debtors were not transferring their powers to actually assume and assign unexpired leases. Rather, the debtors were realizing the value inherent in the ability to designate for whose benefit and to whom any such lease would be assumed and assigned. However, any such designation still would have to be brought to the bankruptcy court for review under the powers which, at the time, would be exercised under §365, "subject to the usual requirements for a debtor's exercise of business judgment and notice and opportunity for parties in interest to be heard, bankruptcy courts can accommodate evolving ways to maximize value for creditors."
- In re Pasta Café Corp., 284 B.R. 564 (Bankr. D. Md. 2002) (pre-petition personal property taxes were not entitled to be treated as administrative expense or to be paid on an eighth-level priority basis as taxes were secured by personal property and the priority provision was limited to unsecured tax claims);
- In re Feltman, 285 B.R. 82 (Bankr. D. D.C. 2002) (disagreeing with In re Dececco, 224 B.R. 202 (Bankr. N.D. Fla. 1998), the court held that Bankruptcy Rule 1014(b) cannot be invoked by the bankruptcy court to transfer to itself a case that was filed by a chapter 7 debtor's wife in another jurisdiction);
- In re Stinson, 285 B.R. 239 (Bankr. W.D. Va. 2002) (probation against discrimination with respect to employment contained in §525(b) does not include act of refusing to hire but termination or discrimination with only respect to current employment); and
- In re Silicon Valley Telecom Exchange LLC, 284 B.R. 700 (Bankr. N.D. Cal. 2002) (good discussion of the difference between setoff and recoupment in contractual relationships).