One Big Government Family The Unitary Creditor Doctrine Under 553

One Big Government Family The Unitary Creditor Doctrine Under 553

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Section 553 of the Bankruptcy Code recognizes that except as provided in that section, title 11 of the U.S. Code does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor if the mutual debts arose prior to the commencement of the bankruptcy case. When more than one department, agency or instrumentality of the federal or state government are creditors in a bankruptcy case, the issue of whether those entities ought to be considered a single creditor for purposes of §553 must be considered. Although within the last few years four circuit courts of appeal have concluded that various governmental entities should be treated as a single or unitary creditor under §553, not all circuit courts have opined on the issue. This article analyzes the legal authorities that have grappled with the unitary government creditor issue in the context of set-offs and considers points relevant to the breadth to which such doctrine should be applied.

Often cited as the seminal case recognizing that separate government entities should be considered as a unitary creditor is Cherry Cotton Mills Inc. v. United States, 327 U.S. 536, 105 Ct. Cl. 824, 665 S. Ct. 729, 90 L.Ed. 835 (1946), a non-bankruptcy case. In Cherry Cotton Mills the petitioner was entitled to a refund under the Agricultural Adjustment Act and it owed the Reconstruction Finance Corp. (RFC) a balance on a promissory note. The General Accounting Office directed the Treasury to effect a set-off.1 The petitioner contended that the court of claims had no jurisdiction because the RFC was, in essence, a private corporation. In concluding that the RFC was in fact a government agency, although it used the word "corporation" in its name, the U.S. Supreme Court considered the following factors: (i) the directors were appointed by the president and confirmed by the Senate; (ii) its activities were all aimed at accomplishing a public purpose; (iii) all of the funding for the RFC came from the federal government; and (iv) its profits, if any, were paid to the government, and its losses had to be borne by the government. Id. at 536. The critical factor was that the RFC was "selected by government to accomplish purely governmental purposes." Id. at 536.

Courts that have applied Cherry Cotton Mills to support holdings that governmental entities should be treated as a single creditor for purposes of §553 have not scrutinized the entities by specifically applying the four factors described in the opinion, and only rarely have analyzed the nature of any "governmental purpose," much less whether such purpose was "purely" governmental. With the ever-expanding government bureaucracy, including the plethora of quasi-governmental entities (e.g., Pension Benefits Guarantee Corp., Securities Investor Protection Corp.), greater attention should be given to an analysis of whether a government department, agency or instrumentality actually accomplishes a "purely governmental purpose." If the entity fails that test, it should not be included as part of the governmental single creditor.

Authorities exist in each circuit (although not necessarily at the court of appeals level) that various government entities should be considered to be a single creditor for purposes of §553. Arguments that the definition of "governmental unit" (§101(27)) reflects an intent by Congress that departments, agencies and instrumentalities of the United States constitute separate units (i.e., creditors), and therefore should not be consolidated for purposes of §553, have been rejected. The obvious lack of clarity of the definition often has been ignored, or Cherry Cotton Mills has merely been cited without analysis as authority for how the Code's definition should be interpreted.

Recently the Seventh Circuit Court of Appeals added that circuit to the unitary government creditor fold with U.S. v. Maxwell, 157 F.3d. 1099 (7th Cir. 1998). Reversing the lower court, the circuit court concluded that no exception to the right of set-off existed based on the "pervasive nature" of the federal government. Both the bankruptcy and district courts had concluded that because there are so many agencies, if they were considered to be one creditor the federal government would be substantially more likely to be able to enjoy the extraordinary benefits of set-off, and that to permit such agency consolidations would be inequitable to the other creditors. Although set-off can be denied under the Code for equitable reasons, the circuit court rejected the argument that the mere size of the government with its numerous entities supported denial of the right to interagency set-off.

In 1996, the Second Circuit in Aetna Casualty & Surety Co. v. LTV Steel Co. Inc. (In re Chateaugay Corp.), 94 F.3d 772 (2nd Cir. 1996) adopted the unitary government creditor approach when it, in essence, rejected the reasoning set forth in In re Ionosphere Clubs Inc., 164 B.R. 839 (Bankr. S.D.N.Y. 1994). Chief Judge Lifland in Ionosphere Clubs had followed the analysis in Illinois v. Lakeside Community Hosp. Inc. (In re Lakeside Community Hosp. Inc.), 151 B.R. 887 (N.D. Ill. 1993) that (i) only "a creditor" has a set-off right, (ii) a creditor, under §101(10), is an "entity" with a claim, (iii) an entity includes a "governmental unit," and (iv) a "governmental unit" is the United States or a department, agency or instrumentality of the United States. Judge Lifland concluded that units of the government were intended by Congress to be treated as separate entities and not consolidated into the same creditor. In its decision on appeal in Chateaugay, the Second Circuit, relying in part on Cherry Cotton Mills, held that tax refunds could be set off against non-tax liabilities. Chateaugay was recently followed in In re Whimsey Inc., 221 B.R. 69 (S.D.N.Y. 1998), reversing the bankruptcy court, which had relied on Ionosphere Clubs. The district court, noting that recent opinions by the Courts of Appeals in the Ninth and Tenth Circuits applied Cherry Cotton Mills in the context of bankruptcy cases, held that the Internal Revenue Service (IRS) and the Customs Services were government agencies that were considered for purposes of §553 to be a single unitary creditor.

The Ninth Circuit in Hal Inc. v. U.S. (In re Hal Inc.), 122 F.3d 851 (9th Cir. 1997), a case raising set-off issues among the IRS, Federal Aviation Administration, Defense Finance Accounting Service, National Finance Center and Immigration and Naturalization Service, relied on its decision in Doe v. U.S., 58 F.3d 494 (9th Cir. 1995) to reach its conclusion that all the entities were a single "governmental unit."2 Hal, supra at 853. However, it is interesting to note that Doe, an opinion regarding sovereign immunity, specifically held that a government-created entity should not be consolidated if the entity functioned in a "distinct private capacity." Doe, supra at 498. An example of an entity established by Congress that was not to be consolidated under the unitary creditor doctrine was the Federal Deposit Insurance Corp. when it acted as a private receiver.

In 1996, the Tenth Circuit, relying on Cherry Cotton Mills, held in Turner v. SBA (In re Turner), 84 F.3d 1294 (10th Cir. 1996) (en banc) that the Small Business Administration (SBA) and the Agricultural Stabilization and Conservation Service were a single creditor for purposes of §553. The circuit court could find no reason that the unitary creditor doctrine should not apply with respect to set-offs in a bankruptcy case. Although accepting the debtor's argument that the definition of "governmental unit" reflects that the Bankruptcy Code recognizes a difference between the United States and agencies of the federal government, the court found that the unitary creditor approach applied under §553 "comports with the language of the section and avoids any inconsistencies between the set-off provisions of the Bankruptcy Code and 31 U.S.C. §3716(a), the statutory grant of the right to collect debts by administrative offset." Turner, supra at 1298.

While it is not subject to dispute that the unitary government creditor doctrine has been pervasively adopted by the federal courts,3 merely because a nexus exists between an entity and the federal government does not conclusively establish that the entity constitutes a department, agency or instrumentality that will support consolidation of that entity with another government entity to become a unitary creditor for purposes of being entitled to exercise set-off rights under §553. A court should consider whether the entity is functioning for a "purely governmental purpose" (see Cherry Cotton Mills) or is actually performing a non-governmental role. Parties opposing the set-off claims of governmental entities claiming a right to apply the unitary creditor doctrine might be able to raise significant questions about whether at least one of the entities is satisfying a governmental purpose. Such a question raises interesting philosophical issues about what the federal government's purpose is. With the breadth of the federal government, an increasing number of entities created by the legislative and the executive branches of government might not withstand scrutiny regarding their governmental purpose to qualify for consolidation with other governmental entities.

Another interesting issue raised by the application of the unitary creditor doctrine is its application outside of the federal and state government context. Could agencies of a foreign state also use the doctrine?4 Can a federally chartered credit union be consolidated for set-off purposes with the IRS? A federal credit union has been held to be a governmental instrumentality, although such institutions are not owned or operated by the United States. In re Trusko, 212 B.R. 819 (Bankr. D. Md. 1997). Although they are independent financial institutions, is their "governmental purpose" enough to bring them into the unitary creditor fold? Whether a government-related entity is actually carrying out a government function to fulfill a purely governmental purpose is likely to lead to continuing litigation regarding the application of the unitary governmental creditor doctrine in the context of setoffs under §553. The family of departments, agencies and instrumentalities of the federal government is large, but some of the distant cousins might not get invited to the set-off reunion.


1 The opinion interprets 28 U.S.C. §250, which specifically provided that the court of claims had jurisdiction to hear and determine set-offs "on the part of the government of the United States against any claimant against the government in said court." Return to article

2 Other decisions in the Ninth Circuit that had previously held that separate government agencies were a single creditor under §553 are In re Gibson, 176 B.R. 910 (Bankr. D. Ore. 1994) and In re Mohar, 140 B.R. 273 (Bankr. D. Mont. 1992). In light of Hal, the opinion of Westamerica Bank v. U.S., 178 B.R. 493 (N.D. Cal. 1995) (mutuality to support a set-off did not exist among the Maritime Administration (Department of Transportation), IRS, Environmental Protection Agency and the United States) no longer appears to have precedential value. Return to article

3 1st Circuit: Lopes v. U.S. Dept. of Housing and Urban Development (In re Lopes), 211 B.R. 443 (D. R.I. 1997); 2nd Circuit: Chateaugay, supra, Whimsey, supra; 3rd Circuit: See Sacred Heart Hospital of Norristown v. Commonwealth of Pennsylvania Dept. of Welfare (In re Sacred Heart Hospital of Norristown), 199 B.R. 129 (Bankr. E.D. Pa. 1996) rev. on other grounds, 204 B.R. 132 (E.D. Pa. 1997), aff'd 133 F.3d (3rd Cir. 1998); 4th Circuit: In re A. J. Nielson, 90 B.R. 172 (Bankr. W.D.N.C. 1988); 5th Circuit: In re Young, 144 B.R. 45 (Bankr. N.D. Tex. 1992), In re Fryar, 93 B.R. 101 (Bankr. W.D. Tex. 1998); 6th Circuit: In re Holder, 182 B.R. 770 (Bankr. M.D. Tenn. 1995), In re Stall, 125 B.R. 754 (Bankr. S.D. Ohio 1991), In re Julien Company, 116 B.R. 623 (W.D. Tenn. 1990), 7th Circuit: Maxwell, supra; 8th Circuit: Kalenze v. Federal Crop Ins. Corp. (In re Kalenze), 175 B.R. 35 (Bankr. D. N.D. 1994); In re Gore, 124 B.R. 75 (Bankr. E.D. Ark. 1990); 9th Circuit: Hal, supra, In re Gibson, 176 B.R. 910 (D. Ore. 1994), In re Mohar, 140 B.R. 273 (Bankr. D. Mont. 1992); 10th Circuit: Turner, supra; 11th Circuit: In re Lykes Bros. Steamship Co. Inc., 217 B.R. 304 (Bankr. M.D. Fla. 1997); In re Reed, 179 B.R. 353 (Bankr. S.D. Ga. 1995). Return to article

4 A "governmental unit" as defined in §101(27) includes the agency of a foreign state. In re Rimsat Ltd., 196 B.R. 791 (N.D. Ind. 1995). Return to article

Journal Date: 
Thursday, April 1, 1999