698 F.2d 42 (1st Cir. 1983), 82-1420, In re Saugus General Hosp.

Docket Nº:82-1420.
Citation:698 F.2d 42
Party Name:In re SAUGUS GENERAL HOSPITAL, INC., Debtor. Philip L. SISK, Receiver of Saugus General Hospital, Plaintiff, Appellee, v. SAUGUS BANK AND TRUST COMPANY, Defendant, Appellant.
Case Date:January 20, 1983
Court:United States Courts of Appeals, Court of Appeals for the First Circuit
 
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Page 42

698 F.2d 42 (1st Cir. 1983)

In re SAUGUS GENERAL HOSPITAL, INC., Debtor.

Philip L. SISK, Receiver of Saugus General Hospital,

Plaintiff, Appellee,

v.

SAUGUS BANK AND TRUST COMPANY, Defendant, Appellant.

No. 82-1420.

United States Court of Appeals, First Circuit

January 20, 1983

Argued Nov. 3, 1982.

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James R. DeGiacomo, Boston, Mass., with whom Susan J. Baronoff, and Roche, Carens & DeGiacomo, Boston, Mass., were on brief, for Saugus Bank and Trust Co.

Anthony M. Feeherry, Boston, Mass., with whom Jon D. Schneider, Marjorie R. Corman, and Goodwin, Procter & Hoar, Boston, Mass., were on brief, for Philip L. Sisk.

Before BROWN, [*] Senior Circuit Judge, BOWNES and BREYER, Circuit Judges.

BREYER, Circuit Judge.

This bankruptcy appeal requires us to determine the setoff rights of a secured creditor under Massachusetts law. The creditor-appellant, Saugus Bank and Trust Co. ("the Bank"), set off about $83,000 contained in a general account and a payroll account of the debtor, Saugus General Hospital ("the Hospital"), against a $134,000 Hospital debt that was secured by a mortgage on the Hospital facility itself. The Hospital's receiver, Philip Sisk, contested the setoff and sued to recover the deposits. In our view, Massachusetts law allowed the Bank to set off funds from the Hospital's general account, to the extent that the Bank reasonably believed that the security it held was inadequate to pay the outstanding Hospital debt. We remand this case to the bankruptcy court for application of this principle to the facts.

I

In early 1967, the Bank loaned the Hospital $200,000, to be repaid over fifteen years at 6 percent interest. The loan was secured by a first mortgage on real property, namely the 110-bed facility and adjacent land in Saugus. The Hospital, in and out of default over the years, stopped paying the Bank entirely after September 1977. On July 20, 1978, the Bank informed the Hospital that it would foreclose on the mortgage. On August 19, 1978, the Hospital's directors voted to close the facility and dissolve the corporation. Nine days later, on August 28, the Bank took the steps at issue here.

On August 28, the Hospital owed the bank $134,775.77 on its mortgage loan. On the same day, the Hospital had on deposit with the Bank the following amounts in three separate accounts: $63,261.40 in a general account; $20,006.68 in a payroll account; and $388.84 in a tax account. The Bank simply debited the three accounts for the amounts they contained and credited its own treasurer's account with the total sum, namely $83,656.92. There is testimony it did this because it believed that the Hospital could not pay what it owed and that the foreclosure would not bring in enough money to cover the debt. Immediately after it learned what the Bank had done, the Hospital wrote a check for about $31,000 to transfer money out of its general account, but the Bank refused to honor the check.

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Three days later an involuntary bankruptcy petition was filed against the Hospital. The Hospital stopped operating altogether on September 6. The sale of its property was not completed, however, for another sixteen months. By that time, enough taxes (and possibly other priority expenses) had accrued so that the Bank received only $6,500 from its first mortgage foreclosure sale. In the meantime, the receiver had begun an action in the bankruptcy court to recover from the Bank the money that the Hospital had had on deposit.

The bankruptcy court held for the receiver as to the funds in the payroll account. It concluded that the Bank could not set off such "special purpose" funds. It held against the receiver, however, as to the funds in the general account. It reasoned that, under Massachusetts law, a bank can set off funds only if it has good reason to believe that its security is inadequate, but that here the Bank had such reasons. The court did not ask the further question whether the Bank had set off more money than was necessary to make up for the security's inadequacy. The court thought that Massachusetts law did not require this inquiry and that a bank whose security was inadequate in any amount could set off the full amount of a debtor's deposits (up to the amount of the debt). Finally, because the receiver waived all claims to the $388 in the tax account, the court did not consider the propriety of that setoff.

The receiver appealed to the district court, where he won a larger recovery. The district court held that the Bank, as a secured creditor, could set off nothing unless it had an objective basis for believing that the security was inadequate. The court stated that the Bank should have had the security, the Hospital's property, appraised before setting off any Hospital funds. And, since the Bank had not conducted such...

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