In re Harmon

• Decision Date: 25 October 1995
• Docket Number: BAP No. OR-93-2179-VHAs. Bankruptcy No. 392-35798-H7. Adv. No. 93-3422.
• Parties: In re Verda Kathlyn HARMON, Debtor. STATE of Oregon, acting By and Through SAIF CORP., Appellant, v. Verda Kathlyn HARMON, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

188 B.R. 421 (1995)

In re Verda Kathlyn HARMON, Debtor.

STATE of Oregon, acting By and Through SAIF CORP., Appellant, v. Verda Kathlyn HARMON, Appellee.

BAP No. OR-93-2179-VHAs. Bankruptcy No. 392-35798-H7. Adv. No. 93-3422.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted June 22, 1995.

Decided October 25, 1995.

Daniel H. Rosenhouse, Portland, OR, for Appellant.

Michael A. Gilbertson, Portland, OR, for Appellee.

Before VOLINN, HAGAN and ASHLAND, Bankruptcy Judges.

OPINION

VOLINN, Bankruptcy Judge:

OVERVIEW

Appellant, State Accident Insurance Fund Corporation (SAIF), is liable to the debtor for compensation for a permanent partial disability she suffers due to a work-related injury. SAIF seeks to reduce the amount of the award by a sum equal to an excess of temporary disability payments which SAIF overpaid to the debtor on her claim.¹ On cross-motions for summary judgment, the bankruptcy court determined that the overpayments could not constitute a setoff under 11 U.S.C. § 553,² nor could SAIF deduct the overpayments by way of recoupment. It entered a declaratory judgment to that effect. We REVERSE.

FACTS AND PROCEEDINGS BELOW

On May 30, 1987, Verda Kathlyn Harmon filed a claim under Oregon's Workers' Compensation Law, O.R.S. §§ 656.001 et seq., arising from an injury she received in a work-related accident on February 25, 1985. SAIF, which acts for the State of Oregon in regard to workers' compensation, responded to Ms. Harmon's claim by paying her temporary disability or "time-loss" payments. SAIF continued to make time-loss payments through April 15, 1992, for a total of $28,495. The State of Oregon ultimately determined that a substantial portion of this amount, $10,436.67, was an overpayment.

Under Oregon law, SAIF is entitled to "credit"³ the amount of such overpayment against a permanent disability award. In June 1992, SAIF issued Ms. Harmon a notice of case closure which stated that she had not sustained any permanent injury. The notice of closure commenced the state proceedings which led to a finding of overpayment referred to above. These proceedings were ongoing at the time debtor filed her chapter 13 petition on August 28, 1992.

SAIF's right to reduce the amount of any permanent disability award by the amount of excess time-loss payments was first presented to the bankruptcy court in a motion for civil contempt, filed by the debtor in December 1992. The motion alleged that SAIF had violated the automatic stay of § 362 and the permanent injunction of § 524 by asserting a right of recoupment against the debtor's right to an as yet undetermined permanent disability award. In the reply memorandum to the motion for civil contempt, debtor's counsel stated that, absent recoupment by SAIF, the debtor would be entitled to some $15,000 in permanent partial disability funds.

The debtor dismissed this proceeding voluntarily, but revisited the issue by way of a motion in which she sought a declaratory judgment that withholding of any portion of a permanent award would violate the stay. For various procedural reasons, the parties and the court determined that a ruling on the issue was not necessary at that time. Instead of entering a formal disposition of the motion, Bankruptcy Judge Hess drafted a letter opinion, dated June 22, 1993, which stated that in his view, if SAIF reduced a permanent disability award, it would violate the automatic stay. The court's analysis was based on its reading of Lee v. Schweiker, 739 F.2d 870 (3rd Cir.1984), a case that barred the government from offsetting or recouping prepetition overpayments of social security benefits from benefits due to the debtor postpetition.

The debtor converted her case to one under chapter 7 on May 13, 1993, and it was assigned to Bankruptcy Judge Sullivan. On July 8, 1993, SAIF filed a complaint for declaratory relief to resolve whether it was entitled to credit its alleged overpayment of time-loss benefits against a permanent award to which the debtor might be entitled. The parties brought cross-motions for summary judgment. While articulating some reservations about the letter opinion, Judge Sullivan adopted its conclusion in favor of the debtor. The judgment provided that SAIF could not recover excess temporary disability payments from any future permanent disability award.⁴ SAIF filed this timely appeal on September 22, 1993.

In February 1994, a BAP panel determined that the issue presented was not ripe for review because no permanent award had yet been established. Accordingly, it dismissed the appeal without prejudice to reinstatement. In November 1994, the Workers' Compensation Board of the State of Oregon issued its order. The Board adopted a state referee's permanent disability award and affirmed his finding that the debtor had become "medically stationary" on May 18, 1991. The Board authorized SAIF to "offset" the excess temporary disability payments as of that date against the permanent disability payment due. The debtor did not appeal the order of the Workers' Compensation Board. SAIF reinstated the instant appeal in January 1995.

STANDARD OF REVIEW

The doctrines of setoff and recoupment are equitable in nature, and their use by the bankruptcy court is permissive. As such, the court's decision is reviewed for an abuse of discretion. In re Pieri, 86 B.R. 208, 210 (9th Cir. BAP 1988).

ISSUE PRESENTED

Whether the bankruptcy court abused its discretion by denying SAIF the right to deduct the amount of excess temporary disability payments made prior to the filing of the bankruptcy petition from the debtor's permanent disability award.

DISCUSSION

I.

Setoff and recoupment originated as equitable rules of joinder to expand the strict rules of pleading under the common law, allowing creditors to offset mutual and reciprocal debts with the debtor. In bankruptcy, the doctrine of setoff is governed by § 553,⁵ and its application is restricted by the automatic stay of § 362(a)(7).⁶

Analysis of the difference between setoff and recoupment in a given transaction does not easily lend itself to a bright-line resolution. Compare, for example, the holding of In re California Canners and Growers, 62 B.R. 18 (9th Cir. BAP 1986), with that of In re B & L Oil Co., 782 F.2d 155 (10th Cir. 1986). California Canners concluded that various claims arising under an ongoing distribution agreement constituted a series of separate transactions for the purpose of determining whether recoupment could be applied and, accordingly, refused to allow recoupment between pre- and post-petition claims. B & L Oil reached the opposite result under similar circumstances and allowed recoupment of prepetition overpayments from post-petition purchases performed under an ongoing oil purchase agreement.

Although the terms have come to be used somewhat interchangeably, there are distinctions which remain relevant in bankruptcy. Setoff allows adjustments of mutual debts arising out of separate transactions between the parties. Recoupment, on the other hand, involves a netting out of debt arising from a single transaction. To invoke setoff, § 553 requires that each of the mutual debts arise before commencement of the case. In recoupment, the elements of the debt may arise either before or after the commencement of the case.

Both doctrines have application in the bankruptcy setting, where the distinctions between them continue to be valid:

The doctrine of recoupment can clearly be distinguished from setoff in a bankruptcy setting. It has no greater effect than a defense to a claim, and hence should not be subject to the limitations on setoff. A recoupment claim arises out of the same transaction that forms the basis of the plaintiff\'s cause of action. Its function is to reduce the amount demanded, but only to the extent of the plaintiff\'s claim. "In other words, recoupment goes to the justice of plaintiff\'s claim and no affirmative judgment for any excess over the claim of plaintiff can be awarded thereon." Therefore, allowing recoupment will not affect property of the estate other than the subject claim.

Furthermore, the invocation of the recoupment doctrine promotes no preference problem. It is applied when there are countervailing claims arising from the same transaction "strictly for the purpose of abatement or reduction. . . ." In effect, the application of recoupment goes to the equity of the claim. It provides for the adjudication of the just apportionment of liability relative to a dispute regarding a singular transaction.

In re Hiler, 99 B.R. 238, 243 (Bankr.D.N.J. 1989) (internal citations omitted). See also In re Clowards, Inc., 42 B.R. 627, 628 (Bankr.D.Idaho 1984).

Because recoupment only reduces a debt as opposed to constituting an independent basis for a debt, it is not a claim in bankruptcy, and is therefore unaffected by the debtor's discharge. See Brown v. General Motors Corp., 152 B.R. 935 (W.D.Wis. 1993), where the District Court held that the right of a private employee benefit plan to reduce its payments to a bankrupt debtor who was a participant in the plan in order to recover past overpayments was a right of recoupment and not a claim. "Because of its unique nature as a limited equitable defense the right of recoupment does not constitute a claim within the meaning of 11 U.S.C. § 101(5). . . ." Id. at 938.

II.

On the facts here, two awards were made, time-loss and permanent disability: on the one hand, income lost from work interruption, and on the other, loss of future income-earning capacity based on permanent disability. Each liability was asserted by the debtor pre-petition and were treated independently. The trial court concluded that the two awards should be considered as separate or...