In re Morristown Lincoln-Mercury, Inc., Bankruptcy No. 3-81-01889

• Decision Date: 31 July 1984
• Docket Number: Adv. No. 3-83-0886.,Bankruptcy No. 3-81-01889
• Citation: 42 BR 413
• Parties: In re MORRISTOWN LINCOLN-MERCURY, INC., Debtor. Richard STAIR, Jr., Trustee, Plaintiff, v. HAMILTON BANK OF MORRISTOWN, Defendant.
• Court: U.S. Bankruptcy Court — Eastern District of Tennessee

42 B.R. 413 (1984)

In re MORRISTOWN LINCOLN-MERCURY, INC., Debtor Richard STAIR, Jr., Trustee, Plaintiff, v. HAMILTON BANK OF MORRISTOWN, Defendant.

Bankruptcy No. 3-81-01889, Adv. No. 3-83-0886.

United States Bankruptcy Court, E.D. Tennessee.

July 31, 1984.

Richard Stair, Jr., Knoxville, Tenn., pro se.

Frank P. Cantwell, Jr., Morristown, Tenn., for defendant.

MEMORANDUM

CLIVE W. BARE, Bankruptcy Judge.

Section 542 of the Bankruptcy Code, 11 U.S.C.A. § 542 (1979), generally requires anyone holding property of the estate to deliver such property to the trustee. In this adversary proceeding the plaintiff trustee seeks an order requiring the defendant Hamilton Bank of Morristown (Bank) to turn over all funds on deposit in a dealer reserve account, to wit, $43,343.05, together with interest. The defendant Bank denies the trustee is entitled to a turnover order and asserts, by counterclaim, that it is entitled, pursuant to 11 U.S.C.A. § 553(a) (1979), to set off the funds on deposit in the reserve account against its claims, totaling approximately $43,583.71 plus attorney fees, owing by the debtor. Relief from the automatic stay, 11 U.S.C.A. § 362(a) (Supp.1984), is requested for the purpose of exercising the asserted setoff right. The Bank also asserts that it holds a security interest in the disputed funds, or, alternatively, that the reserve account represents a common law pledge securing any indebtedness of the debtor to the Bank.

I

The facts have been stipulated. Morristown Lincoln-Mercury, Inc. filed its voluntary chapter 11 petition on December 17, 1981. Four weeks later the debtor's case was converted to a case under chapter 7. 11 U.S.C.A. § 1112 (1979).

The ordinary course of debtor's prepetition business involved the sale and leasing of its inventory of new and used motor vehicles. The Bank provided financing for some of the debtor's customers by purchasing their retail installment sale contracts from the debtor at a discount. All of these installment sale contracts purchased by the Bank were purchased with recourse against the debtor.

A "Repurchase Agreement (Retention Plan)," dated September 19, 1975, between the debtor and the Bank provided for the creation of the reserve account at issue. Under the terms of this agreement, when the Bank purchased chattel paper from the debtor, an amount determined by an equation specified in their agreement was withheld by the Bank and deposited in a noninterest-bearing reserve account established in the debtor's name at the Bank. No funds were deposited in this account other than funds withheld by the Bank from its payment to the debtor for the chattel paper it purchased. The debtor did not have access to funds in the reserve account.¹ All chargeoffs or unearned interest refunds to the debtor's customers or related withdrawals from the account were effected by the Bank. Further, the Bank was not obligated to either segregate funds deposited in the reserve account from general deposits or refrain from using the funds in its general business operations. Monthly statements reflecting the balance in the reserve account were forwarded to the debtor. On the date debtor's bankruptcy petition was filed the balance in the reserve account was $43,343.05.

In addition to purchasing chattel paper from the debtor, the Bank also provided "floor plan" financing for the debtor pursuant to a "Security Agreement on Dealer Inventory, Accounts Receivable, Contract Rights and Proceeds." This agreement, dated July 30, 1981, secures the payment of "all indebtedness and liabilities whatsoever" of the debtor to the Bank, "absolute or contingent, due or to become due, whether now existing or hereafter arising, as principal . . . guarantor or otherwise." It grants the Bank a security interest in the debtor's "inventory." As specifically defined in the agreement, "inventory" includes the proceeds from lease or sale of motor vehicles and "all contract rights of debtor now or hereafter existing or acquired under purchased title or documents of title and all proceeds . . . thereof included but not limited . . . to all accounts receivable arising therefrom. . . ." The perfection of this security agreement is not challenged by the trustee.²

The Bank held a variety of claims against the debtor when the bankruptcy petition was filed. A claim for $180,487.82, based on eight promissory notes executed under the floor plan financing arrangement, was secured by sixteen automobiles. After the automatic stay was vacated the Bank enforced its security agreement by selling these automobiles. A deficiency of $13,765.76 remains. A second claim arises from the debtor's practice of purchasing its own inventory vehicles, financing the purchases with the Bank, and then leasing the vehicles to customers. Rights under the lease agreements were assigned to the Bank by the debtor. Exercise by the lessees of a purchase option on three of the leased vehicles resulted in a net postpetition loss by the Bank of $1,683.49. Additionally, the whereabouts of another vehicle financed by the Bank and leased by the debtor, without the Bank's consent, are unknown. The balance due the Bank on this third claim totaled $5,569.28 when the debtor's bankruptcy petition was filed. A fourth claim is attributable to the Bank's prepetition purchase of chattel paper representing the retail installment sale of a 1977 Toyota van. The Bank obtained a post-petition judgment against the debtor since the retail installment contract was not enforceable against the purported buyer. Because the debtor double financed the Toyota van, the Bank, whose security interest was inferior to that of another bank, sustained a net loss of $4,793.71.³ A fifth claim arises from the debtor's prepetition issuance to the Bank of two checks, in the combined sum of $2,981.35, returned for insufficient funds. Proofs of claim with respect to these five claims, totaling $28,793.59, have been filed by the Bank.

Additionally, when the debtor filed its bankruptcy petition on December 17, 1981, the Bank held chattel paper (representing retail installment contracts not in default) purchased from the debtor having a value of $830,313.00. As a result of installment payments through October 30, 1983, the value of this chattel paper has been reduced to $167,608.00. However, between the petition date and October 30, 1983, the Bank experienced losses in the aggregate amount of $10,141.34 due to deficiencies from the sale of automobiles it repossessed. Also, the Bank has paid $4,648.78 in interest rebates and refunds to installment buyers who prepaid their retail purchase contracts. The sum of these two amounts, $14,790.12, would have been paid from the reserve account at issue if the deficiencies or the rights to refunds had arisen prepetition. No formal proof of claim for this sum has been filed, but the validity of the indebtedness is stipulated.

The combined total of all these claims, $43,583.71, slightly exceeds the balance in the reserve account. This combined total does not include an amount representing the Bank's projected loss on the remaining unpaid retail installment contracts or its attorney fees, both of which the Bank claims are chargeable to the reserve account.⁴

II

Bankruptcy Code § 542(b) provides in relevant part:

An entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order, shall pay such debt to, or on the order of, the trustee, except to the extent that such debt may be offset under section 553 of this title against a claim against the debtor.

11 U.S.C.A. § 542(b) (1979).

With exceptions immaterial herein, Code § 553 enacts in part:

Setoff (a) Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case. . . .

11 U.S.C.A. § 553(a) (1979).

The Bank concedes that the dealer reserve account is property of the debtor's estate, 11 U.S.C.A. § 541 (1979). The critical dispute is whether some of the Bank's claims against the debtor arose before the commencement of the bankruptcy case.

Code § 553 continues the recognition in bankruptcy law of the "possible injustice" in compelling a creditor to pay his indebtedness in full to the debtor when his claim against the debtor will be only partially paid, if at all. 4 Collier on Bankruptcy ¶ 553.02, 553-10 (15th ed. 1984).⁵ The provision merely preserves setoff rights existing under nonbankruptcy law.

Three elements are necessary to establish a creditor's setoff right:

(1) a debt owing by the creditor to the debtor which arose before commencement of the case;

(2) a claim of the creditor against the debtor which also arose before commencement of the case; and

(3) the debt and claim must be mutual obligations.

Waldschmidt v. Columbia Gulf Transmission Co. (In re Fulghum Constr. Corp.), 23 B.R. 147, 151 (Bankr.M.D.Tenn.1982). A "debt" is a liability on a "claim." 11 U.S.C.A. § 101(11) (1979). "Claim" is very broadly defined in the Bankruptcy Code and means, in part, "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. . . ." 11 U.S.C.A. § 101(4) (1979). Mutuality of obligation simply means that the creditor is indebted to the debtor who likewise owes a debt to the creditor; something must be owed by both sides. 4 Collier on Bankruptcy ¶ 553.042, 553-15 (15th ed. 1984). The claims between the parties must be owing and due in the same capacities. Bank of Dixie v. Gentry (In re Todd), 37 B.R. 836 (Bankr. W.D.La.1984) (setoff against note of debtor to bank from funds in his IRA denied because IRA was obligation...