In re Pyramid Industries, Inc., 94 C 7497.

• Decision Date: 17 June 1997
• Docket Number: No. 94 C 7497.,94 C 7497.
• Citation: 210 BR 445
• Parties: In re PYRAMID INDUSTRIES, INC., Debtor UNITED STATES of America, Plaintiff/Appellant, v. Andrew MAXWELL, not individually but as Trustee of the Estate of Pyramid Industries, Inc., et. al., Defendants/Appellees.
• Court: U.S. District Court — Northern District of Illinois

210 B.R. 445 (1997)

In re PYRAMID INDUSTRIES, INC., Debtor

UNITED STATES of America, Plaintiff/Appellant, v. Andrew MAXWELL, not individually but as Trustee of the Estate of Pyramid Industries, Inc., et. al., Defendants/Appellees.

No. 94 C 7497.

United States District Court, N.D. Illinois, Eastern Division.

June 17, 1997.

COPYRIGHT MATERIAL OMITTED

Joel Robert Nathan, U.S. Atty's. Office, Chicago, IL, for U.S.

Timothy Joseph McGonegle, Law Office of Andrew J. Maxwell, Chicago, IL, for Andrew Maxwell, trustee.

Robert C. Samko, Robert C. Samko, P.C., Chicago, IL, for All American Corp.

Peter G. Swan, Emalfarb, Swan & Bain, Highland Park, IL, for Gerson Electric Const. Co.

Kurt Alexander Muller, The Muller Firm, Ltd., Chicago, IL, for Lazzaro Companies, Inc.

MEMORANDUM AND ORDER

MANNING, District Judge.

This matter comes before the court on appeal from a decision of the United States Bankruptcy Court for the Northern District of Illinois denying plaintiff's motions for summary judgment and reconsideration. For the reasons set forth below, the decision of the bankruptcy court is affirmed.

BACKGROUND

On September 14, 1989, Pyramid Industries, Inc. ("Pyramid") filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code. The case was converted to chapter 7 on October 30, 1989, and Andrew Maxwell became the trustee. Among the assets of Pyramid's estate was the sum of $51,050 in proceeds arising from a contract between Pyramid and the United States Navy ("Navy").

There are several entities, each with an interest in the proceeds of Pyramid's estate. Among them was the SBA which loaned $590,574.88 to Pyramid in notes dating from July 2, 1984 through July 3, 1989. Additionally, All American Corporation ("All American"), holds a claim for $54,817.71 as one of Pyramid's subcontractors under a contract between Pyramid and the Navy ("Prime Contract"). Likewise, Gerson Electric Construction Company ("Gerson"), another subcontractor, entered into a contract with Pyramid to provide electrical labor and materials at the Naval Station. Gerson has not yet received $92,208.50 from Pyramid for work that Gerson has completed.

The United States, on behalf of the SBA, filed a complaint to determine its interest in the Pyramid estate. Among the parties named as defendants were All American and Gerson (hereinafter collectively, "Appellees"). The complaint alleged that Appellees' interests were inferior to those of the SBA. Specifically, the SBA urged that it had a secured priority lien claim arising out of loans extended to Pyramid which predated any interests held by Subcontractors. Alternatively, they argued that their right to offset its claims against the proceeds from the Prime Contract ("Proceeds") was superior to any interest held by Subcontractors. Appellees maintained that the SBA did not have the right to setoff or, alternatively, that the bankruptcy court should use its discretion to deny the SBA that right. Further, Appellees contended that they had an equitable lien in the Proceeds which was superior to the SBA's interest. The United States on behalf of the SBA moved for summary judgment on its declaratory judgment complaint against Appellees.

The bankruptcy court denied both the SBA's motion for summary judgment and a subsequent motion for reconsideration. See United States v. Maxwell (In re Pyramid Industries, Inc.), 170 B.R. 974 (Bankr. N.D.Ill.1994). In its decision, the bankruptcy court began by examining several Supreme Court cases involving public construction, and determined the relative priorities of the SBA and Subcontractors. First, the bankruptcy court reviewed Supreme Court precedent which developed the concept of the equitable lien. Next, the court determined a priority ranking for entitlement to the available Proceeds. After a thorough review of the law, the court adopted the analysis provided in United States v. TAC Constr. Co., 760 F.Supp. 590 (S.D.Miss.1991). Id. at 980-81 & n. 6. This analysis placed any rights to setoff first, followed by the rights of unpaid subcontractors or laborers under an equitable lien, followed by sureties who paid subcontractors pursuant to a payment bond.¹ Last came assignees of the general contractor, including creditors with perfected security interests shared in the remaining proceeds. See id.

As discussed in greater detail below, the bankruptcy court then considered whether the SBA could take advantage of the Navy's right to setoff. In light of bankruptcy's emphasis on the equitable treatment of creditors, the court narrowly interpreted the bankruptcy code to preclude the SBA from asserting that it and the Navy, as mere divisions of the same United States Government, were the same entity that could use each other's rights to setoff. The bankruptcy court also indicated that it would reach the same result even if the terms of the bankruptcy code did not render the SBA and Navy separate entities.

The matter is now before this court on the United States' appeal. For the reasons that follow, the bankruptcy court is affirmed.

DISCUSSION

The United States District courts have jurisdiction over appeals from final judgments and final orders in bankruptcy cases pursuant to 28 U.S.C. § 158(A). This court must accept the bankruptcy court's findings of fact unless clearly erroneous. In re Excalibur Auto. Corp., 859 F.2d 454, 457 n. 3 (7th Cir.1988) (construing Federal Rule of Bankruptcy Procedure 8013). The court reviews de novo issues of law. Excalibur, 859 F.2d at 457 n. 3. Whether or not the United States is a single entity for purposes of setoff is a question of law. HAL, Inc. v. United States (In re HAL, Inc.), 196 B.R. 159, 161 (9th Cir.BAP 1996) (citing In re Doe, 58 F.3d 494, 498 (9th Cir.1995)). The decision to allow setoff pursuant to section 553 of the Bankruptcy Code is left to the sound discretion of the bankruptcy court. In re HAL, 196 B.R. at 161 (citing In re Cascade Roads, Inc., 34 F.3d 756, 763 (9th Cir.1994)). Hence, we review the bankruptcy court's decision not to allow setoff for abuse of discretion. Id.

I. Setoff.

Setoff allows entities that owe each other money to apply their mutual debts against each other. Citizens Bank of Maryland v. Strumpf, ___ U.S. ___, ___, 116 S.Ct. 286, 289, 133 L.Ed.2d 258 (1995). Setoff is created by state or federal statute or common law. State of Illinois v. Lakeside Community Hospital, Inc. (In re Lakeside Community Hospital), 151 B.R. 887, 890 (N.D.Ill.1993). In section 553 of the Bankruptcy Code, Congress preserves the right to setoff debts owed to parties protected by the bankruptcy laws. Strumpf, ___ U.S. at ___, 116 S.Ct. at 289. That section states, in pertinent part, as follows:

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. § 553(a)(emphasis added).

The crucial points of section 533 are the requirements of "mutual" debt between the debtor and the creditor, and that such debt existed prior to the petition for bankruptcy. See In re Pyramid, 170 B.R. at 982. Here, mutuality is the only element in doubt. Id. Even when the power to setoff exists, section 553 does not make the right to setoff mandatory: A bankruptcy court must still exercise its equitable discretion to allow or disallow a setoff. SBA v. Rinehart, 88 B.R. 1014, 1018 (D.S.D.1988), aff'd on other grounds, 887 F.2d 165, (8th Cir.1989); see In re HAL, 196 B.R. at 166.

The court first considers whether separate departments and agencies of the federal government are a single entity for mutuality purposes of section 553 of the Bankruptcy Code. While mutuality exists when the debts are between the "same parties", there is no requirement that the debts arise out of the same transaction. In re Pyramid, 170 B.R. at 982 n. 9. Moreover, while the "same parties" requirement of mutuality generally prevents "triangular setoffs" (i.e. prevents A's attempt to offset an obligation owed by B against B's debt to C), In re Elcona Homes, 863 F.2d 483, 486 (7th Cir.1988), most courts view separate federal government agencies together as one entity, the United States. Collier on Bankruptcy at 553-31; see also In re HAL, 196 B.R. at 163 (stating a recent majority of courts have held that the governmental agencies satisfy mutuality for purposes of Bankruptcy Code Section 553, and those that have not have often been reversed on appeal).

Outside of the bankruptcy arena, there is no doubt that separate federal agencies are treated as a unitary creditor, and that these agencies may setoff debts owed by one agency against claims that another agency has against a single debtor. E.g., Turner v. Small Business Administration (In re Turner), 84 F.3d 1294, 1298 (10th Cir.1996). The seminal cases involving the common law right to setoff by the federal government are United States v. Munsey Trust Co., 332 U.S. 234, 108 Ct.Cl. 765, 67 S.Ct. 1599, 91 L.Ed. 2022 (1947), and Cherry Cotton Mills v. United States, 327 U.S. 536, 66 S.Ct. 729, 90 L.Ed. 835 (1946). Together Munsey Trust and Cherry Cotton Mills stand for the propositions that the United States, like other creditors, had a common law right to setoff, and that agencies of the United States Government are deemed a unitary creditor. In re Turner, 84 F.3d at 1298; see Munsey Trust, 332 U.S. at 239, 67 S.Ct. at 1602.

In Cherry Cotton Mills, the government owed petitioner a tax refund under the Agricultural Adjustment Act, and the petitioner owed the government, specifically the Reconstruction Finance Corporation ("RFC"), the balance on a loan. Cherry Cotton Mills, 327 U.S. at 537, 66 S.Ct. at 729. The Treasury paid the tax refund to RFC, not the petitioner. Id. at 538, 66 S.Ct....