In re Rinehart

• Decision Date: 24 July 1987
• Docket Number: Bankruptcy No. 87-30042.
• Citation: 76 BR 746
• Parties: In re Harold RINEHART and Marilyn Rinehart, d/b/a Farmers, Debtors.
• Court: U.S. Bankruptcy Court — District of South Dakota

76 B.R. 746 (1987)

In re Harold RINEHART and Marilyn Rinehart, d/b/a Farmers, Debtors.

Bankruptcy No. 87-30042.

United States Bankruptcy Court, D. South Dakota.

July 24, 1987.

James P. Hurley, Bangs, McCullen, Butler, Foye & Simmons, Rapid City, S.D., Jonathan K. Van Patten, Vermillion, S.D., for debtors.

Jon Haverly, acting through Small Business Admin., Sioux Falls, S.D., for U.S.

MEMORANDUM DECISION

PEDER K. ECKER, Bankruptcy Judge.

INTRODUCTION

This is before the Court on an amended motion for order to show cause filed on behalf of Harold and Marilyn Rinehart ("debtors") by Attorney James P. Hurley on May 18, 1987.¹ Debtors substantively allege: 1) the Small Business Administration ("SBA") does not have a right to offset its prefiling claims against Agricultural Stabilization and Conservation Service-Commodity Credit Corporation ("ASCS-CCC") farm program payments owed by the ASCS-CCC to the debtors to satisfy prefiling claims of the SBA because this is not a "mutual debt" as required under Bankruptcy Code Section 553(a); 2) the SBA's offset violated the automatic stay provisions of Bankruptcy Code Section 362(a); and 3) because the SBA's offset was "willful," debtors are entitled to damages under Bankruptcy Code Section 362(h). SBA conversely contends: 1) pursuant to the Debt Collection Act, 31 U.S.C. § 3701, et seq., and C.F.R. § 140.5, which give rise to an "administrative offset," it has a right to offset postfiling ASCS-CCC payments under Section 553(a); 2) that it did not violate the automatic stay provisions of Bankruptcy Code Section 362(a) because, postfiling, it only preserved the "status quo," which is comparable to an "administrative freeze" on a bank account, and no Section 542 turnover action was otherwise commenced. Attorney Jon Haverly represented the SBA, and a hearing was held in Pierre, South Dakota, on June 1, 1987. The material facts are these.

BACKGROUND

Debtors, who are husband and wife, filed for relief under Chapter 11 of the Bankruptcy Code on February 27, 1987. They operate a farming and ranching business near Highmore, South Dakota. Over the years, debtors have expanded their operation to 8,561 acres owned, plus additional leased acreage. They also participate in the Agricultural Stabilization and Conservation Service and Commodity Credit Corporation ("ASCS-CCC") farm programs.

During April, 1981, in exchange for a second mortgage on certain property and an executed promissory note, SBA lent the debtors $103,000. In January, 1982, the principal was increased to $171,600 in exchange for a third mortgage on certain other property and an executed "modification" of the promissory note. Under the latter note, debtors were to make twenty-four annual payments of $12,177.00 on January 1 of each year, beginning with January 1, 1983 (SBA ex. 1). When debtors failed to make the 1986 payment, SBA declared a default and accelerated the debt (SBA ex. 3).

Beginning in January, 1987, SBA commenced an action for administrative offset pursuant to certain federal regulations. In a letter dated January 2, 1987, SBA informed the debtors that this constituted thirty days' "written notification" of intended offset unless the parties have otherwise entered into a repayment agreement or the debtors timely petitioned for review to the SBA's Hearings and Appeals Office (SBA ex. 4). No repayment agreement was reached or appeal taken (SBA ex. 6).

On February 16, 1987, SBA received a letter dated February 13, 1987, from the Department of Agriculture, approving the SBA's request for offset of ASCS-CCC farm program payments in the amount of $161,563.06. In that letter, the Department noted that the interest on that amount was accruing at a daily rate of $20.33 after December 4, 1986 (SBA ex. 7). SBA filed a proof of claim in the amount of $163,250.24 on March 19, 1987.

As stated, debtors filed their Chapter 11 petition on February 27, 1987.

On March 9, 1987, SBA received a letter dated March 5, 1987, from the Department of Agriculture, which reads, in part (SBA ex. 8):

"Dear SBA Director:

This acknowledges a request by one of your employees to refrain from setoff action with respect to debtors until further notification from the Small Business Administration."²

On March 10, 1987, debtors' attorney, James P. Hurley, sent SBA's attorney, Jon Haverly, a letter which reads, in part (debtors' ex. A):

Dear Attorney:

Our firm represents the debtors. They filed a Voluntary Petition under Title Eleven, United States Code on February 26, 1987 . . . the automatic stay provisions of the Code prevent any further attempts including telephone calls, letters, collection suits or otherwise, without prior Court approval to collect the amounts claimed.

On April 1, 1987, the United States Department of Agriculture (CCC) issued a check, No. 89038720, in the amount of $1,388.47 payable to the order of the SBA. This was the first ASCS-CCC installment payment.

Debtors were unaware that the SBA had been allowed an ASCS offset. When the debtors did not timely receive payment as expected, after preliminary investigation, they filed a motion for order to show cause on Farmers Home Administration ("FmHA") for turnover of that payment on May 8, 1987. FmHA replied that it had not requested the offset, but suggested the SBA had done so.

On May 11, 1987, SBA's attorney wrote a memo to SBA's "collateral cashier," which reads, in part (SBA ex. 9):

This memorandum is to advise you that Check No. 89038720 payable to SBA relating to debtors is the subject of litigation in U.S. Bankruptcy Court.

As a result of this litigation and the stay imposed by 11 U.S.C. § 362 the check must not be processed or applied to the account. The check must be held pending resolution of the litigation and advice of counsel.

On May 15, 1987, the SBA filed a motion for relief from stay to offset the ASCS-CCC payment. On May 18, 1987, debtors amended their motion to show cause directed to the SBA. SBA continued to have possession of the check up and until the June 1, 1987, hearing.

According to the debtors' schedules and disclosure statement, SBA, in its respective second and third mortgage positions on the debtors' real property, is totally undersecured based on the debtors' valuation estimates. See 11 U.S.C. § 506(a).

ISSUES

The principal issues raised are:

1) Whether the Small Business Administration ("SBA") has a right to offset its prefiling claims against ASCS-CCC farm payments under Bankruptcy Code Section 553(a);

2) Whether the Small Business Administration\'s ("SBA\'s") postfiling continuation of the offset process, including holding of the Department of Agriculture\'s check payable to SBA, violates the automatic stay provisions of Bankruptcy Code Section 362(a); and

3) If so, whether the Small Business Administration ("SBA") "willfully" violated the automatic stay under Bankruptcy Code Section 362(h).

LAW

First Issue

As to the first issue, the Court holds that the SBA does not have a right to offset its prefiling claims against ASCS-CCC farm payments because the ASCS-CCC, and not the SBA, owes payments to the debtors and, therefore, this is not a "mutual debt owing by such creditor" under Bankruptcy Code Section 553(a). This is based on the following discussion.

An understanding of Section 553³ is fundamental in analyzing this issue. A creditor establishes a right of setoff under this section when the following three-part test is met:

1. A debt owed by the creditor to the debtor arose prior to the commencement of the bankruptcy case;

2. A claim of the creditor against the debtor arose prior to the commencement of the bankruptcy case; and

3. The debt and claim are mutual obligations.

In re Brooks Farms, 70 B.R. 368, 371 (Bankr.E.D.Wis.1987). The Code recognizes setoff rights which are created under either federal or state law. See, e.g., In re Sarkis, 17 B.R. 174 (Bankr.D.S.D.1982); In re Brooks Farms, 70 B.R. at 368. Once established under Section 553, the right to setoff is treated as an allowed secured claim under Bankruptcy Code Section 506(a).⁴ What this would mean in the instant case is that the SBA, who, for purposes of this matter, is totally undersecured in terms of its collateral, will otherwise be treated as a secured creditor up to the amount of its debt, right of setoff, and any ASCS-CCC payments owing to the reorganizing farmer debtors.

SBA claims its right to offset postfiling ASCS-CCC farm program payments under the Debt Collection Act, 31 U.S.C. § 3701, et seq.,⁵ and C.F.R. § 140.5.⁶ Debtors insist that the SBA does not have a right to offset the ASCS-CCC payments because either the payments are owed to them by the ASCS-CCC, and not the SBA, and, therefore, no "mutual debt is owing by such creditor," as required under Section 553(a), or an attempted offset against a Chapter 11 debtor-in-possession lacks mutuality as required under that section. Conversely, SBA contends that because it is part of the government and the government, through its ASCS program, owes the debtors, there is a "mutual debt" owing.

The third part of the Section 553 test requires that the right to an offset must be on account of a "mutual debt." The term, "mutual debt," is not defined in the Bankruptcy Code and, thus, applicable case law must be reviewed to understand the meaning of the term. "To be mutual, the debts must be in the same right and between the same parties standing in the same capacity." 4 Collier on Bankruptcy ¶ 553.042, at 553-18 (15th ed. 1987); see also In re Visiting Home Services, Inc., 643 F.2d 1356, 1360 (9th Cir.1981); In re Brooks Farms, 70 B.R. 368, 371 (Bankr.E.D.Wis. 1987); In re Braniff Airways, 42 B.R. 443, 449 (Bankr.N.D.Tex.1984); In re Brendern Enterprises, Inc., 12 B.R. 458, 459 (Bankr. E.D.Pa.1981). The mutuality requirement is strictly construed. See 4 Collier on Bankruptcy ¶ 553.04, at 553-16 (15th ed. 1987).

The question then presented is whether the debts are "between the same parties, standing in...