In re Walat Farms, Inc.

• Citation: 69 BR 529
• Decision Date: 27 January 1987
• Docket Number: Bankruptcy No. 85-09344,Adv. No. 86-9031.
• Parties: In re WALAT FARMS, INC., Debtor. WALAT FARMS, INC., a Michigan corporation, Plaintiff, v. UNITED STATES of America, acting Through the U.S. DEPARTMENT OF AGRICULTURE, Agricultural Stabilization and Conservation Service and Commodity Credit Corporation, Defendant.
• Court: United States Bankruptcy Courts. Tenth Circuit. U.S. Bankruptcy Court — Eastern District of Michigan

69 B.R. 529 (1987)

In re WALAT FARMS, INC., Debtor.

WALAT FARMS, INC., a Michigan corporation, Plaintiff, v. UNITED STATES of America, acting Through the U.S. DEPARTMENT OF AGRICULTURE, Agricultural Stabilization and Conservation Service and Commodity Credit Corporation, Defendant.

Bankruptcy No. 85-09344, Adv. No. 86-9031.

United States Bankruptcy Court, E.D. Michigan, N.D.

January 27, 1987.

Randall L. Frank, Bay City, Mich., for debtor.

Michael J. Hluchaniuk, Asst. U.S. Atty., Bay City, Mich., for defendant.

MEMORANDUM OPINION DENYING DEBTOR IN POSSESSION'S REQUEST FOR TURNOVER OF FUNDS

ARTHUR J. SPECTOR, Bankruptcy Judge.

The facts are not disputed. In 1984, the debtor Walat Farms, Inc., (hereafter plaintiff) obtained loans from the Commodity Credit Corporation (hereafter defendant), secured by liens on debtor's 1984 corn and soybean crops. In February, 1985 the debtor signed a contract with the defendant to participate in the 1985 Price Support and Production Adjustment Program. The program required the debtor to refrain from planting crops and to maintain ground cover on its farmland in return for which the defendant would pay a deficiency payment to the farmer based on a statutory formula. As stated in the defendant's brief, deficiency payments are essentially subsidies, designed to stabilize farm income by reducing the amount of crops taken to market. The formula for determining the deficiency payment is set forth in 7 C.F.R. § 713.108 and, according to the defendant, read as follows:

The deficiency payment rate shall be the amount by which the target price for the crop exceeds the higher of: (1) The national weighted average market price received by farmers for the crop year during the first five months of the market year . . . or (2) the national loan rate established for the crop.

At present approximately $460,000 is owed on the 1984 loans. The value of the debtor's crops in storage falls short of covering the amount of the lien on the crops by approximately $28,000. The debtor satisfactorily completed the 1985 contract with the defendant.

On July 11, 1985, the debtor filed its Chapter 11 petition. It filed this adversary proceeding on April 24, 1986 to compel the defendant to turn over the 1985 contract's deficiency payment.¹ While acknowledging that the deficiency of $33,641.54 is owed, the defendant claims that it has a right, under 11 U.S.C. § 553(a), to set off that debt against the money owed to it from the 1984 crop loans. That section states in pertinent part that, with irrelevant exceptions, the Bankruptcy Code

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. . . .

A leading commentator explains:

Section 553(a) speaks of the set-off of "a mutual debt" owed by a creditor to the debtor against the creditor\'s claim against the debtor. Thus, mutuality is a requirement for any right of set-off. The mutuality requirement was strictly construed under the former Act and is strictly construed under § 553.

The term "mutual debt" is not defined in the Code. 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, ¶ 553.041, 2, pp. 553-16, 18 (15th ed. 1986). Since the date on which the case is commenced is the date upon which all rights are adjusted,

To be eligible for set-off, both the mutual claim of the creditor and debt of the debtor must have arisen prior to the commencement of the case. Claims arising after the commencement of the case lack the requisite mutuality for set-off, because the postpetition trustee or debtor in possession is a different entity from the prepetition debtor.

Collier, supra, ¶ 553.08, p. 553-37.

The defendant claims that since the formula for determining whatever payment would be forthcoming to Walat Farms, Inc. was set at the creation of the contract, the amount owed should be treated as a pre-petition debt owed the debtor, and not a post-petition debt due the estate. Therefore, it argues that the mutuality required under 11 U.S.C. § 553 is present.

The defendant relies on In re Wilson, 29 B.R. 54 (Bankr.W.D.Ark.1982). In Wilson, the Chapter 13 debtor owed the Internal Revenue Service a tax obligation from the year ending 1978. The Chapter 13 petition was filed on November 19, 1980. The debtors timely filed their tax returns for the calendar year 1980 and alleged an over-payment of taxes. Neither party disputed the obligations owed the other; instead, the dispute centered around whether or not the IRS could set off the 1980 tax refund against the debtors' pre-petition obligation. The debtors claimed the debts were not mutual as their entitlement to the refund did not arise until after the petition in bankruptcy was filed, since there could not have been a determination of the amount of the refund prior to January 1, 1981. The bankruptcy court determined that the right to a tax refund, albeit inchoate, was property of the estate for purposes of § 541, and must therefore be considered a debt owed to the debtor pre-petition, at least as to the 322/365th's of the year represented by the days in 1980 which preceded the filing of the petition for relief.

We have no argument with the conclusion reached in Wilson but it is factually dissimilar in important ways. Clearly the right to a tax refund in Wilson arose prepetition since the debtor had overpaid his taxes pre-petition. The plaintiff correctly distinguishes that case on the ground that here we are dealing with an executory contract while Wilson dealt with debts not arising out of contract.

Professor Countryman defined an executory contract as

A contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.

V. Countryman, Executory Contracts in Bankruptcy: Part 1, 57 Minn.L.Rev. 439, 460 (1973). When the petition for Chapter 11 relief was filed on July 11, 1985, the debtor still owed performance of its duties in a number of substantial ways such as the duty to not plant crops in the set-aside acres, to keep cover on those acres, etc. If a farmer in the program fails to fulfill the contract's obligations during the course of a growing season, the CCC can utilize a choice of damage remedies, among them being the right to refuse to pay anything to the farmer.² Of course, the defendant still owed the entirety of its obligation, that is, to pay the deficiency amount. It is plain to see, therefore, that the 1985 agreement was an executory contract. It follows then that if the contract is properly assumed by the debtor in possession, any right to a deficiency payment could only arise post-petition, and be owed to the debtor in possession qua trustee, and not the debtor. Consequently, mutuality would not exist and setoff would be disallowed. In re Braniff Airways, Inc., 42 B.R. 443, 449, 12 C.B.C.2d 610 (Bankr.N.D.Tex.1984); Collier, supra, ¶ 553.08.

For the same rationale we reject the defendant's assertion that In re Fred Sanders Co., 33 B.R. 310 (Bankr.E.D.Mich.1983) is controlling. That case declared that a utility refund which arose from pre-petition overpayments by the debtor but which was not ordered repaid by the Michigan Public Service Commission until after the filing of the Chapter 11 petition, was a pre-petition obligation which could be set off against a pre-petition claim of the utility company. The court held that the mere fact that the refund was not payable until after the Michigan Public Service Commission had approved it did not transform a pre-petition overpayment by the debtor into a post-petition obligation to repay it. The court stated:

The refund claim here is rooted in prepetition transactions between the debtor and the utility. All of the facts necessary to determine the debt and the claim occurred prior to the filing of the bankruptcy petition. The right to a refund is not traceable to any postpetition transaction between the debtor and the utility.

Id. at 312. Our case is quite different: if the debtor in possession had not continued the set-aside and the ground cover during the post-petition period, conceivably no debt at all would be owed it by the defendant. Moreover, neither it nor Wilson involved an executory contract, that is, a contract assumable by the trustee or debtor in possession; therefore, neither are apposite.

Reliance by the defendant on In re Matthieson, 63 B.R. 56 (Bankr.D.Minn.1986) is also misplaced. Matthieson dealt with Chapter 7 cases. The case did not deal with executory contracts in a Chapter 11 setting, and therefore the opinion properly did not discuss the issue. Apparently³ this was because, pursuant to § 365(d)(1), the pre-petition contracts were not timely assumed and so were deemed rejected. Since rejected executory contracts are themselves considered pre-petition unsecured claims, § 365(g), the necessary mutuality for use of § 553 existed; hence, the government obligations were available for set-off against the pre-petition crop loans obtained by the debtors. In essence, Mathieson adds nothing to Wilson and Fred Sanders.

Section 365 of the Bankruptcy Code provides the standards by which such contracts are to be treated. Section 365(a) states that the debtor in possession, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.⁴ In Chapter 11 cases such as this, § 365(d)(2) provides that the debtor in possession may assume or reject "at any time before the confirmation of a plan but the court, on the request of any party to such contract or lease, may order the debtor in possession to determine within a specified period of time...