U.S. on Behalf of U.S. Postal Service v. Dewey Freight System, Inc.

• Decision Date: 02 November 1994
• Docket Number: No. 93-2767,93-2767
• Citation: 31 F.3d 620
• Parties: 31 Collier Bankr.Cas.2d 1110, 25 Bankr.Ct.Dec. 1485, Bankr. L. Rep. P 76,016 UNITED STATES of America, on behalf of the UNITED STATES POSTAL SERVICE, Plaintiff-Appellant, v. DEWEY FREIGHT SYSTEM, INC., Debtor-Appellee, Boatmen's First National Bank of Kansas City, as successor in interest to The Merchants Bank, Intervenor-Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 620

31 F.3d 620

31 Collier Bankr.Cas.2d 1110, 25 Bankr.Ct.Dec. 1485,

Bankr. L. Rep. P 76,016

UNITED STATES of America, on behalf of the UNITED STATES POSTAL SERVICE, Plaintiff-Appellant, v. DEWEY FREIGHT SYSTEM, INC., Debtor-Appellee Boatmen's First National Bank of Kansas City, as successor in interest to The Merchants Bank, Intervenor-Appellee.

No. 93-2767.

United States Court of Appeals Eighth Circuit.

Submitted Jan. 12, 1994.

Decided July 25, 1994.

Rehearing Denied Nov. 2, 1994.

Samuel R. Maizel, Washington, DC, argued (J. Christopher Kohn, Tracy J. Whitaker, Judith M. Strong, Frank W. Hunger and Julie Holvik, on the brief), for appellant.

Steven M. Leigh, Kansas City, MO, argued (Richard L. Martin and Kristen B.P. Clark, on the brief), for appellee.

Before LOKEN, Circuit Judge, JOHN R. GIBSON, Senior Circuit Judge, and KYLE, ^* District Judge.

LOKEN, Circuit Judge.

In this bankruptcy case, the United States Postal Service (USPS) seeks to recoup, or offset, damages incurred when Chapter 11 debtor Dewey Freight System, Inc. ("Debtor" or "Dewey"), refused to perform certain executory contracts, against sums USPS owes Debtor for post-petition trucking services under those contracts. USPS proceeded by motion to lift the automatic stay in bankruptcy. ¹ The bankruptcy court ² denied that motion, the district court ³ affirmed, and USPS appeals. This appeal requires us to explore the interplay between the equitable doctrine of recoupment and the bankruptcy law of executory contracts as construed in NLRB v. Bildisco & Bildisco, 465 U.S. 513, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984). We affirm.

I.

USPS and Dewey entered into multi-year contracts for the shipment of mail from St. Louis to Kansas City, and from Kansas City to Milwaukee. The contracts require USPS to pay Dewey an annual contract rate in thirteen four-week installments. The contracts' General Provisions permit USPS to "deduct from the compensation otherwise due [Dewey] under this contract ... those amounts for which [Dewey] is accountable [for failure to perform in accordance with the contract]."

In July 1991, Dewey filed a petition to reorganize under Chapter 11 of the Bankruptcy Code. Initially, Dewey continued as debtor-in-possession to haul mail for USPS in accordance with the contracts, and USPS continued to make installment payments consistent with the contracts' terms. By September 1991, however, Debtor concluded it would no longer perform. It asked another company, Quick Trucking, Inc., to assume Dewey's obligations under the USPS contracts. Quick Trucking was willing to do so, but USPS refused to accept an assignment of the contracts. Debtor then notified USPS that it would promptly cease performance.

USPS subsequently solicited bids on six-month "emergency service" contracts for these mail truck routes. Quick Trucking was awarded the emergency contracts but at short-term rates substantially higher than the rates in the original contracts with Dewey. The costs incurred by USPS in awarding the substitute contracts, plus the higher trucking costs it would incur over the life of the substitute contracts, totaled approximately $27,000. Claiming this amount as damages for Debtor's refusal to perform, USPS moved to lift the automatic stay so that it could retain (recoup) $18,959.32 that would otherwise be paid to Debtor in the next installment payments under the breached contracts. The Merchants Bank, and later its successor, Boatmen's First National Bank of Kansas City, intervened to oppose USPS's motion because it threatens their security interest in Debtor's accounts receivable.

The bankruptcy court denied USPS's motion, concluding that USPS must instead pay any amounts due under the contracts for post-petition trucking services and file an unsecured claim against the bankruptcy estate for damages resulting from Debtor's failure to perform. The court reasoned: (i) the trucking contracts were executory when Dewey petitioned for Chapter 11 protection and therefore governed by Sec. 365; (ii) Dewey as debtor-in-possession rejected those contracts when it refused to perform; (iii) under Sec. 365(g)(1) and Sec. 502(g), a damage claim for rejection of an executory contract "must be administered through bankruptcy and receive the priority provided general unsecured creditors," Bildisco, 465 U.S. at 531; and (iv) USPS may not invoke the equitable doctrine of recoupment because the money owed Debtor for post-petition shipments and USPS's damage claim for rejection of the contracts "did not arise out of the same transaction."

USPS appealed to the district court, which affirmed on the ground that USPS has no right of recoupment because the claims of Debtor and USPS did not arise out of the same transaction. USPS now appeals to this court, arguing that Debtor did not reject the executory contracts before USPS invoked its contractual right to recoup; that prior to rejection Debtor and USPS were bound by the terms of those contracts, including USPS's right to recoup; and finally, that even if the contracts were rejected, USPS had an equitable right to recoup because the parties' claims arose from the same transaction.

II.

The ultimate question in this case is whether USPS may invoke the equitable doctrine of recoupment to reduce its obligation to pay Debtor for post-petition trucking services. Unlike set-off, the limits of which are defined in Sec. 553, recoupment does not appear in the Bankruptcy Code. Rather, it is an equitable principle that allows a creditor in bankruptcy "to show that because of matters arising out of the transaction sued on, he or she is not liable in full for the [debtor's] claim." 4 Collier on Bankruptcy p 553.03, at 553-17 (15th ed. 1994).

Recoupment is a general doctrine not limited to bankruptcy litigation. See, e.g., Reiter v. Cooper, --- U.S. ----, ----, 113 S.Ct. 1213, 1218, 122 L.Ed.2d 604 (1993). In the bankruptcy setting, permitting a creditor to recoup a pre-petition claim by reducing its obligation to pay for a bankrupt's post-petition services raises serious concerns:

A fundamental tenet of bankruptcy law is that a petition for bankruptcy operates as a "cleavage" in time. Once a petition is filed, debts that arose before the petition may not be satisfied through post-petition transactions.... Any recoupment exception to this general principle perhaps should be narrowly construed.

In re B & L Oil Co., 782 F.2d 155, 158 (10th Cir.1986) (citations omitted). To prevent a bankrupt's creditors from using recoupment to gain unwarranted preferences, courts require that "the creditor ... have a claim against the debtor that arises from the same transaction as the debtor's claim against the creditor." In re NWFX, Inc., 864 F.2d 593, 597 (8th Cir.1989). To justify recoupment in bankruptcy, "both debts must arise out of a single integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations." In re University Medical Ctr., 973 F.2d 1065, 1081 (3d Cir.1992).

The claims that USPS seeks to offset in this case clearly arose out of the same contracts as Debtor's claims; the question is whether they arose out of the "same transactions." Not surprisingly, given the equitable nature of the doctrine, courts have refrained from precisely defining the same-transaction standard, focusing instead on the facts and the equities of each case. Prior recoupment cases have allowed bankruptcy creditors to offset pre-petition overpayments against a debtor's claim for post-petition work under the same contracts, see B & L Oil, 782 F.2d at 158-59; In re Mohawk Indus., 82 B.R. 174 (Bankr.D.Mass.1987); In re Midwest Serv. & Supply Co., 44 B.R. 262, 266 (1983) and to offset damages for pre-petition fraud in the inducement of a lease against a landlord-debtor's claim for post-petition rent, see In re Holford, 896 F.2d 176 (5th Cir.1990).

These cases suggest that USPS could recoup, for example, claims for overpayment or damage-in-transit arising from Dewey's pre-petition trucking services against Debtor's claims for post-petition services under the same contracts. But USPS's claim here is different--it stems from Debtor's failure to perform its future contractual commitments, a failure that is inextricably tied to its status as a Chapter 11 debtor. USPS argues that we can nonetheless decide the question under general principles of recoupment; it urges us to follow cases that have more or less equated "same transaction" with "same contract." Boatmen's argues with equal vigor that we should consider each trucking shipment, or at least each four-week installment period, a distinct transaction, much as the court in University Medical Center held that Medicare reimbursement payments in different years were not part of the same transaction for recoupment purposes. 973 F.2d at 1081-82. With these competing arguments rather nicely balanced in the abstract, we conclude that the question requires a closer look at the Bankruptcy Code's treatment of executory contracts.

III.

The parties agree that when Dewey petitioned for Chapter 11 protection, its contracts with USPS were executory, that is, they were contracts "so unperformed that the failure of either [party] to complete performance would constitute a material breach excusing the performance of the other." Cameron v. Pfaff Plumbing & Heating, Inc., 966 F.2d 414, 416 (8th Cir.1992). A debtor-in-possession such as Dewey may, with the court's approval, assume or reject an executory contract. See Secs. 365(a), 1107(a). While a Chapter 7 trustee must assume an executory contract within sixty days or it is deemed rejected, see Sec. 365(d)(1), a Chapter 11 debtor may assume or reject at any time prior to confirmation of the reorganization plan, unless the court has ordered that the decision be made within a specified period. See Sec. 365(d)(2); 2 Collier on Bankruptcy p 365.03, at 365-27 to -30. This additional...