Valid Setoffs Are Unavoidable
Claybrook v. Metro Auto Xpress, LLC (In re American Remanufacturers, Inc.), Case No. 05-20022, 2008 WL 2909871 (Bankr. D. Del. July 25, 2008) (Walsh, J.)
In this Chapter 7 case, the American Remanufacturers, Inc.’s (the “Debtors”) business involved remanufacturing automobile parts for resale. Prior to and after the bankruptcy, the Tri-City purchased automotive parts produced by the Debtors and received credits for used parts it sold to the Debtors. The Chapter 7 Trustee commenced an adversary proceeding against Metro Auto Xpress trading as Tri-City Automotive Warehouse (“Tri-City”) alleging breach of contract, unjust enrichment, quantum meruit, and avoidance and turnover of estate property. The Bankruptcy Court granted Tri-City’s motion to dismiss the avoidance and recovery claims.
The Debtors initially filed a petition for relief under chapter 11 of title 11 of the United Stated Code, §§ 101, et seq. (the “Bankruptcy Code”) in November 2005. Shortly thereafter, the case was converted to chapter 7. As of January 12, 2006, Tri-City owed the Debtors $218,328.96. Tri-City alleged that it was entitled to setoff the balance due against credits owed for returned goods. The Debtors contended that any setoffs that occurred within the preference period and post-petition were avoidable pursuant to 11 U.S.C. §§ 547, 548 or 549. Tri-City moved to dismiss the avoidance and recovery claims, which were premised on the Court finding that Tri-City possessed setoff rights under 11 U.S.C. § 553.
The Bankruptcy Court rejected the argument that if the Court granted the setoffs, the result would be to elevate Tri-City to secured status and thus, diminish the estate to the detriment of other creditors as irrelevant. The Court quoted Collier’s and stated that such a result is “precisely the purpose of a setoff.” As Collier’s states, “…setoff in bankruptcy is the equivalent of a lawful preference….Section 503(a)… treats rights arising through setoff in the same manner as rights arising from a security agreement or other relevant security devise.” 5 Collier on Bankruptcy ¶ 553.02 (15th ed. rev. 2008).
Further, the Court held that valid setoffs are not avoidable as preferential or fraudulent transfers because setoffs are not transfers of estate property. Again the Court referred to Collier’s which notes that avoidance actions require a “prepetition ‘transfer’ of an interest of the debtor in property….The term ‘transfer’ is defined in the Code section 101, and the definition intentionally omits ‘setoffs.’ The legislative history to section 101 explains the omission in clear terms; ‘Inclusion of ‘setoff’ is deleted’…section 553 provides that this title, i.e., title 11, does not affect setoff rights. Thus, setoff cannot be a preference or a fraudulent transfer.” Id. at ¶ 553.09[1][a].
The Court also dismissed Debtors’ attempt to avoid post-petition transfers pursuant to 11 U.S.C. § 549. Section 549 permits avoidance of a transfer of estate property that is not authorized by the court. Thus, if the Court finds that Tri-City is entitled to setoff as preserved by 11 U.S.C. § 553, then such a finding provides the court authorization contemplated by § 549(a)(1)(2)(B).
Finally, because valid setoffs cannot be avoided, § 550 is not applicable.
