43 F.4th 1
1st Cir.2022Background
- Builders Holding Co., a general contractor, had an indemnity agreement with surety MAPFRE that assigned payments on contracts to MAPFRE; MAPFRE perfected a security interest in Builders’ accounts receivable.
- Builders maintained an operational deposit account at Oriental Bank and opened two secured lines of credit with Oriental that matured in late 2015, leaving Builders owing >$450,000.
- The Puerto Rico Financing Authority (payor) was instructed by MAPFRE and Builders to make payments on certain projects jointly to MAPFRE and Builders, but on May 23, 2016 it deposited $537,924.18 directly into Builders’ deposit account at Oriental.
- Oriental Bank, asserting a perfected security interest/control over the deposit account, applied $464,757.60 of that deposit as a set-off against Builders’ outstanding lines of credit; MAPFRE and the bankruptcy trustee demanded turnover.
- The Bankruptcy Court granted summary judgment for MAPFRE/trustee, holding Oriental’s set-off was barred because the deposit was a payment in error under Puerto Rico Civil Code art. 1795; the District Court affirmed.
- The First Circuit vacated and remanded, concluding the Bankruptcy Court legally erred in extending Article 1795 to require Oriental to return funds and directing further proceedings on set-off mutuality, priority, and other Puerto Rico-law defenses.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Puerto Rico Article 1795 (payment-in-error) required Oriental to return funds it set off | Financing Authority/MAPFRE: the Financing Authority paid mistakenly to Builders; under Article 1795 recipient (or recipient’s transferee) must restore funds | Oriental: Article 1795 does not apply to a third-party bank that received funds only because they were deposited into the debtor’s account; Financing Authority failed to prove payment error | Court: Bankruptcy Court misapplied Article 1795 to compel Oriental to return funds; reversal and remand (statute not properly extended to bank in these facts) |
| Whether Oriental’s set-off is allowed under 11 U.S.C. § 553 (mutuality and prepetition debt) | MAPFRE/trustee: § 553 blocked because payment-in-error eliminated bank’s right to offset | Oriental: § 553 permits set-off because bank held a prepetition mutual debt/claim and perfected security interest/control over deposit account | Court: Left unresolved; remanded to determine mutuality and whether § 553 applies given Puerto Rico law constraints |
| Priority between Oriental’s asserted set-off/security interest and MAPFRE’s perfected security interest | MAPFRE: its earlier registered security interest in accounts receivable is senior and entitles it to the funds | Oriental: contends its security interest in the deposit account and exercise of control/set-off entitles it to retain funds | Court: Priority unresolved; remanded for determination under Puerto Rico law (including possible unjust enrichment issues) |
| Whether federal court may (or should) expand Puerto Rico law or certify novel questions to PR Supreme Court | MAPFRE/Financing Authority: Article 1795 facially controls; no certification requested | Oriental: urges caution; the Federal courts should not create new state-law rules and may certify novel questions | Court: Declined to expand PR law; suggested certifying to PR Supreme Court if appropriate on remand; remanded for further state-law determinations |
Key Cases Cited
- City Sanitation, LLC v. Allied Waste Servs. Mass., LLC (In re Am. Cartage, Inc.), 656 F.3d 82 (1st Cir. 2011) (federal appellate review of bankruptcy-court decisions)
- Desmond v. Varrasso (In re Varrasso), 37 F.3d 760 (1st Cir. 1994) (de novo review of summary judgment in bankruptcy appeals)
- In re Pub. Serv. Co. of N.H., 884 F.2d 11 (1st Cir. 1989) (mutuality requirement for set-off under § 553)
- Phoung Luc v. Wyndham Mgmt. Corp., 496 F.3d 85 (1st Cir. 2007) (federal courts bound by state supreme court on state-law issues)
- Grella v. Salem Five Cent Sav. Bank, 42 F.3d 26 (1st Cir. 1994) (remand to bankruptcy court for further proceedings on unresolved factual/legal issues)