588 B.R. 82
Bankr. C.D. Cal.2018Background
- Process America (Debtor) and Cynergy (successor to original processor) litigated disputes under a 2004 ISO Agreement involving merchant processing residuals, an EP/ISO reserve, and a Cure Stipulation from Cynergy's predecessor’s bankruptcy. Cynergy ceased residual payments in 2011 and Debtor later filed chapter 11 (Nov. 12, 2012).
- Debtor sued in federal court (E.D.N.Y.) and the District Court adjudicated liability and damages; the Second Circuit affirmed/vacated in part and remanded for recalculation, ultimately producing a reduced damages award to Cynergy. The District Court did not finally adjudicate certain post-petition or estate-administration issues.
- Debtor commenced an adversary proceeding in the bankruptcy court seeking declaratory relief and turnover of the EP/ISO Reserve and alleged offsets/recoupment for Second Period Residuals (post-Jan 1, 2013). Cynergy filed a motion to dismiss, moved to confirm recoupment/setoff, and sought relief from stay.
- Central contested assets: (1) First Period Residuals (pre-petition) and Second Period Residuals (post-petition); (2) EP/ISO Reserve (contract $250,000 plus ~$1.54M from Cure Stipulation); and (3) whether Cynergy’s judgment is secured and entitled to pre/post-judgment interest or recoupment/setoff.
- The bankruptcy court held that many contract-liability issues were litigated in District Court and are given preclusive effect, but that questions about property of the estate, post-petition residuals, turnover, recoupment against Cure/Stipulation funds, perfection/security, interest in bankruptcy, and post-petition conduct remain for this Court to decide after discovery.
Issues
| Issue | Plaintiff's Argument (Process America) | Defendant's Argument (Cynergy) | Held |
|---|---|---|---|
| Motion to dismiss FAC | FAC pleads viable claims: turnover, accounting, offset/recoupment, avoidance, equitable subordination, declaratory relief; discovery needed | Must be dismissed on preclusion grounds and for failure to state a claim | MTD largely denied; only specified paragraphs dismissed with prejudice; most issues survive to discovery |
| Ownership of Second Period Residuals | Second Period Residuals are post-petition estate property; District Court rulings did not decide estate-administration of post-petition funds | District Court’s rulings and Rule 59 denial barred Debtor from claiming Second Period Residuals | Court held Residuals are estate property and that District Court did not bar bankruptcy adjudication of post-petition residuals |
| Turnover of EP/ISO Reserve under §542 | Reserve (and excess over formula) is estate property and turnover may be appropriate now | Turnover precluded because District Court ruled funds not yet returnable until 270 days after termination of all merchant agreements; disputed funds cannot be turned over | Turnover claim plausibly pleaded but immediate turnover denied without prejudice as premature; factual determination (merchant status, amounts) required |
| Recoupment / Setoff by Cynergy | Debtor asserts recoupment/setoff of post-petition residuals against Cynergy’s claim; Debtor also has competing recoupment claims | Cynergy seeks recoupment/setoff of judgment against Reserve and Cure funds, arguing same-transaction/logical-relationship and preclusive effect of prior rulings | Court allowed limited prior recoupment ($128K) and denied broader recoupment/setoff for now; disputed issues (Cure Stipulation relation, competing claims, interest) remanded for factual development |
| Secured status / perfection of Cynergy’s claim | At most $128K secured (formula); remainder is estate property; Cynergy’s claimed lien/perfection disputed | Cynergy says ISO creates lien/security interest and control/perfection under UCC justifies secured status and setoff | Whether claim is secured and extent of perfection is a disputed factual/legal question inappropriate for 12(b)(6); claim avoidance cause survives |
| Pre- and post-judgment interest | Debtor: interest post-petition and post-judgment may be disallowed in bankruptcy; prejudgment interest after petition date should not be collectible | District Court awarded pre- and post-judgment interest under NY law; Cynergy seeks full interest recovery | District Court resolved non-bankruptcy entitlement to interest but bankruptcy-allowability (postpetition/postjudgment) left to this court; requires discovery on insolvency/security |
| Accounting and Reserve use (including attorneys’ fees) | Debtor seeks full accounting of funds Cynergy collected/used; alleges improper deductions from reserves | Cynergy claims reserves used properly (losses, fees); District Court declined fee award; details not disclosed | Accounting claim survives; full accounting ordered to determine amounts, uses, and any improper post-petition deductions |
| Equitable subordination | Debtor alleges Cynergy’s withholding was inequitable and harmed other creditors, warranting subordination | Cynergy says conduct not egregious; District Court/Second Circuit found no gross misconduct pre-petition | Pre-petition allegations that were rejected by District Court/Second Circuit are precluded; claims about post-petition continuing harm survive to be proven |
Key Cases Cited
- Process America v. Cynergy Holdings, LLC, 839 F.3d 125 (2d Cir. 2016) (appellate decision on liability, damages and inclusion/exclusion of withheld residuals)
- Brown Media Corp. v. K & L Gates, LLP, 854 F.3d 150 (2d Cir. 2017) (bankruptcy context complicates claim-preclusion analysis)
- Newbery Corp. v. Fireman's Fund Ins. Co., 95 F.3d 1392 (9th Cir. 1996) (recoupment/setoff principles in bankruptcy; distinction between recoupment and setoff)
- In re Comstock Fin. Serv., Inc., 111 B.R. 849 (Bankr. C.D. Cal. 1990) (limits on giving preclusive effect to non-bankruptcy court judgments regarding allowance/disallowance of claims)
- Cogliano v. Anderson, 355 B.R. 792 (9th Cir. BAP 2006) (exceptions to claim-splitting and res judicata in bankruptcy context)
- Moore v. New York Cotton Exchange, 270 U.S. 593 (U.S. 1926) (transactional/logical-relationship test for recoupment)
- In re Gurga, 176 B.R. 196 (9th Cir. BAP 1994) (turnover doctrine and arbitration/abstention context)