Feltman v. Noor Staffing Group, LLC (In re Corporate Resource Services, Inc.)Feltman v. Noor Staffing Group, LLC (In re Corporate Resource Services, Inc.)
MEMORANDUM OPINION AND ORDER STRIKING DEFENDANTS’ DEFENSE UNDER BANKRUPTCY CODE § 553
Thе issue before the Court is whether the defendants may assert a right of setoff under Bankruptcy Code section 553 for admittedly contingent claims. The defendants assert setoff as a defense in this adversary proceeding; they also assert a right to set off against any judgment entered against them in this adversary proceeding the amount of any of their contingent claims allowed in the claims allowance process. The parties have fully briefed the issue
I. BACKGROUND
James S. Feltman, as chapter 11 trustee (the “Trustee”) of the debtors,
The Trustee’s claims against Noor, asserted in the adversary complaint, and Noor’s defenses, arise out of CRS’s sale to Noor of substantially all of CRS’s assets (the “Purchased Assets”) that closed on February 27, 2015. The sale was pursuant to an Asset Purchase Agreement (the “APA”) governed by New York law.
On July 23, 2015, CRS and certain of its affiliated Debtors commenced cases under chapter 11 of the Bankruptcy Code. On September 22, 2015, James S. Feltman was appointed as the Trustee for the Debtors. Some of the facts surrounding the filing are unclear, but it is undisputed that the Debtors collected from their customers amounts due to governmental tax collectors for employee tax withholding. Further, it is undisputed that CRS failed to pay to the IRS and state tax authorities well over $100 million of employee withholding taxes. Almost certainly, CRS is hopelessly insolvent, but whoever may be liable for these unpaid taxes has still not been determined. Obviously, as successor to substantially all of CRS’s assets, Noor is concerned that claims for unpaid taxes (or other amounts) may be asserted against it, but this has not happened so far.
On March 4, 2016, the Trustee commenced this adversary proceeding against Noor, alleging, among other causes of action, turnover, breach of contract, and avoidance of the sale of the Purchased Assets as a constructive fraudulent transfer under section 548 of the Bankruptcy Code (the “Complaint”). On August 19, 2016, Noor filed its amended answer to the Complaint.
On September 2, 2016, the Trustee filed the Motion to Dismiss Noor’s Amended Counterclaims and Strike Noor’s Affirmative Defenses and Recanted Admissions (the “Motion to Dismiss,” ECF Doc. # 60.) Noor opposed the Motion to Dismiss. At a subsequent hearing on October 13, 2016, the Court, inter alia: (i) found that Noor’s breach of contract and misrepresentation claims had to be asserted in a proof of claim; (ii) denied the Trustee’s motion to dismiss Noor’s unclean hands and in pari delicto defenses; and (iii) reserved ruling on Noor’s setoff and collateral source defenses. That same day, Noor filed its proof of claim asserting, among other things, breach of contract, fraudulent inducement, and misrepresentation against CRS. Noor’s Proof of Claim seeks: (i) $135,419.56 in fixed damages (the “Fixed Claims”); (ii) $8,478,516.16 in contingent damages (the “Contingent Claims”); and (iii) unliquidated damages in a yet to be determined amount.
Noor’s amended proof of claim, filed on December 23, 2016, contends that Noor is
(i) CRS’s Pre-Transaction U.S. Immigration Law Violations;
(ii) CRS’s Pre-Transaction New York State Labor Law Violations;
(iii) CRS’s Pre-Transaction Violations of DOE Contract and Medicaid Regulations; and
(iv) CRS’s Pre-Transaction Federal and State Tax Liabilities
The focus of the Trustee’s current motion is on the Contingent Claims. As explained below, New York law does not permit setoff of contingent claims; Noor does not dispute this legal rule. The dispute here is whether applicable bankruptcy law creates a party’s right to set off contingent claims, indepеndent of New York law. Put another way, the issue is whether anything in the Bankruptcy Code creates a right of setoff not available under state law.
The Trustee also argues that even if setoff of contingent claims is permissible, Noor cannot meet the additional requirements of section 553. The Trustee argues that:
even if there was a preexisting right to setoff under New York law for contingent claims (there is not), Noor cannot meet the additional requirements of § 553. Although bankruptcy law allows contingent claims generally, a claim for setoff of a prepetition debt—which allows a dollar for dollar recovery—only arises when all transactions upon which the liability is premised occurred before the petition date. Here, the transactions necessary to establish liability still have not come to pass 18 months after the petition date and two years after the Transaction closed.”
(Trustee’s Memorandum of Law at 3 (emphasis in original).)
The starting point for the analysis is whether New York law permits setoff of contingent claims; it does not. The analysis then shifts to whether the Bankruptcy Code creates a right to set off contingent claims; it does not.
II. DISCUSSION
A. New York Law Does Not Allow Setoff of Contingent Claims
Section 151 of the New York Debt- or and Creditor Law (“DCL”) codifies New York’s equitable and common law right to setoff. It provides that a debtor has the right “to setoff and aрply against any indebtedness, whether matured or un-matured” any amount owing from the debtor to the creditor. N.Y. Debt. & Cred. Law § 151; see Thai Lao Lignite (Thailand) Co. v. Gov’t of the Lao People’s Democratic Republic,
Even when a lawsuit has been filed, claims that are not finally adjudicated are contingent. See Cytec Indus., Inc. v. Allnex (Luxembourg) & Cy S.C.A.,
Noor does not dispute that the bulk of its claims have not yet accrued and are dependent on future events that may never occur. In other words, Noor concedes the vast majority of its claims are contingent. See, e.g., Declaration of Minta J. Nester, Esq. in Support of Trustee’s Memorandum of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553 of the Bankruptcy Code (ECF Doc. # 81), Ex. E (Claim at ¶¶ 13, 15(a)—(d), 16(с)) (describing six categories of “Contingent Liability Damages” that total approximately $8.4 million); Ex. F (Jacobson Report at ¶¶ 8, 30(b), 33-37) (discussing Noor’s “Contingent Liabilities Damages” which “represent claims by Noor against the Plaintiffs [sic] related to liabilities that have not been incurred by Noor through the writing of this report, but might be incurred in the future”) (emphasis added). There is uncertainty whether liability will ever arise—no fines have been levied; no court has found Noor responsible for CRS’s alleged wrongdoing before the sale closed; and Noor has not paid any money to resolve any “contingent” liabilities.
B. The Bankruptcy Code Does Not Create a Right to Setoff
The Supreme Court has definitively resolved that the Bankruptcy Code
The right of setoff (also called ‘offset’) allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding “the absurdity of making A pay B when B owes A.” Although no federal right of setoff is created by the Bankruptcy Code, 11 U.S.C. § 553(a) provides that, with certain exceptions, whatever right of setoff otherwise exists is preserved in bankruptcy.
Citizens Bank of Maryland v. Strumpf,
Strumpf involved a chapter 13 bankruptcy case. The debtor was- in default on a loan from the bank, and the bank’s account agreement expressly provided the bank with the right of setoff. Before the debtor filed the bankruptcy case,
After stating the rule that there is no federal right to setoff under the Bankruptcy Code, the Court went on to conclude that “the question whether a setoff under § 862(a)(7) has occurred is a matter of federal law ....” Id. at 19,
Section 542(b) of the Code, which concerns turnover of property to the estate, requires a bankrupt’s debtors to “pay” to the trustee (or on his order) any “debt that is property of the estate and that is matured, payable on demand, or payable on order ... except to the extent that such debt may be offset under section 558 of this title against a claim against the debtor.” 11 U.S.C. § 542(b)(emphasis added). Section 553(a), in turn, sets forth a general rule, with certain exceptions, that any right of setoff that a creditor possessed prior to the debtor’s filing for bankruptcy is not affected by the Bankruptcy Code. It would be an odd construction of § 362(a)(7) that required a creditor with a right of setoff to do immediately that which § 542(b) sрecifically excuses it from doing as a general matter: pay a claim to which a defense of setoff applies.
Id. at 20,
Strumpf is not alone in stating this very clear rule that the Bankruptcy Code does not create a right of setoff. See In re Bennett Funding Grp., Inc.,
In order to establish a right to setoff under section 553, a creditor must first demonstrate a preexisting right of setoff under nonbankruptcy or state law.
The creditor asserting the right to setoff has the burden to establish that the right to setoff exists. See Geron v. Schulman (In re Manshul Constr. Corp.),
As already explained, New York law does not recognize a right of setoff for contingent claims. Section 542(b) of the Code requires Noor to turn over CRS’s property to the Trustee. Section 553 provides no exception to this requirement in the absence of a nonbankruptcy law right of setoff. To permit Noor to retain CRS’s property and to claim a right to setoff when no such right arises from New York law would have the effect of elevating its unsecured claim (if any) to secured status. See 11 U.S.C. § 506(a)(1) (“An allowed claim of a creditor ... that is subject to setoff under section 553 of this title, is a secured claim to the extent of ... the amount subject to setoff ....”); 4 Collier on Bankruptcy ¶ 506.03[l][b] (16th ed. rev. 2009) (“In general, section 506(a) provides that the existence of a right of setoff under nonbankruptcy law establishes the existence of a secured claim for purposes of the section if the setoff right under non-bankruptcy law is preserved in section 553 of the Code.”).
Noor improperly relies on McCollum v. Hamilton National Bank of Chattanooga,
Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debt- or 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, except to the extent that—....
11 U.S.C. § 553(a). The Supreme Court in Strumpf read the language of this section together with other sections of the Bankruptcy Code. It found no ambiguity—the Bankruptcy Code does nоt create a federal right to setoff.
Noor also relies on In re Chestnut Co., Inc.,
Noor also relies on Elsinore Shore Assocs. v. First Fidelity Bank,
Finally, Noor relies on In re Comm’n Dynamics, Inc.,
Communication Dynamics does provide some support for the premise of Noor’s argument—namely, the court appears to accept the argument that section 553 is ambiguous and should not be read as preventing setoff of a claim arising under another section of the Bankruptcy Code— in that case, under section 365(g) for rejection damages. The supposed ambiguity is that section 553 speaks only of not affecting a right to setoff—“this title does not affect any right of a creditor to offset a mutual debt ... that arose before the commencement of the case,” 11 U.S.C. § 553(a)—without identifying the sources for setoff rights.
Communication Dynamics did not hold that there is a federal right to set off contingent state law claims, as Noor urges. The court cited an article that proposed that contingent claims should be entitled to setoff regardless of state law becаuse of what it perceived as an ambiguity in section 553 of the Bankruptcy Code. See id. at 232; Daniel W. Linna, Jr., Contract Rejection Damages May Not Be Eligible For Setoff After All, Says Delta Court, Am. Bankr. Inst. J., Sept. 25, 2006, at 53. The premise of the argument that setoff of contingent claims is permissible is that section 101(5) of the Bankruptcy Code defines “claim” broadly to include a “right to payment, whether or not such right is reduced to judgment, liquidated, unliqui-dated, fixed, contingent, matured, unma-tured, disputed, undisputed, legal, equitable, secured, or unsecured_”11 U.S.C. § 101(5)(A) (emphasis added). Why, then, in light of the broad definition in section 101(5), should contingent claims be excluded from setoff, even if state law does not permit setoff? The answer here is thаt while Noor may have a claim against CRS under section 101(5), it does not mean that such a claim entitles Noor to setoff under section 553 where state law would not permit setoff. Section 553 does not extend the right to setoff to any “claim” falling within the definition in section 101(5).
Communication Dynamics does not discuss Strumpf or the numerous other cases that make clear that setoff is only available to the extent that the right of setoff is available under nonbankruptcy law. Sections 101(5) and 553 should not be read together to create a federal right of setoff for contingent state law claims, unless set-off of such contingent claims is permissible under applicable nonbankruptcy law. As already еxplained, the effect of doing so would be to elevate unsecured claims to secured status to the disadvantage of all other unsecured creditors, a result contrary to the Code’s policy promoting a distribution to unsecured creditors in pari passu. Absent a clear indication that Congress intended that result, the Court cannot read the Code as commanding a result that Strumpf and the many cases that follow it reject. As explained below, the broad language of section 101(5) does mean that Noor’s contingent claim should not be disallowed at this stage of the case (other than to deny the ability to set off the claim).
C. Noor Has Not Satisfied the Other Requirements of Section 553
1. Section 55S Requires Finality
After a creditor has established a right to setoff under applicable state law, the creditor must then make an additional showing that mutual debts “arose before
“[F]or setoff purposes [under section 553], a claim—even a contingent one—arises when ‘all transactions necessary for liability occur.’ ” WL Homes LLC,
2. Noor’s Claim Does Not Relate Back to the Signing of the APA
Noor argues that the violation of the APA relates back to the time of its execution, and, therefore, its claim arose before the commencement of these cases and is therefore eligible for setoff. The law does not support this argument. As the Trustee correctly argues, to effectuate setoff, Noor must show that “all transactions necessary for liability [have] ocсur[ed].” See Lehman II,
Noor’s reliance on Communications Dynamics in support of its relation-back argument is misplaced. The debtor in that case rejected a contract, triggering a rejection damages claim under section 365(g).
D. Noor’s General Unsecured Claim Survives
The Trustee’s motion requests that Noor’s general unsecured claim should be disallowed and expunged. Section 101(5)(A) includes within its permissible scope claims that are “contingent.” Noor’s claim fairly falls into that category. See 2 Collier on Bankruptcy ¶ 101.05[1] (16th ed. rev. 2011) (“Neither the contingency of the debt nor thе immaturity of the obligation affects whether a right to payment is a claim.”) (collecting cases). The contingent claim (whether asserted as a defense to the adversary proceeding or as a stand-alone claim as part of the claims allowance process) may not be used to set off against the Trustee’s claims against Noor, but Noor is
III. CONCLUSION
For the reasons explained above, Noor may not set off its contingent claims, either as a defense in the adversary proceeding or as a claim against these estates. Therefore, the Trustee’s motion to strike the setoff defense, and the related claim to the extent it seeks setoff for contingent claims, is GRANTED.
IT IS SO ORDERED.
Notes
. See Trustee’s Memorandum of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553 of the Bankruptcy Code (ECF Doc, # 80); Declaration of Minta J. Nester, Esq. in Support of Trustee’s Memorandum of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553 of the Bankruptcy Code (ECF Doc. #81); Noor Staffing Group, LLC and Noor Associates, Inc. ’s Memorandum of Points and Authorities in Support of Right to Setoff Claims Against Debtor Pursuant to Section 553 of the Bankruptcy Code (ECF Doc. # 82); Declaration of Michael D. Hamersky in Support of Noor Staffing Group, LLC and Noor Associates, Inc.’s Memorandum of Points and Authorities in Support of Right to Setoff Claims Against Debtor Pursuant to Section 553 of the Bankruptcy Code (ECF Doc, # 83).
. The debtors in these chapter 11 cases are; (1) Corporate Resource Services, Inc.; (2) Accountabilities, Inc.; (3) Corporate Resource Development Inc.; (4) Diamond Staffing Services, Inc,; (5) Insurance Overload Services, Inc.; (6) Integrаted Consulting Services, Inc.; (7) The CRS Group, Inc.; and (8) TS Staffing Services, Inc. (collectively, the "Debtors”).
.Noor’s defense that a material breach of the contract by CRS partially or wholly excuses Noor’s performance in failing to pay remaining amounts due under the APA is unaffected by the results of this decision. Noor Staffing, LLC’s and Noor Associates, Inc.’s Amended Answer and Counterclaims ¶ 59 (ECF Doc. # 52). See Restatement (Second) of Contracts § 237 (1981) ("Except as stated in § 240, it is a condition of each party’s remaining duties to render performances to be exchanged under an exchange of promises that there be no uncured material failure by the other party to render any such performance due at an earlier time.”).
. The parties do not dispute that, to the extent state law governs, New York law governs.
. Noor does not contend that any other non-bankruptcy federal law creates a right to set-off applicable in this adversary proceeding.
. Noor did not assert a right of setoff until after the petition was filed. "In the setoff context, timing may be of critical importance in determining the creditor's right, for example, in determining whether the creditor's debt to the debtor is pre- or postpetition in nature. As a general rule, checks deposited into the debtor’s bank account are not subject to setoff until they have ‘cleared.’ Thus, if a debtor deposits funds into his or her account the day before the commencement of the case, but the funds do not clear until the day after, the bank's debt may be postpetition in nature and therefore not subject to setoff against the bank’s prepetition claim, In general, the burden of proof rests on the creditor asserting the right of setoff to establish the relevant timing issues. Similarly, timing may be highly relevant with respect to any alleged violation of the automatic stay. A setoff that occurred three hours before the debtor’s filing of the bankruptcy petition was determined to be a prepetition setoff and therefore nоt subject to the stay. In addition, timing may be relevant under the avoidance provisions of section 553(b).’’ 5 Collier on Bankruptcy ¶ 553.05 (16th ed. rev. 2016). This Court need not address whether Noor properly timed its right of setoff, because, no such right ever existed.
. A creditor with a right to setoff is entitled to adequate protection before it turns over funds it holds that are subject to setoff,
. "Federal rights of setoff exist principally to provide the government, as a creditor, with the ability to offset mutual debts owing between the government and others." 5 Collier on Bankruptcy ¶ 553.04[3] (Alan N. Resnick & Henry J. Sommer eds., 16th ed. rev. 2016).
. But see In re Delta Air Lines, Inc.,