Lead Opinion
The Department of Agriculture’s Agricultural Stabilization and Conservation Service (ASCS) appeals from denial of a motion for modification of automatic stay and for setoff in a Chapter 12 reorganization proceeding.
I. BACKGROUND
Willis Gerth, a farmer, and ASCS enterеd into two CRP contracts on August 27,1987, and. July 7, 1989.
On January 1, 1991, Gerth commenced the present bankruptcy proceeding under Chapter 12. ASCS filed a proof of claim regarding a debt which Gerth owed the government.
Gerth then filed a plan of reorganization which treated ASCS’s claim as unsecured. ASCS opposed the plan and moved for relief from the automatic stay to allow ASCS to set off Gerth’s CRP payments against his debt to the government. Gerth objected to the setoff.
The bankruptcy court denied ASCS’s motion. It reasoned that because Gerth, as the debtor-in-possession, may accept or reject an executory contract under 11 U.S.C. §§ 365 and 1222(b)(6), the payments to which the debtor bеcomes entitled are post-petition payments. A prepetition debt cannot set off a postpetition claim; therefore, the court found ASCS had no right of set-off. The court also held that the debtor and the debtor-in-possession are the same entity for determining whether the debt and the claim are mutual obligations. Because the court found no right of setoff, it did not reach the issue of whether ASCS was entitled to relief from the automatic stay under 11 U.S.C. § 362. The district court affirmed.
II. DISCUSSION
Whether ASCS has a right of setoff is a matter of law, which wе review de novo. See Mickelson v. Leser (In re Leser),
Except as otherwise provided in this section and in [§ ] 362 ... this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against*1431 the debtor that arose before the commencement of the case.
11 U.s.c. § 553.
In order for ASCS to establish its right of setoff, it must demonstrate:
1. A debt exists from the creditor to the debtor and that debt arose prior to the commencement of the bankruptcy case.
2. The creditor has a claim against the debtor which arose prior to the commencement of the bankruptcy case.
3. The debt and the claim are mutual obligations.
Braniff Airways, Inc. v. Exxon Co., U.S.A.,
Gerth contends that the first and third requirements-that the debt from ASCS to him under the ORP contracts arise preрetition and that the debt and claim be mutual obligations-are not satisfied. Gerth urges us to adopt the reasoning in a line of bankruptcy court decisions beginning with Walat Farms, Inc. v. United States of America (In re Walat Farms),
We disagree with the reasoning in Walat Farms and the cases following it, and reject that rationale. We find Matthieson and the cases following it persuasive, and adopt that reasoning.
A. Effect of Assuming an Executory Contract
Gerth argues that when he assumed the executory CRP contracts, ASCS's obligation to pay was transformed into a post-petition obligation. Whether mere assumption of an executory contract by the debtor-in-possession will change unperformed obligations into postpetition obligations is an issue of first impression by this circuit. Both parties agree that the CRP contracts at issue are executory.
Gerth сites to Walat Farms, which states that when an executory contract is assumed postpetition, the right to payment arises postpetition, and is owed to the debt- or-in-possession, not the debtor. Walat Farms,
Several courts have followed Walat Farms. See, e.g., Small Business Admin. v. Gore (In re Gore),
Matthieson, which involved a Chapter 7 case, reached a different conclusion when it addressed the same issue of whether payments which ASCS owed the debtor were prepetition obligations and subject to offset against a prepetition claim. The Matthie-son court did not conclude that assumption by a debtor-in-possession transforms obligations into postpetition obligations. Instead, it examined the contract itself, and
Gerth argues Matthieson does not consider the executory nature of contracts in a reorganization context. See Walat Farms,
We agree with Matthieson and the cases which follow it, and hold that mere assumption of an executory contract does not alter when the obligations under the contract arose. The CRP contracts between Gerth and ASCS contain provisions stating that the effective date of the contract is the date on which it is signed. If the CRP contract terms are such that ASCS’s obligation to pay arose prepetition, then a holding by this court that simply assuming the contract causes the obligation to arise postpetition would have the effect of modifying those contract terms. 11 U.S.C. § 365, which governs assumption of executory contracts, contains nothing which would allow such a modification. “Neither the word ‘assume’ nor any other phrase in § 365 suggest that assuming a contract allows the debtor to do anything other than carry on with the contract according to its terms, including the provisions defining the effective date.” Allen,
Not only does § 365 fail to support such a modification, previous case law has established that when assuming a contract, the debtor assumes all the benefits and burdens of the contract. See NLRB v. Bildisco & Bildisco,
Gerth, as the debtor-in-possession, had the option under § 365 of rejecting the CRP contract. He evaluated the contract and assumed it as beneficial to the estate. Having assumed the contract to receive the benefits, he cannot now seek to avoid the
Therefore, we hold that Gerth’s postpetition assumption of the executory CRP contracts does not cause ASCS’s obligation to pay to become postpetition, but that the obligations arise under the contract as the parties originally agreed.
B. Whether ASCS’s Obligation Arose Prepetition
We next must examine the CRP contracts to determine whether, under the contracts as written, ASCS’s obligation to pay arose prepetition. In order for an obligation to pay to arise prepetition, the debt must be “absolutely owed” prepetition. Braniff Airways,
Under the Bankruptcy Code, “debt” is defined as “a liability on a claim.” 11 U.S.C. § 101(12). “Claim” is defined as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured....” 11 U.S.C. § 101(5)(A). “Debt” should be read as being coextensive with the term “claim.” See Pennsylvania Dep’t of Pub. Welfare v. Davenport,
The question then becomes: When did all the transactions necessary for ASCS’s liability to Gerth occur? Gerth argues ASCS’s obligation is not absolutely owed prepetition because the funding for payments under the CRP contracts must be appropriated each year from Congress. He notes that the contracts contain a clause which make ASCS’s agreement to pay subject to availability of funds.
First, we note the contract terms indicate the parties intended the contracts to be ten-year contracts. A provision for liquidated damages in the event that Gerth should fail to perform his duties gives ASCS the right to terminate the contracts. If ASCS terminates the contract, “[Gerth] shall ... [forfeit all rights to payments ... and [rjefund all payments previously received....” Provision 18A(2).
Second, dependency on a postpetition event does not prevent a debt from arising prepetition. “The charaсter of a claim is not transformed from pre-petition to postpetition simply because it is contingent, unliquidated or unmatured when the debtor’s petition is filed.” Braniff Airways,
In this case, Gerth’s claim — his right to payment — came into existence at the time the contract was signed and ASCS promised to pay him. That claim is contingent on Congress appropriating the necessary funds each year. Because a contingency does not change when a claim arises, Congress’ appropriation of the funds is not a necessary transaction for ASCS’s liability to arise.
Gerth also points out that he has obligations to perform each year under the CRP contracts,
We first note that contracts should be construed with a preference for finding mutual promises rather than conditions. Restatement (Second) of Contracts § 227(2) and cmt. d (1982); see Allen,
Examination of the CRP contracts demonstrate they are in the form of mutual promises, not conditions precеdent. Under the contract, each party agreed to perform certain duties: Gerth “must,” inter alia, place land into the Conservation Reserve Program for ten years, and establish and maintain a vegetative cover on the land. Provisión 3A. ASCS “agrees,” inter alia, to pay Gerth an annual rental payment. Provision 3B. The contracts also state the terms of the contract — that Gerth “must” and ASCS “agrees” — are effective when signed by the parties. The contracts contain no language which indicates that the duties of either party is a condition for performance of the other party’s duties.
Another provision explains the reason liquidated damages are assessed in the event Gerth breaches the contract. This provision states that after the parties enter the contract, ASCS will be relying on the participants in the CRP program to perform their obligations. Provision 23(A)(3). By entering the contract, Gerth agreed that he “must” perform, thus assuring ASCS he would perform and inducing ASCS’s reliance. This provision indicates in a definitive manner that Gerth and ASCS intended the contract as an exсhange of promises. See 3A Corbin on Contracts § 633, at 32 (stating that an expression intended to be an assurance of perfor-
We conclude that ASCS and Gerth exchanged mutual promises to perform. Accord Matthieson,
In summary, all transactions necessary for ASCS’s liability under the CRP contract took place upon execution of the contract and entry of Gerth’s land into the program. Therefore, ASCS’s debt was absolutely owed and arose prepetition, satisfying the first requirement for the right of setoff under § 553.
C. Mutuality
Gerth next claims that the requirement of mutuality is not met. Gerth contends that the debtor and the debtor-in-possession are different entities, and that he assumed the CRP contracts postpetition as the debt- or-in-possession. Therefore, he reasons, ASCS’s claim is against him as the debtоr, and ASCS’s debt is to him as the debtor-in-possession, destroying mutuality. Whether the debtor and the debtor-in-possession are the same entity for purposes of mutuality under 11 U.S.C. § 553 also is a matter of first impression by this circuit.
Whether the “different entity” theory is still viable in any context is questionable. The Supreme Court, when discussing enforceability of collective bargaining agreements against a debtor-in-possession, stated that if the debtor-in-possession
were a wholly ‘new entity,’ it would be unnecessary for the Bankruptcy Code to allow it to reject executory contracts, since it would not be bound by such contracts in the first place. For our purposes, it is sensible to view the debtor-in-possession as the same ‘entity’ which existed before the filing of the bankruptcy petition, but empowered by virtue of the Bankruptcy Code to deal with its contracts and property in a manner it could not have employed absent the bankruptcy filing.
NLRB v. Bildisco & Bildisco,
Other courts which have continued to subscribe to the different entity theory have limited Bildisco, see, e.g., Patton v. John Deere Co. (In re Durham),
Although we d.o not decide the broad issue of whether the different entity theory is not viable in any context, we find the discussion in Allen concerning its application in the instant context persuasive. See Allen,
We first note that use of the term “debt- or-in-possession” in the Bankruptcy Code supports our holding. See 11 U.S.C. § 1101(1) (“ ‘debtor-in-possession’ means debtor”). Second, in Bildisco, the Supreme Court explicitly considered the different entity theory in terms of executory contracts and 11 U.S.C. § 365, which governs assumption of executory contracts. In this context, the Bildisco Court stated the debt- or and the debtor-in-possession are the same entity. If the debtor and the debtor-in-possession are the same entity for purposes of an executory contract under § 365, we see no logical reason to consider them different entities when examining an executory contract for purposes of setoff under § 553 after that contract has been assumed under § 365.
Third, if the different entity theory were applicable in a § 553 context, every assumed executory contract would automatically fail to satisfy the requirement of mutuality. Congress intended to preserve set-off rights by enacting § 553. See Cohen v. Savings Bldg. & Loan Co. (In re Bevill, Bresler & Schulman Asset Management),
Finally, our holding that the debtor and the debtor-in-possession are the same entity allows § 553 to be interpreted in a manner that gives the entire statute meaning. The plain language of § 553 already prohibits setoff unless the debt owed by the creditor arises prepetition. In other words, it prohibits setoff if the debt is owed to the debtor-in-possession at the time the obligation arises. If the requirement of mutuality were interpreted to prevent setoff based on a distinction betwеen the debtor and the debtor-in-possession, the prepetition requirement would be meaningless.
Because the debtor and the debtor-in-possession are the same entity, we conclude that the mutuality requirement under § 553 deals with the question of whether the creditor who absolutely owed the debt- or prepetition is the same party asserting setoff. See Bevill, Bresler & Schulman,
Apрlying this interpretation to the facts before us, we hold that the mutuality requirement is met. ASCS is the party who absolutely owed Gerth prepetition, and is the same party asserting setoff.
III. CONCLUSION
In summary, we find that both ASCS’s debt to Gerth and its claim against Gerth arose prepetition and are mutual obligations. All the requirements of § 553 are met, and ASCS has established its right to setoff under this section. Therefore, we vacate the bankruptcy court’s order denying ASCS’s motion for modification of automatic stay and for setoff, and remand for determination of whether ASCS is entitled tо relief from the automatic stay under 11 U.S.C. § 362.
Notes
. The contract provisions refer to the Commodity Credit Corporation (CCC) as the party with which Gerth contracted. CCC is a wholly-owned government corporation within the United States Department of Agriculture. Because CCC has no employees, the Secretary of Agriculture established ASCS to act on behalf of CCC and to administer government farm programs. In re Woloschak Farms,
. The main portion of this debt arose during a former Chapter 11 bankruptcy proceeding in which ASCS allowed Gerth to sell some grain which was collateral for an earlier loan. Gerth used this cash for operating expenses. This Chapter 11 proceeding was dismissed at Gerth's request in 1990. The balance of Gerth's debt to the government is from agricultural price support overpayments in 1988 and 1989.
. The Evatt court stated that In re Fryar,
. The contract also incorporated a federal regulation allowing ASCS to set off debts owed the government against the CRP payments. By assuming the contract, Gerth also assumed thе burden of the right of setoff.
. The contract states:
CCC agrees:
1) Subject to the availability of funds to:
a) Pay to the participant an annual rental payment for a period of years....
. This provision states in pertinent part:
(1) If the participant fails to carry out the terms and conditions of this contract, CCC may terminate this contract.
(2) If this contract is terminated ... the participant will:
(a) Forfeit all rights to payments under this contract: and
(b) Refund all payments previously received together with interest ...; and
(c) Pay liquidated damages....
. Gerth’s continuing obligations under the contract are basically to maintain the vegetative cover on the land, comply with noxious weed laws, and annually file forms. Gerth must also refrain from аctions such as allowing grazing, harvesting, or other commercial use of the forage or trees, and refrain from other actions that would defeat the purpose of the contract. ASCS submitted an affidavit from the ASCS county executive director who administers Gerth's CRP contracts stating that “only minimal operations" are necessary for Gerth to meet these obligations. On appeal, Gerth argues that his obligations are not minimal. We cannot consider this allegation because Gerth failed to submit any evidence to support it in the courts below. In any event, whether the obligations are minimal or not is irrelevant, as the terms of the contract, not how much Gerth will perform postpetition, indicate when ASCS’s obligations arise.
. Gerth argues Allen is poor support because a portion of the case was decided on the basis of Iowa contract law: We note, however, that the Allen court used general contract principles and the terms of the contract to determine that the contract was based on mutual promises.
. The Matthieson court stated that even if the contracts at issue had been in the form of conditions precedent, ASCS’s obligations were binding from the inception of the contract. The court noted that a condition precedent does not affect formation of the contract. It stated that the contract remains in existence when a party fails to satisfy a condition precedent, but performance cannot be compelled. Matthieson,
Dissenting Opinion
dissenting.
In my view, this case was correctly decided by the bankruptcy court and the district court. I would affirm on the basis of the wеll-reasoned opinion of the bankruptcy court. It is important to add that if the position of the ASCS is sustained in this
I realize that the majority leaves open the possibility of the debtor’s plan still being confirmed pursuant to 11 U.S.C. § 362 if the district court finds that the effect of allowing the offset will be to prevent the plan from being confirmed. On the basis of the record before us, I believe this to be the case, and I agree with the majority that it is the district court’s right to make this decision initially.