Summary of a Recent
Judicial Development in
Bankruptcy

USDA Denied Right of Setoff
in Chapter 12 Case

Jay Kiiha
National AgLaw Center Graduate Assistant

The Bankruptcy Appellate Panel ("BAP") for the Tenth Circuit has ruled that the USDA did not have a right to setoff the amount it owed to two Chapter 12 debtors in farm program payments against what it claimed the debtors owed to it as a result of a foreclosure judgment. In re Myers, 284 B.R. 478, 479-81 (B.A.P. 10th Cir. 2002). The BAP determined that the debtors discharged their personal liability in their previous Chapter 7 bankruptcy case, and therefore there was no claim that the USDA could setoff against the debtors. See id. at 480.

The debtors were family farmers who owed the Farm Service Agency ("FSA"), an agency within the USDA, a substantial amount of money "which was secured by liens to their land and other assets." Id. at 479. The debtors defaulted on their FSA loan, and the FSA sued to foreclose its interest. See id. The debtors filed for Chapter 12 bankruptcy soon thereafter but converted to a Chapter 7 bankruptcy the following year. See id. As a result, the amount owed by the debtors to the FSA was discharged pursuant to Bankruptcy Code § 727. See id. The FSA then brought its foreclosure complaint in federal district court "and obtained a stipulated foreclosure judgment against the debtors after the Chapter 7 discharge was issued and the case was closed." Id.

In March, 2000, the debtors filed a second Chapter 12 bankruptcy petition. See id. The parties subsequently entered into a stipulation agreement that provided that the debtors were authorized to participate in farm subsidy programs. See id. The stipulation provided that "[t]he Department of Agriculture does not waive any rights it may have as to setoff or recoupment as to any amounts which become payable to Debtors as a result of enrollment for the years 2000, 2001, 2002, in any such program.'" Id. (citation omitted). The stipulation also stated that "the debtors do not admit that the Department of Agriculture has any rights of setoff." Id. (citation omitted). The BAP noted that "[i]t is significant to our decision that this stipulation was made after the debtors had received their Chapter 7 discharge." Id.

After entering into the stipulation agreement, the USDA "moved to modify the automatic stay in order to setoff payments made to the debtors against what it claims the debtors owed to it." Id. The bankruptcy court denied relief from the stay, and the USDA appealed the bankruptcy court's decision to the BAP for the Tenth Circuit. See id. The BAP stated that

[T]his appeal of an order denying . . . relief from the stay turns on the issue of whether the appellant may set off funds it owes to the appellee-debtors for certain crop payments against what it claims the debtors owe to it as holder of a foreclosure judgment. The complaint was decided below on complex issues of which one of various Farm Service Agency administrative regulations and programs applies to the case at hand. Under our analysis of the issues, the case can be decided on a straightforward interpretation of applicable provisions of the Bankruptcy Code, and we affirm.

Id. at 479.

The BAP explained that when the debtors' Chapter 7 discharge was filed, they were discharged from "'all debts that arose before the date of the order for relief.'" Id. at 480 (citation omitted). It also explained that under Bankruptcy Code § 348 "the date of the order for relief was in June, 1998, and no one disputes that their debt . . . arose before that date." Id.

Under Bankruptcy Code § 101(12), "debt" is defined as "'liability on a claim.'" See id. Bankruptcy Code § 101(5)(A) defines "liability on a claim" as "'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 . . . .'" Id. (citation omitted). The BAP stated that "[t]his means that . . . ever since the discharge was entered the debtors have had no personal liability for their debt to [the USDA.] Or, put in other terms, since that date the [USDA] has had no claim against the debtors." Id.

In addition, the BAP noted that Bankruptcy Code § 553(a), which controls setoff under the bankruptcy code, provides that "'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 commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case . . . .'" Id. (emphasis supplied). The BAP stated that "[b]ecause the debtors had been discharged of personal liability for their debt to the [USDA] before commencement of [the] case, there is no 'claim of such creditor against the debtor.'" Id. It added that it "follows that because the [USDA] has no claim against the debtors it has nothing to setoff against what it owes to the debtors under the various agricultural programs." Id.

The BA rejected the USDA's argument that it had a right to setoff because the Chapter 7 discharge "only extinguished the debtors' personal liability and not in rem liability." Id. (citation omitted) (emphasis supplied). The USDA cited In re Davidovich , 90 F.2d 1533 (10th Cir. 1990) to support its argument. See id. In Davidovich, the debtor brought suit against his former law partner for funds obtained via post-petition arbitration proceedings. See id. The defendant argued that he had a right to setoff the debt. See id. The bankruptcy court allowed the setoff, and the holding was upheld by the district court. See id. On appeal to the Tenth Circuit, the debtor argued against setoff "because the defendant had not filed proof of claim and the debtor had already received his discharge." Id. The Tenth Circuit upheld the lower court's decision to allow the defendant a right of setoff "because [the defendant] held an in personam pre-petition claim against the debtor." Id. (emphasis supplied). In the present case, the BAP stated that the facts in Myers were not on point, and the USDA had no right to setoff because it "held no pre-petition claim against the debtors due to the previous Chapter 7 discharge." Id.

The case was decided on October 22, 2002; this summary was posted April, 2003