Summary of a Recent
Judicial Development in
Bankruptcy

Farm Service Agency Lacks Right to
Setoff Debtors' PFC Payments

Dawn M. Stidd
National AgLaw Center Graduate Assistant

Summary of Decision

In United States of America v. Myers, 362 F.3d 667 (10th Cir. 2004), the United States Court of Appeals for the Tenth Circuit held that the Farm Service Agency (FSA) was unable to offset production flexibility contract (PFC) payments issued by the Commodity Credit Corporation to two Chapter 12 debtors because the debt arose post-petition.

Background

Section 553 of the Bankruptcy Code provides in relevant part the following:

[T]his 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 the debtor that arose before the commencement of the case.

Id. at 670 (quoting 11 U.S.C. § 553).

Debtors Wesley and Sonja Myers defaulted on their FSA loans in 1995. See id. In 1996, the debtors entered into a seven year executory "Production Flexibility Contract" (PFC) with the Commodity Credit Corporation (CCC) and received their first PFC payment in 1996 that same year. See id. The next year the FSA setoff the debtors' 1997 PFC payment and applied it to their outstanding FSA loans. See id. at 671. The FSA instituted foreclosure proceedings against the debtors in 1997. See id. Soon thereafter, the debtors filed a Chapter 12 bankruptcy petition, which they later converted to a Chapter 7 petition. See id.

The filing of the bankruptcy petition stayed the FSA's foreclosure action and terminated the PFC payments. See id. The debtors obtained a discharge of all personal liability as part of their Chapter 7 bankruptcy discharge. See id. The FSA then proceeded with its foreclosure action. See id. Prior to the FSA's foreclosure sale, the debtors filed another Chapter 12 bankruptcy petition that stayed the foreclosure proceedings. See id. The debtors subsequently filed a motion to assume or reaffirm the PFC payments had been previously terminated. See id. The bankruptcy court granted the debtors' motion, stipulating that the debtors could enroll in farm related payment programs, such as the PFC payment program, that the debtors entered into the PFC in July of 2000 as a "successor-in-interest" to the PFC approved in June of 1996, that the 1996 date governed for purposes of setoff, and that the debtors had not conceded that the FSA had a right of setoff. See id. at 671-72.

The debtors subsequently entered into the successor-in-interest PFC and became eligible for the 2000, 2001, and 2002 PFC payments. See id. at 672. The FSA sought relief from the automatic stay so that it could setoff the 2000, 2001, and 2002 payments. See id. The FSA's motion was denied and it appealed the matter to the Tenth Circuit. See id.

Analysis and Holdings

The court explained that the Code does not create a federal right to setoff and thus the right must be found outside of bankruptcy. See id. It also explained that if a right to setoff exists outside of bankruptcy, then a determination must be made as to whether the right exists under § 553. See id. The court stated that "a right to setoff under § 553 arises only when the mutual debt and claim both arose pre-petition." Id.

After determining that the FSA had an independent right of setoff outside of bankruptcy, the court considered whether the FSA had such a right under § 553. See id. It noted that when the debtors filed their first bankruptcy petition the PFC became part of the bankruptcy estate and automatically terminated. See id. at 674. The court stated that since neither the trustee nor debtors assumed the PFC, the PFC payments were no longer owed by the CCC to the debtors. See id. It added that

As a result of the PFC's termination and Debtors' failure to assume the PFC after filing their first bankruptcy petition, no debt or liability existed under the PFC at the time Debtors filed their second bankruptcy petition in March 2000. In other words, a "right to payment" did not exist nor was a debt "absolutely owed" under the PFC at the time Debtors filed their second Chapter 12 bankruptcy petition. Instead, the . . . [CCC's] debt under the PFC only arose when the bankruptcy court entered a stipulated order, approved by the . . . [CCC]., authorizing Debtors to assume the PFC in July 2000. At that point, the . . . [CCC] again owed a debt to Debtors. The stipulated order, however, did not take effect until after Debtors commenced their second Chapter 12 bankruptcy case. Thus, because . . . [the CCC's] debt under the PFC did not "arise before the commencement of" Debtors' second bankruptcy case, the debt is post-petition and not subject to setoff under the first element of § 553.

Id. at 674-75 (citations omitted).

The court therefore concluded that the FSA was precluded from setting off the post-petition debt. See id. at 675.

The case was decided on March 29, 2004; this summary was posted Feb. 16, 2005.