One Big Government Family The Unitary Creditor Doctrine Under 553

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Apr 1999

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Section 553 of the Bankruptcy Code recognizes that except as provided in that section, title 11 of the U.S. Code does not affect any right of a creditor to offset a mutual debt owing by such
creditor to the debtor if the mutual debts arose prior to the commencement of the bankruptcy
case. When more than one department, agency or instrumentality of the federal or state
government are creditors in a bankruptcy case, the issue of whether those entities ought to be
considered a single creditor for purposes of §553 must be considered. Although within the last few years four circuit courts of appeal have concluded that various governmental entities should
be treated as a single or unitary creditor under §553, not all circuit courts have opined on the
issue. This article analyzes the legal authorities that have grappled with the unitary government
creditor issue in the context of set-offs and considers points relevant to the breadth to which
such doctrine should be applied.

Often cited as the seminal case recognizing that separate government entities should be
considered as a unitary creditor is <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Cotton Mills Inc. v. United States, 327 U.S. 536, 105
Ct. Cl. 824, 665 S. Ct. 729, 90 L.Ed. 835 (1946)</a>, a non-bankruptcy case. In Cherry Cotton
Mills the petitioner was entitled to a refund under the Agricultural Adjustment Act and it owed
the Reconstruction Finance Corp. (RFC) a balance on a promissory note. The General Accounting
Office directed the Treasury to effect a set-off.<a href="#1" name="1a">1</a> The petitioner contended that the court of
claims had no jurisdiction because the RFC was, in essence, a private corporation. In concluding
that the RFC was in fact a government agency, although it used the word "corporation" in its
name, the U.S. Supreme Court considered the following factors: (i) the directors were appointed
by the president and confirmed by the Senate; (ii) its activities were all aimed at accomplishing
a public purpose; (iii) all of the funding for the RFC came from the federal government; and
(iv) its profits, if any, were paid to the government, and its losses had to be borne by the
government. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 536</a>. The critical factor was that the RFC was "selected by government to
accomplish purely governmental purposes." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 536</a>.

Courts that have applied Cherry Cotton Mills to support holdings that governmental entities
should be treated as a single creditor for purposes of §553 have not scrutinized the entities by
specifically applying the four factors described in the opinion, and only rarely have analyzed
the nature of any "governmental purpose," much less whether such purpose was "purely"
governmental. With the ever-expanding government bureaucracy, including the plethora of
quasi-governmental entities (e.g., Pension Benefits Guarantee Corp., Securities Investor
Protection Corp.), greater attention should be given to an analysis of whether a government
department, agency or instrumentality actually accomplishes a "purely governmental
purpose." If the entity fails that test, it should not be included as part of the governmental
single creditor.

Authorities exist in each circuit (although not necessarily at the court of appeals level) that
various government entities should be considered to be a single creditor for purposes of §553.
Arguments that the definition of "governmental unit" (§101(27)) reflects an intent by
Congress that departments, agencies and instrumentalities of the United States constitute
separate units (i.e., creditors), and therefore should not be consolidated for purposes of §553,
have been rejected. The obvious lack of clarity of the definition often has been ignored, or
Cherry Cotton Mills has merely been cited without analysis as authority for how the Code's
definition should be interpreted.

Recently the Seventh Circuit Court of Appeals added that circuit to the unitary government
creditor fold with <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…. v. Maxwell, 157 F.3d. 1099 (7th Cir. 1998)</a>. Reversing the lower
court, the circuit court concluded that no exception to the right of set-off existed based on the
"pervasive nature" of the federal government. Both the bankruptcy and district courts had
concluded that because there are so many agencies, if they were considered to be one creditor the
federal government would be substantially more likely to be able to enjoy the extraordinary
benefits of set-off, and that to permit such agency consolidations would be inequitable to the
other creditors. Although set-off can be denied under the Code for equitable reasons, the circuit
court rejected the argument that the mere size of the government with its numerous entities
supported denial of the right to interagency set-off.

In 1996, the Second Circuit in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Casualty & Surety Co. v. LTV Steel Co. Inc. (In re
Chateaugay Corp.), 94 F.3d 772 (2nd Cir. 1996)</a> adopted the unitary government creditor
approach when it, in essence, rejected the reasoning set forth in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Ionosphere Clubs Inc.,
164 B.R. 839 (Bankr. S.D.N.Y. 1994)</a>. Chief Judge Lifland in Ionosphere Clubs had followed the
analysis in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Lakeside Community Hosp. Inc. (In re Lakeside Community Hosp. Inc.),

151 B.R. 887 (N.D. Ill. 1993)</a> that (i) only "a creditor" has a set-off right, (ii) a creditor,
under §101(10), is an "entity" with a claim, (iii) an entity includes a "governmental unit,"
and (iv) a "governmental unit" is the United States or a department, agency or instrumentality
of the United States. Judge Lifland concluded that units of the government were intended by
Congress to be treated as separate entities and not consolidated into the same creditor. In its
decision on appeal in Chateaugay, the Second Circuit, relying in part on Cherry Cotton Mills,
held that tax refunds could be set off against non-tax liabilities. Chateaugay was recently
followed in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Whimsey Inc., 221 B.R. 69 (S.D.N.Y. 1998)</a>, reversing the bankruptcy court,
which had relied on Ionosphere Clubs. The district court, noting that recent opinions by the
Courts of Appeals in the Ninth and Tenth Circuits applied Cherry Cotton Mills in the context of
bankruptcy cases, held that the Internal Revenue Service (IRS) and the Customs Services were
government agencies that were considered for purposes of §553 to be a single unitary creditor.

The Ninth Circuit in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Inc. v. U.S. (In re Hal Inc.), 122 F.3d 851 (9th Cir. 1997)</a>, a case
raising set-off issues among the IRS, Federal Aviation Administration, Defense Finance
Accounting Service, National Finance Center and Immigration and Naturalization Service, relied
on its decision in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. U.S., 58 F.3d 494 (9th Cir. 1995)</a> to reach its conclusion that all the
entities were a single "governmental unit."<a href="#2" name="2a">2</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra at 853</a>. However, it is interesting to
note that Doe, an opinion regarding sovereign immunity, specifically held that a
government-created entity should not be consolidated if the entity functioned in a "distinct
private capacity." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra at 498</a>. An example of an entity established by Congress that was
not to be consolidated under the unitary creditor doctrine was the Federal Deposit Insurance
Corp. when it acted as a private receiver.

In 1996, the Tenth Circuit, relying on Cherry Cotton Mills, held in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. SBA (In re
Turner), 84 F.3d 1294 (10th Cir. 1996) (en banc)</a> that the Small Business Administration
(SBA) and the Agricultural Stabilization and Conservation Service were a single creditor for
purposes of §553. The circuit court could find no reason that the unitary creditor doctrine
should not apply with respect to set-offs in a bankruptcy case. Although accepting the debtor's
argument that the definition of "governmental unit" reflects that the Bankruptcy Code
recognizes a difference between the United States and agencies of the federal government, the
court found that the unitary creditor approach applied under §553 "comports with the language
of the section and avoids any inconsistencies between the set-off provisions of the Bankruptcy Code and <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §3716(a)</a>, the statutory grant of the right to collect debts by administrative
offset." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra at 1298</a>.

While it is not subject to dispute that the unitary government creditor doctrine has been
pervasively adopted by the federal courts,<a href="#3" name="3a">3</a> merely because a nexus exists between an entity and
the federal government does not conclusively establish that the entity constitutes a
department, agency or instrumentality that will support consolidation of that entity with
another government entity to become a unitary creditor for purposes of being entitled to
exercise set-off rights under §553. A court should consider whether the entity is functioning
for a "purely governmental purpose" (see Cherry Cotton Mills) or is actually performing a
non-governmental role. Parties opposing the set-off claims of governmental entities claiming a
right to apply the unitary creditor doctrine might be able to raise significant questions about
whether at least one of the entities is satisfying a governmental purpose. Such a question raises
interesting philosophical issues about what the federal government's purpose is. With the
breadth of the federal government, an increasing number of entities created by the legislative
and the executive branches of government might not withstand scrutiny regarding their
governmental purpose to qualify for consolidation with other governmental entities.

Another interesting issue raised by the application of the unitary creditor doctrine is its
application outside of the federal and state government context. Could agencies of a foreign state
also use the doctrine?<a href="#4" name="4a">4</a> Can a federally chartered credit union be consolidated for set-off
purposes with the IRS? A federal credit union has been held to be a governmental
instrumentality, although such institutions are not owned or operated by the United States. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re
Trusko, 212 B.R. 819 (Bankr. D. Md. 1997)</a>. Although they are independent financial
institutions, is their "governmental purpose" enough to bring them into the unitary creditor
fold? Whether a government-related entity is actually carrying out a government function to
fulfill a purely governmental purpose is likely to lead to continuing litigation regarding the
application of the unitary governmental creditor doctrine in the context of setoffs under §553.
The family of departments, agencies and instrumentalities of the federal government is large,
but some of the distant cousins might not get invited to the set-off reunion.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The opinion interprets <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §250</a>, which specifically provided that the court of claims had jurisdiction to hear and determine set-offs "on the part of the
government of the United States against any claimant against the government in said court." <a href="#1a">Return to article</a>

<a name="2">2</a> Other decisions in the Ninth Circuit that had previously held that separate government agencies were a single creditor under §553 are <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gibson, 176 B.R.
910 (Bankr. D. Ore. 1994)</a> and <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Mohar, 140 B.R. 273 (Bankr. D. Mont. 1992)</a>. In light of Hal, the opinion of <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Bank v. U.S., 178 B.R. 493
(N.D. Cal. 1995)</a> (mutuality to support a set-off did not exist among the Maritime Administration (Department of Transportation), IRS, Environmental
Protection Agency and the United States) no longer appears to have precedential value. <a href="#2a">Return to article</a>

<a name="3">3</a> 1st Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. U.S. Dept. of Housing and Urban Development (In re Lopes), 211 B.R. 443 (D. R.I. 1997)</a>; 2nd Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra</a>, Whimsey,
supra; 3rd Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Sacred Heart Hospital of Norristown v. Commonwealth of Pennsylvania Dept. of Welfare (In re Sacred Heart Hospital of Norristown), 199
B.R. 129 (Bankr. E.D. Pa. 1996) rev. on other grounds, 204 B.R. 132 (E.D. Pa. 1997)</a>, aff'd 133 F.3d (3rd Cir. 1998); 4th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re A. J. Nielson, 90 B.R.
172 (Bankr. W.D.N.C. 1988)</a>; 5th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Young, 144 B.R. 45 (Bankr. N.D. Tex. 1992)</a>, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Fryar, 93 B.R. 101 (Bankr. W.D. Tex. 1998)</a>; 6th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…
re Holder, 182 B.R. 770 (Bankr. M.D. Tenn. 1995)</a>, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Stall, 125 B.R. 754 (Bankr. S.D. Ohio 1991)</a>, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Julien Company, 116 B.R. 623 (W.D. Tenn.
1990)</a>, 7th Circuit: Maxwell, supra; 8th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Federal Crop Ins. Corp. (In re Kalenze), 175 B.R. 35 (Bankr. D. N.D. 1994)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gore, 124 B.R. 75
(Bankr. E.D. Ark. 1990)</a>; 9th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra, In re Gibson, 176 B.R. 910 (D. Ore. 1994)</a>, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Mohar, 140 B.R. 273 (Bankr. D. Mont. 1992)</a>; 10th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; supra</a>; 11th Circuit: <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Lykes Bros. Steamship Co. Inc., 217 B.R. 304 (Bankr. M.D. Fla. 1997)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Reed, 179 B.R. 353 (Bankr. S.D. Ga. 1995)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> A "governmental unit" as defined in §101(27) includes the agency of a foreign state. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Rimsat Ltd., 196 B.R. 791 (N.D. Ind. 1995)</a>. <a href="#4a">Return to article</a>

Journal Authors

Robert G. Richardson

Journal Date

Thursday, April 1, 1999 - 12:00