A postpetition default on a mortgage nonetheless gives rise to prepetition debt, thus barring setoff of an otherwise mutual postpetition obligation, according to Bankruptcy Judge David T. Thuma of Albuquerque, N.M.
A chapter 12 debtor took down a $300,000 mortgage from the U.S. Department of Agriculture almost 10 years before bankruptcy. At filing, the farmer was current on the mortgage.
Postpetition, the debtor missed two payments aggregating some $32,000. Also postpetition, the debtor was entitled to receive about $40,000 in crop subsidies from the Agriculture Department.
The department filed a motion to modify the automatic stay to permit setoff. Naturally, the debtor objected and sought an order requiring the department to pay the subsidy.
The debtor won. Finding no right of setoff, Judge Thuma ruled in favor of the debtor in his May 20 opinion, which reads like a primer on setoff.
Section 553 does not create a federal right of setoff. Rather, the section provides that the Bankruptcy Code “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 . . . .”
Judge Thuma explained that a creditor with a right of setoff does not have a lien, although the effect can sometimes be the same. Rather, he said, setoff is a defense “to payment of an otherwise valid obligation.” Furthermore, the government has the same rights of setoff as a private party.
Interpreting Section 553, Judge Thuma said that “the offsetting obligations must have arisen prepetition and must be ‘mutual.’” Debts and credits must be in the same right and between the same parties, standing in the same capacity. Setting off a prepetition claim against a postpetition debt is not permitted, he said.
The department clamed there was mutuality, contending that the postpetition default on the mortgage could be offset against the postpetition right to receive crop subsidies. Judge Thuma disagreed.
The Collier treatise has four tests for deciding whether an obligation arose before or after filing. Under all of them, Judge Thuma said that the postpetition default on a mortgage gives rise to a prepetition debt, because the debt was incurred when the debtor drew down the mortgage 10 years before bankruptcy. It doesn’t matter that the debt was unmatured, contingent or unliquidated on the filing date.
Judge Thuma therefore denied the department’s lift-stay motion and directed the department to turn the subsidy payments over to the debtor.
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A postpetition default on a mortgage nonetheless gives rise to prepetition debt, thus barring setoff of an otherwise mutual postpetition obligation, according to Bankruptcy Judge David T. Thuma of Albuquerque, N.M.
A chapter 12 debtor took down a $300,000 mortgage from the U.S. Department of Agriculture almost 10 years before bankruptcy. At filing, the farmer was current on the mortgage.
Postpetition, the debtor missed two payments aggregating some $32,000. Also postpetition, the debtor was entitled to receive about $40,000 in crop subsidies from the Agriculture Department.
The department filed a motion to modify the automatic stay to permit setoff. Naturally, the debtor objected and sought an order requiring the department to pay the subsidy.
The debtor won. Finding no right of setoff, Judge Thuma ruled in favor of the debtor in his May 20 opinion, which reads like a primer on setoff.
Section 553 does not create a federal right of setoff. Rather, the section provides that the Bankruptcy Code “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 . . . .”
Judge Thuma explained that a creditor with a right of setoff does not have a lien, although the effect can sometimes be the same. Rather, he said, setoff is a defense “to payment of an otherwise valid obligation.” Furthermore, the government has the same rights of setoff as a private party.