A panel of the Ninth Circuit needed 11 months to write an opinion applying the appeals court’s indistinct standard differentiating setoff from recoupment. Where the circuit’s flexible standard largely favors creditors, the new opinion moves the bar ever so slightly in favor of debtors.
Recoupment is a judge-made equitable doctrine lacking some of the strictures of setoff. Under Section 362(a)(7), setoff is subject to the automatic stay, and Section 553 has a list of circumstances when setoff is not enforceable.
In general terms, Section 553 allows a creditor to offset mutual debts and credits that arose before bankruptcy. As Circuit Judge Daniel P. Collins explained in his September 16 opinion, setoff allows a creditor to net out debts and claims arising from different transactions, so long as they were mutual and arose before bankruptcy. Furthermore, mutuality is strictly construed.
Originating as a pleading concept before the advent of the Federal Rules of Civil Procedure, recoupment appears nowhere in the statute. Contrasted to setoff, recoupment requires that the debts and credits must have arisen from the same transaction or occurrence. The two leading Ninth Circuit recoupment cases tell us that “recoupment is often thought not to be subject to the automatic stay” and “may be employed across the petition date.” Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 1392, 1399 (9th Cir. 1996); and Sims v. U.S. Dep’t of Health & Human Servs. (In re TLC Hosps., Inc.), 224 F.3d 1008, 1011 (9th Cir. 2000).
Unlike the Third Circuit, which applies a narrow definition to “transaction,” Judge Collins explained that Newbery and Sims only require a “logical relationship” between the transactions or occurrences, thus giving a “flexible meaning” to the same-transaction requirement.” Sims, id., at 1012; Newbery, id., at 1402.
Furthermore, the Ninth Circuit rejected the Third Circuit’s requirement of a temporal proximity between the transactions, Judge Collins said.
The case on appeal did not entail an easy application of the Ninth Circuit’s flexible standard.
The debtor was a hospital where the State of California was asserting the right to recoup Medicaid payments owing to the hospital against fees that the hospital owed to the state. Upheld by the Bankruptcy Appellate Panel, the bankruptcy court allowed the state’s recoupment in full.
Judge Collins upheld the lower courts in part, reversed in part and remanded.
Applying Sims and Newbery, Judge Collins held that the state was entitled to recoup payments coming from a specified state fund against payments the hospital owed to the same fund. However, he reversed the lower courts by holding that the state only had a right to offset payments the hospital owed to the fund against ordinary Medicaid payments that did not come from the fund.
Judge Collins ended his opinion with a holding that may have application in other circuits.
The state argued it was entitled to offset everything owing to the hospital because state law specifically allowed the state to deduct payments owing by a hospital to the fund against Medicaid payments owing to the hospital.
Judge Collins rejected the state’s argument, saying it “would effectively obliterate the distinction between recoupment and setoff and thereby exempt California entirely from the Bankruptcy Code’s restrictions on setoff.”
Observations
The appeals court’s difficulty in applying the circuit’s squishy recoupment standard shows the virtue of bright-line rules. Although bright lines sometimes result in seemingly inequitable outcomes, bright lines are easier for courts to apply and for parties to anticipate the outcome.
As a judge-made doctrine nowhere sanctioned by statute, this writer submits that recoupment should be narrowly construed to avoid transgressing fundamental principles underlying the Bankruptcy Code.
A panel of the Ninth Circuit needed 11 months to write an opinion applying the appeals court’s indistinct standard differentiating setoff from recoupment. Where the circuit’s flexible standard largely favors creditors, the new opinion moves the bar ever so slightly in favor of debtors.
Recoupment is a judge-made equitable doctrine lacking some of the strictures of setoff. Under Section 362(a)(7), setoff is subject to the automatic stay, and Section 553 has a list of circumstances when setoff is not enforceable.
In general terms, Section 553 allows a creditor to offset mutual debts and credits that arose before bankruptcy. As Circuit Judge Daniel P. Collins explained in his September 16 opinion, setoff allows a creditor to net out debts and claims arising from different transactions, so long as they were mutual and arose before bankruptcy. Furthermore, mutuality is strictly construed.
Originating as a pleading concept before the advent of the Federal Rules of Civil Procedure, recoupment appears nowhere in the statute. Contrasted to setoff, recoupment requires that the debts and credits must have arisen from the same transaction or occurrence. The two leading Ninth Circuit recoupment cases tell us that “recoupment is often thought not to be subject to the automatic stay” and “may be employed across the petition date.” Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 1392, 1399 (9th Cir. 1996); and Sims v. U.S. Dep’t of Health & Human Servs. (In re TLC Hosps., Inc.), 224 F.3d 1008, 1011 (9th Cir. 2000).
Unlike the Third Circuit, which applies a narrow definition to “transaction,” Judge Collins explained that Newbery and Sims only require a “logical relationship” between the transactions or occurrences, thus giving a “flexible meaning” to the same-transaction requirement.” Sims, id., at 1012; Newbery, id., at 1402.
Furthermore, the Ninth Circuit rejected the Third Circuit’s requirement of a temporal proximity between the transactions, Judge Collins said.