Folger Adam Security, Inc. v. DeMatteis/MacGregor, JV

Opinions of the United
2000 Decisions States Court of Appeals
for the Third Circuit
3-20-2000
Folger Adam Security v Dematteis/MacGregor
Precedential or Non-Precedential:
Docket 98-2164, 98-2165, 99-1107, and 99-1108
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Recommended Citation
"Folger Adam Security v Dematteis/MacGregor" (2000). 2000 Decisions. Paper 58.
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Filed March 20, 2000
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
Nos. 98-2164, 98-2165, 99-1107, 99-1108
FOLGER ADAM SECURITY, INC.
v.
DEMATTEIS/MACGREGOR, JV;
INSURANCE COMPANY OF NORTH AMERICA;
FIDELITY & DEPOSIT COMPANY OF MARYLAND;
SWISS REINSURANCE AMERICA CORPORATION,
formerly know as North American Reinsurance
Corporation
DeMatteis/MacGregor, JV;
Insurance Company of North America;
Fidelity & Deposit Company of Maryland;
Swiss Reinsurance America Corporation,
Appellants
Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. Civ. Nos. 96-04072, 96-cv-04073)
District Judge: Honorable Charles R. Weiner
Argued: October 1, 1999
Before: MANSMANN, McKEE and STAPLETON,
Circuit Judges.
(Filed: March 20, 2000)
B. Christopher Lee, Esquire (Argued)
Jacoby, Donner & Jacoby
1515 Market Street
Suite 2000
Philadelphia, PA 19102
Counsel for Appellee
Carl A. Solano, Esquire (Argued)
Philip G. Kircher, Esquire
Jacqulynn M. Broughton, Esquire
Schnader, Harrison, Segal & Lewis
1600 Market Street
Suite 3600
Philadelphia, PA 19103
Counsel for Appellants
OPINION OF THE COURT
MANSMANN, Circuit Judge.
In this appeal, we are asked to decide whether the
affirmative defenses of setoff, recoupment, and other
contract defenses, which arose as a consequence of alleged
defaults under certain contracts with the debtors,
constitute an "interest" under section 363(f) of the
Bankruptcy Code such that a sale of the debtors' assets in
a consolidated Bankruptcy Court auction free and clear,
extinguished such affirmative defenses and effectively
transformed such contract rights into unimpeachable
accounts receivable in the hands of the purchaser. Further,
this appeal raises a question as to whether the creditor
whose affirmative defenses were extinguished by the
Bankruptcy sale received constitutionally adequate notice
such that failure to object would result in a waiver of its
affirmative defenses and its deemed consent to the
transformation of the debtors' contract claims into
unimpeachable accounts receivable.
We find that the affirmative defenses do not constitute an
"interest" for purposes of section 363(f) and, therefore, were
not extinguished by the Bankruptcy sale. A setoff right,
2
however, may only be asserted to the extent the creditor
can prove it actually took the setoff prior to the bankruptcy
filing. Moreover, we find that the notice of the section 363
sale given by the debtors failed to give the creditor notice
that it would lose its defenses and, therefore, was
constitutionally inadequate. Accordingly, we will reverse the
judgment of the District Court and remand for further
proceedings consistent with this opinion.
I.
For the most part, the parties do not dispute the facts.
Folger Adam Security, Inc. ("Folger") instituted the
underlying declaratory judgment action against
DeMatteis/MacGregor Joint Venture ("DeMatteis"), along
with three sureties, Insurance Company of North America,
Fidelity & Deposit Company of Maryland, and Swiss
Reinsurance America Corporation, seeking $370,446.67 in
unpaid "accounts receivable" relating to equipment sold to
DeMatteis for a construction project. Folger acquired
substantially all of the assets of three bankrupt companies
through a bankruptcy auction "free and clear" of all claims
and other interests.1 The facts leading up to this litigation
are set forth below.
The alleged debts that are the basis of Folger's claim
against DeMatteis arose from a construction project at the
Curran Fromhold Prison in Northeast Philadelphia (the
"Northeast Project"). DeMatteis sells and installs security
systems for use within prisons. In October 1993,
Perini/TriState, the general contractor on the Northeast
Project, hired DeMatteis as a subcontractor to supply
security equipment for the project. Prior to contracting with
DeMatteis, Perini/TriState executed a labor and
materialman's bond on the Northeast Project, with Fidelity
& Deposit Company of Maryland and Swiss Reinsurance
America Corporation (then known as the North American
Reinsurance Company) acting as sureties. Insurance
_________________________________________________________________
1. In addition to the William Bayley Company and Folger Adam
Company, Folger also purchased the assets of a third debtor, Stewart-
Dicatur Security Systems, Inc., through the Bankruptcy auction.
3
Company of North America issued a similar subcontractor's
bond in favor of DeMatteis.
After contracting with Perini/TriState to supply the
security equipment, DeMatteis sought and received
proposals from the William Bayley Company ("Bayley") and
the Folger Adam Company ("FAC") (collectively the
"Companies" or "Debtors") to supply security hardware and
furniture for the Northeast Project. In response to the
proposals, DeMatteis sent letters to Bayley and FAC
informing them that it intended to issue a purchase order
for the equipment. On January 12, 1994, DeMatteis issued
a purchase order to FAC for security equipment in the
amount of $801,500.2 DeMatteis also issued a purchase
order to Bayley on January 13, 1994, in the amount of
$315,900.
Pursuant to the purchase orders, Bayley and FAC began
supplying materials and equipment to DeMatteis for the
Northeast Project sometime after April 20, 1994. They
continued to supply materials and equipment until June 6,
1995 in the case of Bayley, and until December 20, 1995 in
the case of FAC. After supplying all the materials, Bayley
and FAC claimed that DeMatteis still owed them $310,648
and 59,798.67, respectively. DeMatteis refused to pay the
balances due, however, claiming that the Companies had
breached their contractual obligations. Specifically,
DeMatteis claimed that materials and equipment furnished
by Bayley and FAC were defective, requiring repurchase of
missing components and the performance of remedial work.
DeMatteis also claimed that materials were delivered late,
causing disruption to the project's schedules and a need for
"work-arounds."
Bayley and FAC advised DeMatteis that they would try to
cure their defective performances. Shortly thereafter, on
February 8, 1996, the Companies filed separate petitions
for reorganization relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court
for the District of Delaware. On that same date, Bayley and
FAC filed a motion, pursuant to sections 363 and 365 of
_________________________________________________________________
2. FAC accepted DeMatteis' purchase order subject to its letter of
exception.
4
the Bankruptcy Code, for approval of the sale of
substantially all of their assets to Folger which had been
newly formed and whose management was comprised of
many of the principals from Bayley and FAC. The Notice of
Auction and Final Hearing on Motion to Approve the Sale of
Substantially All of the Debtors' Assets and Assumption
and Assignment of Certain Contracts Pursuant to 11 U.S.C.
SS 363 and 365 and Providing for Final Distribution of
Proceeds of Sale (the "Notice of Auction"), indicated that the
sale was to be "free and clear" of all claims and other
"interests" that could be asserted against the Debtors. The
Notice of Auction further stated that a list of the Debtors'
contracts that were being assumed by and assigned to
Folger in the sale pursuant to section 365 of the
Bankruptcy Code would be provided on or before February
18, 1996. Although the Debtors' contracts with DeMatteis
were specifically excluded from this list, DeMatteis only
became aware that Folger was not assuming these
contracts some time after the March 7, 1996 bankruptcy
auction.3
DeMatteis maintains that although it was listed on an
affidavit of service, it did not receive the Notice of Auction
from either of the Debtors. In support of this statement,
DeMatteis provided the affidavit of M. MacGregor, Project
Director for DeMatteis/MacGregor Security Constructors. In
his affidavit, MacGregor stated that the official Notice of
Auction was never received but, on February 15, 1996, an
_________________________________________________________________
3. The Notice of Auction stated that Folger was to file with the
Bankruptcy Court, on or before February 18, 1996, a list of those
executory contracts and leases that it desired to accept by assignment.
Pursuant to the terms of the notice of auction, on February 16, 1996,
Folger filed a Notice of Designation of Executory Contracts and Leases to
be Assumed and Assigned to Folger (the "Designation Notice"). Folger did
not list any of the DeMatteis contracts with Bayley in the Designation
Notice; however, Folger listed two DeMatteis contracts with FAC, one
pertaining to the Northeast Project, and the other relating to another
project not at issue in this case. Subsequently, on March 7, 1996, the
Debtors and Folger filed a Notice of Removal of Designation in which
they removed and deleted certain executory contracts previously listed in
the Designation Notice. Included among these delisted contracts were the
two DeMatteis contracts with FAC. Thus, none of the DeMatteis
contracts were assumed and assigned to Folger.
5
incomplete copy of the notice was received by fax from
another party. He further stated that he did not understand
the Debtors' accounts receivable to include monies claimed
by the Debtors but denied by DeMatteis because of
nonperformance of contracts. Because it believed that the
disputed amounts were not included among the assets
being sold at the bankruptcy auction, DeMatteis did not file
an objection to the sale.
At the March 7, 1996 auction, Folger was the sole bidder
and, therefore, successfully acquired substantially all of the
assets of the Debtors. The Bankruptcy Court approved this
sale on March 8, 1996.4
Between March 20 and 22, 1996, DeMatteis completed
four proofs of claim which it filed in the Chapter 11
bankruptcy cases, one each with respect to the two projects
which form the basis for the claims in this consolidated
appeal, and the two others relating to cases pending in
other courts. In the proofs of claim, DeMatteis asserted
claims for replacement costs, late/incomplete delivery
costs, quality problems, third party claims, productivity
loss, extended overhead, loss of cash flow and interest paid,
warranty costs, and additional bond premium associated
with each project. On August 21, 1996, the Debtorsfiled an
objection to the proofs of claim filed by DeMatteis, claiming
that the March 8, 1996 order approving the sale and asset
purchase agreement transferred the Debtors' accounts
receivables from DeMatteis to Folger "free and clear" of all
rights of setoff, recoupment, counterclaim and other
defenses and claims of DeMatteis (the "Omnibus Motion").
DeMatteis contested this assertion, disagreeing with the
Debtors' re-characterization of the executory contracts
(which were specifically excluded from the sale) as
"accounts receivable." Nonetheless, the Bankruptcy Court
entered an order on October 10, 1996, disallowing and
_________________________________________________________________
4. The Bankruptcy Court entered its approval of the sale in its Order
Granting Motion to Approve the Sale of Substantially All of the Debtors'
Assets to Purchaser and Assumption and Assignment of Certain
Contracts Pursuant to 11 U.S.C. SS 363 and 365 (the "Sale Order.").
6
expunging the proofs of claim objected to in the Omnibus
Motion.5
In the meantime, on May 31, 1996, Folger instituted two
lawsuits against DeMatteis in the United States District
Court for the Eastern District of Pennsylvania asserting
breach of contract. In Civil Action No. 96-4072, Folger
sought money damages of $310,648, plus interest and
costs, from DeMatteis on its contract with Bayley; and in
Civil Action 96-4073, Folger sought money damages of
$59,798.67, plus interest and costs, from DeMatteis on its
contract with FAC. On September 19, 1996, the District
Court dismissed the case at No. 96-4072 without prejudice
to give the parties an opportunity to seek relief in the
Bankruptcy Court. Thereafter, on December 5, 1996, Folger
filed with the Bankruptcy Court a Motion for Determination
that the March 8, 1996 order of the Bankruptcy Court
approving the sale and asset purchase agreement
transferred accounts receivable free and clear of all setoffs,
defenses, and counterclaims, which DeMatteis opposed.
The Bankruptcy Court concluded, however, that it lacked
jurisdiction and dismissed Folger's Motion for
Determination, advising the parties that the March 8, 1996
order spoke for itself and should be interpreted by the
courts in which the accounts receivable claims were
pending. After the Bankruptcy Court entered its order on
February 13, 1997, the parties agreed to resolve both cases
together before the District court on a motion for summary
judgment.6
_________________________________________________________________
5. On April 9, 1997, the Debtors and DeMatteis entered into a stipulation
whereby they agreed that the Bankruptcy Court's October 10, 1996
order disallowing and expunging certain claims against the Debtors
would be vacated as to the claims. Thus, the amended joint liquidation
plan was not deemed to discharge, bar, enjoin, or otherwise preclude
DeMatteis from asserting any defense, including defenses of setoff or
recoupment, in any action or proceeding by the Debtors or Folger.
Approval of the stipulation agreement was included in the Bankruptcy
Court's order confirming the plan. Ultimately, DeMatteis did not recover
any money on its proofs of claim against Bayley and FAC because the
bankruptcy estate lacked sufficient assets.
6. By stipulation of the parties, No. 96-4073 was placed in suspense at
the time the parties sought relief in the Bankruptcy Court. When the
7
On August 7, 1998, Folger filed a motion for summary
judgment requesting that the Court enter judgment in its
favor in the amounts prayed for in the complaints
($370,466.67, plus interest and costs), and a grant
declaratory judgment pursuant to 28 U.S.C. S 2201 that the
Bankruptcy Court's March 8, 1996 order approving the sale
and asset purchase agreement transferred the accounts
receivables "free and clear" of all rights of setoff,
recoupment, counterclaim and other defenses and claims of
DeMatteis. The District Court entered an order on
November 25, 1998, granting Folger's motion for summary
judgment. DeMatteis filed timely appeals in both cases on
December 18, 1998, and this court consolidated the two
appeals on December 30, 1998.7
We have jurisdiction over this appeal pursuant to 28
U.S.C. S 1291. We exercise de novo review over the District
Court's grant of summary judgment.
II.
The dispute before us centers around the sale of the
Debtors' assets pursuant to section 363(f) of the
Bankruptcy Code, which authorizes the trustee, under any
one of five prescribed conditions, to sell property of the
estate free and clear of "any interest" that an entity has in
such property. The term "any interest," as used in section
_________________________________________________________________
Bankruptcy Court dismissed Folger's motion, No. 96-4073 was taken out
of the suspense file, transferred to the District Court and dismissed
without prejudice while the parties prepared the cases for summary
judgment. Although Nos. 96-4072 and 96-4073 were not formally
consolidated, they have been litigated together from that point forward.
7. After DeMatteis filed its notice of appeal in the two cases, Folger
moved for entry of a single money judgment in the two cases that
included the total alleged debt plus prejudgment interest and costs, for
a total of $448,695.51. The District Court entered judgment in that
amount on the following day, January 21, 1999, before DeMatteis had
received service of the motion. DeMatteis also took a timely appeal from
the judgment entered on January 21, 1999 in both cases and this court
consolidated these appeals with the earlier two appeals on February 5,
1999.
8
363(f), is not defined anywhere in the Bankruptcy Code.
DeMatteis contends that the term "any interest" does not
include affirmative defenses, such as the right of setoff or
recoupment, or other defenses to breach of contract. On the
other hand, the Debtors have asserted, and the District
Court has agreed, that the sale of the Debtors' assets was
made free and clear of all defenses as well.
In reaching its conclusion, the District Court relied, in
part, on the express language of the Sale Order, which
provided in relevant part:
The sale of the Acquired Assets and the assignment of
the Assigned Contracts to Purchaser is made free and
clear of all liens, mortgages, security interests,
encumbrances, liabilities, claims, or any other
interests, other than the Assumed Liabilities, whether
arising before or after the Petition Date, . . . .
Sale Order, P 3, p. 7 (emphasis added). Although the Sale
Order did not explicitly state that the sale included
defenses, the District Court nonetheless concluded that
"[t]he term ``any other interests' necessarily include[d]
defenses within its scope." Folger Adam Security, Inc. v.
DeMatteis/MacGregor, JV, et al., No. 96-4072/4073, slip op.
at 6 (E.D. Pa. Nov. 24, 1998).
The District Court found further support for its
conclusion in Paragraph 4 of the Sale Order, which stated:
Any and all creditors of the Debtors are permanently
enjoined and restrained from seeking to obtain
payment or satisfaction of their claims against the
Debtors from the Purchaser or the Acquired Assets,
except for and only to the extent of the Assumed
Liabilities.
Sale Order, P 4, p. 8. Because this provision specifically
enjoined creditors from seeking to obtain payment or
satisfaction of their claims, the District Court found the
Sale Order was made free and clear of all interests
including contract defenses. Folger Adam Security, slip op.
at 6. Our review of the case law and other authority
requires us to find, contrary to the District Court, that "any
interest" under section 363(f) does not include defenses to
claims.
9
Under the rule of ejusdem generis, the term"other
interest" would ordinarily be limited to interests of the same
kind as those enumerated, i.e., "liens, mortgages, security
interests, encumbrances, liabilities, [and] claims." Similarly,
the canon of construction noscitur a sociis"instructs that a
provision should not be viewed ``in isolation but in light of
the words that accompany it and give [it] meaning.' " Ballay,
et al. v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 688
(3d Cir. 1991) (quoting Massachusetts v. Morash , 490 U.S.
107, 115 (1989)). We noted in Ballay that when construing
the meaning of one term in a phrase, the Supreme Court
has stated:
The maxim noscitur a sociis, that a word is known by
the company it keeps, while not an inescapable rule, is
often wisely applied where a word is capable of many
meanings in order to avoid the giving of unintended
breadth to Acts of Congress.
Id. (quoting Jarecki v. G.D. Searle & Co., 367 U.S. 303, 307
(1961)). With these canons of construction in mind, we turn
to the case law construing the term "any interest" under
section 363(f).
Courts faced with the task of defining the scope of the
term "any interest" have been unable to provide a precise
definition. 3 Collier on Bankruptcy P 363.06[1]. Although
some courts have narrowly interpreted that phrase to mean
only in rem interests in property, see e.g., In re Fairchild
Aircraft Corp., 184 B.R. 910, 917-19 (Bankr. W.D. Tex.
1995), vacated on other grounds, 220 B.R. 909 (Bankr.
W.D. Tex. 1998), the trend seems to be towards a broader
interpretation which includes other obligations that may
flow from ownership of the property. 3 Collier on
Bankruptcy P 363.06[1] (citing In re Leckie Smokeless Coal
Co., 99 F.3d 573, 582 (4th Cir. 1996) (holding that debtor
coal mine operators could sell their assets underS 363(f)
free and clear of successor liability that otherwise would
have arisen under federal statute); In re P.K.R. Convalescent
Centers, Inc., 189 B.R. 90, 92-94 (Bankr. E.D. Va. 1995)
(holding that S 363(f) permitted sale free and clear of state's
depreciation-recapture interest in the debtor's property); In
re WBQ Partnership, 189 B.R. 97 (Bankr. E.D. Va. 1995)
(holding statutory right to recover depreciation was within
10
"interests" under S 363(f); In re White Motor Credit Corp., 75
B.R. 944 (Bankr. N.D. Ohio 1987) (holding that S 363(f)
precluded tort claims against asset purchaser)).
In Leckie, certain employer-sponsored benefit plans (the
"plans") objected to the extinguishment of their right to
payment of plan liabilities from a successor-in-interest by
operation of S 363(f). In determining whether the plans had
"any interest in property" within the meaning of S 363(f),
the court of appeals in Leckie rejected"an unduly broad
interpretation" of that phrase by the district court, which
found that simply the right to demand money from the
debtor gave rise to an "interest" in the debtor's property
under section 363(f). 99 F.3d at 581. The court of appeals
equated such interests to general unsecured claims which
have not been recognized by the courts as constituting
"interests" within the meaning of section 363(f). Id.
(citations omitted).
The court of appeals then noted that:
... while the plain meaning of the phrase "interest in
such property" suggests that not all general rights to
payment are encompassed by the statute, Congress did
not expressly indicate that, by employing such
language, it intended to limit the scope of section 363(f)
to in rem interests, strictly defined, and we decline to
adopt such a restricted reading of the statute here.
Id. at 582 (citations omitted). The court abstained from
defining the term "any interest" categorically, preferring to
let future decisional law frame the boundaries of the term.
In concluding that the plans' right to payment
constituted an "interest" within the meaning of section
363(f), the court in Leckie was persuaded by the fact that
the right of the plans to seek such payment was predicated
upon the fact that the assets being sold were used in coal
mining operations. Id. Thus, the court's holding seems to
suggest that the term "any interest" is intended to refer to
obligations that are connected to, or arise from, the
property being sold. 3 Collier on BankruptcyP 363.06[1].
In both PKR Convalescent Centers and WBQ Partnership,
a state agency had the right under state law to recapture
11
depreciation from operators of nursing homes if the
operators realized a gain on the sale of their real property.
The statute further provided that if the operators failed to
reimburse the state, the agency had the right to pursue the
purchasers for the amount owed. In those cases, the
Bankruptcy Courts held that because the state agency
could be compelled in a legal or equitable proceeding to
accept a money satisfaction of its statutory right to
depreciation recapture, such interest fell within section
363(f)(5) of the Bankruptcy Code and thus was
extinguished by the "free and clear" sale. 8 PKR Convalescent
Centers, 189 B.R. at 94; WBQ Partnership, 189 B.R. at 107.
Thus, the holdings of the courts suggest that any interest
in property that can be reduced to a money satisfaction
constitutes a claim for purposes of section 363(f) and,
therefore, attaches to the proceeds of the sale. PKR
Convalescent Centers, 189 B.R. at 94; WBQ Partnership,
189 B.R. at 106. Accordingly, the courts held that the
S 363(f) sale extinguished the state agency's interest in the
properties.
The terms "lien" and "setoff" have also been distinguished
within the purview of S 363(f). In Marley v. United States,
381 F.2d 738, 743 (Ct.Cl. 1967), the Court of Claims noted
that the terms "setoff" and "lien" "connote independent
concepts, governed by distinct legal principles."9 Id. at 743.
_________________________________________________________________
8. Section 363(f)(5) of the Bankruptcy Code provides essentially that the
trustee may sell property of the estate free and clear of any interest in
such property if an entity with an interest is such property "could be
compelled, in a legal or equitable proceeding, to accept a money
satisfaction of such interest." 11 U.S.C. S 363(f)(5).
9. In Marley, the government had asserted a right of setoff in a contract
dispute with the debtor in the Court of Claims prior to the
commencement of the bankruptcy proceeding. 381 F.2d 738 (Ct.Cl.
1967). When the trustee applied to sell the debtor's contract claims
against the government and the government failed tofile an answer
objecting to such application, the bankruptcy court authorized the sale
of the contracts free and clear of liens and forever barred the government
from asserting any lien against the contracts or proceeds from the sale
of such contracts. The contracts were subsequently purchased by Marley
who filed an action in the Court of Claims on claims against the
government arising out of the purchased contracts. The government filed
12
The court turned to the definitions of these terms to
illustrate its point. "Setoff," the court stated, referred to
" ``situations where both plaintiff and defendant have
independent causes of action maintainable against each
other in separate actions which can be mutually deducted
whenever either one brings a suit against the other.' " Id.
(quoting Motto v. United States, 360 F.2d 643, 645 (Ct. Cl.
1966)) (other citation omitted). In contrast, the court noted
that a "lien" has been defined as " ``a charge or
encumbrance upon property to secure the payment or
performance of a debt, duty, or other obligation. It is
distinct from the obligation which it secures.' " Id. (citations
omitted). Mortgages, security interests, encumbrances and
liabilities possess characteristics similar to a lien.
It is clear from the definitions of "lien" and "setoff" that
the term "setoff" does not refer to the same type of interest
as a "lien." A lien is distinct from the obligation it secures
while the same is not true of a right of setoff or
recoupment. They have no value separate and apart from a
debtor's or purchaser's claim. Thus, under the canons of
construction set forth previously, the phrase "any other
interests" would not include setoff and recoupment since
those interests are not similar to those enumerated in the
Notice of Auction.
Folger equates the affirmative defenses raised by
DeMatteis to "claims" in order to subject them to the "free
and clear" provision of section 363(f). We find, however,
that a defense is not the same as a claim. The Bankruptcy
Code sets forth the meaning of the word "claim" as a:
right to payment, whether or not such right is reduced
to judgment, liquidated, unliquidated, fixed,
_________________________________________________________________
a counterclaim and asserted the defense of setoff which Marley moved to
strike based on the bankruptcy court's sell order. The Court of Claims
held that even though the sale order stated that the sale was free and
clear of the government's liens and claims, the sale of the contracts was
not free and clear of the government's right of setoff since the
government had raised that defense in a proceeding instituted prior to
the sale of the contracts, a fact of which Marley was aware at the time
of the bankruptcy sale. Id. at 743.
13
contingent, matured, unmatured, disputed,
undisputed, legal, equitable, secured, or unsecured;. .
.
11 U.S.C. S 101(5)(A). The Bankruptcy Code further
provides that "claim" also means a right to an equitable
remedy for breach of performance when the breach triggers
a right to payment. 11 U.S.C. S 101(5)(B).
Although the Bankruptcy Code's definition of claim is
broad, a claim requires an enforceable obligation of the
debtor to pay the claimant. Pennsylvania Dep't of Public
Welfare v. Davenport, 495 U.S. 552, 559 (1990). Here
DeMatteis is not seeking to recover money on an
enforceable obligation of Folger, but rather, is asserting
only defenses to claims by Folger.10 Indeed, a defense seeks
to diminish a claim or to defeat recovery rather than to
share in it. BLACK'S LAW DICTIONARY 419 (6th ed. 1990).
In this case, DeMatteis has asserted several contract
defenses, including a right of recoupment as well as setoff.
Along these lines, a number of courts have held that a right
of recoupment is a defense and not a claim in the
bankruptcy context. See, e.g., Lee v. Schweiker , 739 F.2d
870, 875 (3d Cir. 1984); In re Lawrence United Corp., 221
B.R. 661, 669 (Bankr. N.D.N.Y. 1998); In re Bram , 179 B.R.
824, 827 (Bankr. E.D. Tex. 1995); In re Izaguirre, 166 B.R.
484, 493 (Bankr. N.D. Ga. 1994). For example, in Lee v.
Schweiker, we provided the following explication of the
doctrine of recoupment:
Recoupment . . . allows the creditor to assert that
certain mutual claims extinguish one another in
bankruptcy, in spite of the fact that they could not be
"setoff" under 11 U.S.C. S 553. The justification for the
recoupment doctrine is that where the creditor's claim
_________________________________________________________________
10. Although DeMatteis filed proofs of claim against the Debtors on
unsecured and non-priority claims relating to the alleged substandard
performances of the Debtors, those proofs of claim are not at issue here.
Insufficient assets existed in the estate for a distribution on these
claims. Moreover, because the Sale Order enjoins DeMatteis and other
creditors from seeking payment from Folger of any claims against the
Debtors, Folger does not have an enforceable obligation to pay such
claims against the Debtors in this or any other litigation.
14
against the debtor arises from the same transaction as
the debtor's claim, it is essentially a defense to the
debtor's claim against the creditor rather than a
mutual obligation, and application of the limitations on
setoff in bankruptcy would be inequitable. See In re
Monongahela Rye Liquors, 141 F.2d [864,] at 869 [(3d
Cir. 1944)].
739 F.2d at 875.
Moreover, in In re Lawrence United Corp., the Bankruptcy
Court held that an insurance company's alleged right of
recoupment was not an "interest" in property within the
meaning of section 363(f) and thus was not affected by the
Bankruptcy Court's order authorizing the sale "free and
clear" of all liens and interests. 221 B.R. at 669. In
reaching this conclusion, the Bankruptcy Court opined
that:
The right of recoupment is not itself a claim and any
right of recoupment [the insurance company] may have
does not even fall under the broadest interpretation of
an "interest" in property. Under common law, the right
of recoupment is a defense to a debtor's claim against
the creditor; it is not a mutual obligation.
Id. (citations omitted). The Bankruptcy Court distinguished
the In re Lawrence United Corp. case from In re Leckie
Smokeless Coal Co. and P.K.R. Convalescent Ctrs., Inc.,
cases which both involved an "interest" in property by
virtue of statutes that created a purchaser's liability on the
sale of assets. In In re Lawrence United Corp. , the Court
noted that the dispute over the right to recoupment
centered on what was actually purchased in the "free and
clear" sale as opposed to what purchaser liabilities resulted
from the purchase. Id. Because any right of recoupment
that the insurance company had derived from the collected
premiums the debtor owed to it and arose from the same
transaction or set of transactions involving the
commissions the insurance company owed to the debtor,
the court found the sale of the debtor's insurance policy
accounts did not extinguish the insurance company's
recoupment defense.
15
In the case before us, Folger argues that In re Lawrence
United Corp. is not dispositive for several reasons. It points
to three distinguishing factors in that case -- that the
insurance company actually filed an objection to the sale,
the express language of the contract provided for a right of
recoupment, and that the Bankruptcy Court eventually
found that the insurance company did not have a right of
recoupment against the commissions earned post-petition.
But none of these factors informed the court's holding that
a right of recoupment is a defense and thus does not fall
under the broadest interpretation of "an interest in
property." Rather, the court looked to the common law in
concluding that the right of recoupment is a defense to the
debtor's claim against the creditor. Moreover, we have
previously held that an express contractual right is not
required to effect a recoupment. In re University Medical
Ctr., 973 F.2d 1065, 1080 (3d Cir. 1992).
As noted previously, we have likewise held that the right
of recoupment is a defense, not a claim. Lee v. Schweiker,
supra. Accordingly, we are not persuaded by Folger's
attempts to distinguish Lawrence United Corp. Thus,
whether or not DeMatteis properly failed to object to the
section 363(f) sale to Folger has no bearing on whether "any
other interests" includes defenses such as recoupment and
setoff.
Neither the parties nor the District Court has cited a
single decision which has held that a defense may be
extinguished as a result of a "free and clear" sale. Likewise,
we have not found any such authority to exist. We note
that all of the cases cited by the District Court in support
of its holding that "an interest in property" should be
construed broadly to include defenses, involved affirmative
claims brought by a creditor; none of these cases raised a
defense to a debtor's or purchaser's claim. On the other
hand, at least one Bankruptcy Court has found that a
recoupment defense is not extinguished by a "free and
clear" sale, and a number of other courts, including this
one, have held that a right of recoupment is a defense and
not a claim. Thus, we agree with the Bankruptcy Court in
In re Lawrence United Corp. and hold that a right of
recoupment is a defense and not an interest and therefore
16
is not extinguished by a S 363(f) sale.11 The District Court's
conclusion to the contrary therefore constitutes legal error.
Although its primary defense to Folger's claims is
recoupment, DeMatteis has also asserted a defense of setoff
based on amounts owed by Bayley and FAC to DeMatteis as
a result of breaches of other contracts for other prison
construction projects. DeMatteis has conceded that
property that is otherwise subject to a right of setoff under
section 553 of the Bankruptcy Code may not be setoff if it
has been the subject of a section 363(f) "free and clear"
sale. DeMatteis contends, however, that property as to
which a setoff has been taken prior to bankruptcy is not
property of the estate that would be subject to setoff, but
rather, is the property of the party that took the setoff. In
support of its argument, DeMatteis cites Pioneer
Commercial Funding Corp. v. United Airlines, Inc. , 122 B.R.
871, 877-78 (Bankr. S.D.N.Y. 1991), and 4 Collier on
Bankruptcy, P 553.01. Thus, DeMatteis claims that to the
extent it took setoffs relating to the prison projects prior to
the filing of the bankruptcy petition, that property was not
subject to the section 363 sale and, therefore, it is entitled
to raise a setoff defense against Folger's claims here.
In response, Folger argues that this case is
distinguishable from Pioneer because DeMatteis has not
actually taken a setoff against the receivables. Because
DeMatteis did not actually take a setoff, but merely
asserted a right to setoff, Folger contends the receivables
were property of the estate and therefore the right of setoff
was extinguished by section 553. Folger further contends
that because the "claims" asserted by DeMatteis against
Folger arise out of more than one transaction, recoupment
is not available here. Finally, Folger claims DeMatteis
cannot assert setoff and recoupment defenses in the same
action.
_________________________________________________________________
11. The Sale Order enjoined creditors from seeking to obtain payment or
satisfaction of their claims against the Debtors from the Purchaser or
Acquired Assets. Since we have determined that affirmative defenses are
not claims under S 363(f), this restriction does not apply to DeMatteis'
defenses to Folger's claims.
17
The District Court noted the exception raised by
DeMatteis but found, nonetheless, that it had no
application here since the amounts DeMatteis attempted to
setoff before the filing of the bankruptcy petition had not
yet been received.12 Folger Adams Security, slip op. at 8.
Thus, the District Court concluded the property subject to
setoff was still part of the bankruptcy estate. Id. at 9.
Consequently, the District Court held that the section 363
sale extinguished DeMatteis's setoff rights. Id.
To decide this question, we turn first to section 553 of
the Bankruptcy Code. Section 553(a) provides in relevant
part:
Except as otherwise provided in this section and in
sections 362 and 363 of this title, 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, . . .
11 U.S.C. S 553(a). The legislative history to section 553
bears out the plain meaning of that provision. The Senate
Report explains:
This section [553] preserves, with some changes, the
right of setoff in bankruptcy cases. . . . One exception
to this right is the automatic stay, discussed in
connection with proposed 11 U.S.C. S 362. Another is
the right of the trustee to use property under section
363 that is subject to a right of setoff.
S. Rep. No. 95-989, 95th Cong., 2d Sess., at 91 (1978),
reprinted in 1978 U.S.C.C.A.N. 5787, 5877. Thus, in order
to maintain a right of setoff under section 553, the party
asserting the right must show:
1. A debt exists from the creditor to the debtor and
that debt arose prior to the commencement of the
bankruptcy case.
_________________________________________________________________
12. The basis for the District Court's conclusion, that the amounts
DeMatteis attempted to setoff before the bankruptcyfiling had not yet
been received, is unclear. As we note infra, the record here does not
provide any evidence of actual setoffs taken or received prior to the
filing
of the bankruptcy petition.
18
2. The creditor has a claim against the debtor which
arose prior to the commencement of the
bankruptcy case.
3. The debt and the claim are mutual obligations.
Braniff Airways, Inc. v. Exxon Co., U.S.A., 814 F.2d 1030,
1035 (5th Cir. 1987) (quoting In re Nickerson & Nickerson,
Inc., 62 B.R. 83, 85 (Bankr. D. Neb. 1986)); see also In re
Sherry & O'Leary, Inc., 148 B.R. 248, 252-53 (Bankr. W.D.
Pa. 1992). Even if the above three requirements are met,
the right of setoff will be extinguished if either sections 362
or 363 are invoked.
In this case, the Debtor invoked section 363 to effectuate
a "free and clear" sale of the estate property. Consequently,
assuming DeMatteis has met the three requirements to
maintain a right of setoff, under section 553 its setoff rights
are subject to section 363 and therefore are extinguished
by the "free and clear sale."
It is possible that an exception to this finding exists
where the setoff rights are actually taken prior to the
commencement of the bankruptcy proceeding. In Pioneer
Commercial Funding Corp., the account debtor of the
debtor's accounts receivable filed a motion for relief from
stay. 122 B.R. at 876. The account debtor loaned the
debtor $3.5 million for which it received a promissory note
guaranteeing payment. Id. at 875. Prior to the filing of the
bankruptcy petition, the debtor directed the clearing house
utilized for collecting and disbursing the accounts
receivable, to setoff the account debtor's obligations to
debtor by the $3.5 million against the debtor's accounts
receivable. Id. Also prior to the bankruptcyfiling, the
assignee of the debtor's accounts receivable instituted suit
against the account debtor for conversion and tortious
interference with a contract, claiming the account debtor
knew of the assignee's contract rights with the debtor when
it took the setoff. Id. at 876. In the bankruptcy proceeding,
the assignee sought damages for any setoffs actually taken
by the account debtor prior to the debtor's bankruptcy
filing. Id. The district court there held that the automatic
stay provisions are not implicated with regard to setoffs
already taken by the account debtor for the reason that
19
funds already set off are not estate property under the
Bankruptcy Code. Id. at 877.
The record before us does not show if or when DeMatteis
actually took a setoff against the construction contracts.
Because the motion for summary judgment was filed before
any discovery took place, DeMatteis may not have had an
opportunity to develop the record to adduce evidence that
it had actually taken a setoff against some of the contracts
prior to the bankruptcy filing. On remand, the District
Court should allow DeMatteis an opportunity to
supplement the record to supply any needed
documentation. In our view, DeMatteis must prove that it
actually took a setoff, the amounts and against which
contracts, before the bankruptcy filing. This does not mean
it actually must have received funds, but that its accounts
receivable were reduced or offset. To the extent that
DeMatteis is able to prove an actual setoff prior to
bankruptcy, the property subject to setoff is not deemed
part of the bankruptcy estate and therefore was not subject
to the section 363 sale. Thus, DeMatteis may assert a
defense of setoff but only to the extent it took an actual
setoff prior to bankruptcy.
We note that the facts here indicate that DeMatteis is
seeking to offset Folger's claims by the costs it incurred due
to the Debtors' alleged breach of contract arising out of the
same contract, as well as out of other contracts from other
construction projects. To the extent the amount being
claimed by Folger and the amount of reduction sought by
DeMatteis arise from the same contract, DeMatteis' defense
will be one of recoupment. However, to the extent the
amount being claimed by Folger and the amount of
reduction sought by DeMatteis arise from different
contracts, DeMatteis' defense will be one of setoff. We
express no opinion as to whether DeMatteis has established
the requisite elements of either defense, as that
determination is best left for the District Court in the first
instance. We hold only that DeMatteis is not precluded
from asserting these contract defenses against Folger's
claims provided, as to the setoff defense, DeMatteis proves
it actually took the setoff prior to the bankruptcy.
20
Our holding is further supported by good policy reasons.
First of all, if we were to hold that DeMatteis' contract
defenses were extinguished by the section 363(f) sale, the
value of the Debtors' assets purchased by Folger would be
enhanced at DeMatteis' expense. Bankruptcy law generally
does not permit a debtor or an estate to assume the
benefits of a contract and reject the unfavorable aspects of
the same contract. Lee, 739 F.2d at 876. Yet, allowing the
Debtors to recharacterize their contract rights as accounts
receivable and sell them free and clear of the corresponding
obligations yields that very result.13 Second, the equities do
not favor Folger and the Debtors here. Folger is not an
innocent party. Many of Folger's principals were also
principals of the Debtors. Thus, they should have been
aware of the dispute regarding the DeMatteis' construction
contracts. Indeed, the DeMatteis contracts were removed
from the Designation Notice, presumably because Folger
was not willing to have those contracts assumed and
assigned to it knowing that DeMatteis contested full
payment because of the Debtors' alleged default under
those contracts. Thus, Folger should have been aware of
DeMatteis' contract defenses when it established the
purchase price for the Debtors' assets. Accordingly, we do
not see anything inequitable in allowing DeMatteis to raise
defenses to Folger's claims of breach of contract.
III.
Even if we were to find that the term "any interest"
included affirmative defenses, the notice to DeMatteis was
insufficient to give it notice that by failing to object it was
_________________________________________________________________
13. DeMatteis makes a persuasive argument that prior to the sale,
separate "accounts receivable" and "contracts" did not exist between
itself and the Debtors, and that Folger has recharacterized the contracts
as "accounts receivable" because the contracts were removed from the
Designation Notice. DeMatteis' argument appears to have merit. The only
way Folger can prevail here is to recharacterize the contracts as
accounts receivable since the Joint Liquidating Plan approved by the
Bankruptcy Court specifically preserved DeMatteis' right to raise its
defenses (in particular, recoupment and setoff,) to claims against it
arising out of the contracts not assumed or assigned to Folger.
21
waiving its affirmative defenses.14 Section 363(b)(1) of the
Bankruptcy Code provides that the trustee may use, sell or
lease estate property only "after notice and a hearing." 11
U.S.C. S 363(b)(1). The phrase "after notice and a hearing"
is defined in section 102 of the Bankruptcy Code as follows:
(1) "after notice and a hearing", or a similar phrase--
(A) means such notice as is appropriate in the
particular circumstances, and such opportunity for a
hearing as is appropriate in the particular
circumstances; but
(B) authorizes an act without an actual hearing if
such notice is given properly and if--
(i) such a hearing is not requested timely by a
party in interest; or
(2) there is insufficient time for a hearing to be
commenced before such act must be done, and the
court authorizes such act;
11 U.S.C. S 102(1). The notice requirement and procedure
for sales is set forth in Bankruptcy Rules 6004 and 2002.
Essentially, Rule 6004 requires that notice of a proposed
sale of property shall be given in accordance with Rule
2002(a)(2), (c) and (i).15 Rule 2002(a)(2) directs the clerk to
give all parties in interest at least twenty days' notice by
mail of a proposed sale of property. According to Rule
2002(c), sufficient notice includes the time and place of any
public sale, the terms and conditions of any private sale,
states the time for filing objections, and, if real estate is
being sold, provides a general description of the property.
See also, In re Karpe, 84 B.R. 926, 930 (Bankr. M.D. Pa.
1988).
_________________________________________________________________
14. Although DeMatteis appears to raise an issue of fact with regard to
whether it actually received the Notice of Auction sent by Debtors'
counsel, we will assume, for sake of argument, that the Notice of Auction
was received so that we may proceed to what we perceive as the
determinative issue, that is, whether the Notice of Auction was sufficient
to inform DeMatteis that its affirmative defenses would be extinguished
by the proposed S 363(f) sale if it did notfile an objection by a certain
date.
15. Subsection (i) of Rule 2002 is not relevant to this appeal.
22
In addition to the Bankruptcy Rules, we are guided by
due process considerations. Due process requires"notice
reasonably calculated, under all the circumstances, to
apprize interested parties of the pendency of the action and
afford them an opportunity to present their objections."
Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306,
314-15 (1950) (citations omitted). The Supreme Court
further found that the notice which comports with due
process must be of such nature as to reasonably convey the
required information. Id. at 314.
Informed by these rules and constitutional
considerations, we conclude that the Notice of Auction here
did not provide DeMatteis with any information to put it on
notice that the phrase "any other interests" included
contract defenses and, by failing to object, it would waive
such defenses. Our conclusion is based upon consideration
of the express language of the Notice of Auction as well as
the surrounding facts and circumstances. The Notice of
Auction expressly provided that the proposed sale of the
Debtors' assets would be "free and clear of all liens,
mortgages, security interests, encumbrances, liabilities,
claims or any other interests, of any nature." We have
already found that the phrase "any other interests" does
not include defenses. Moreover, nowhere in the Notice of
Auction do the Debtors state that affirmative defenses will
be waived, nor are we aware of any court to have ever ruled
that affirmative defenses are extinguished in a section
363(f) sale. For these reasons, we find the Notice of Auction
reasonably failed to convey the required information, i.e.,
that the sale included defenses to claims and, therefore,
was constitutionally infirm.
Moreover, the two DeMatteis contracts originally listed in
the Designation Notice as being assumed and assigned to
Folger were subsequently removed from the list, leaving
DeMatteis with the impression that none of its contracts
were being assumed and assigned in the proposed sale to
Folger. Indeed, the express language of the Designation
Notice implies that only those non-debtor counter parties
whose interests were being assumed and assigned to Folger
needed to file an objection and, since none of DeMatteis's
contracts were assumed/assigned to Folger, the permanent
23
bar simply does not apply to DeMatteis.16 Thus, DeMatteis
reasonably believed that its rights would not be affected by
the proposed sale. Under these facts and circumstances, we
cannot say that DeMatteis waived its affirmative defenses
by failing to object to the proposed sale. Thus, the District
Court's conclusion to the contrary constitutes legal error.
Accordingly, we hold that DeMatteis is entitled to raise
the defense of recoupment and any other defenses it may
have with respect to the disputed Bayley and FAC
contracts, in response to the lawsuits brought by Folger.
On remand, DeMatteis will have to prove, and the District
Court will have to decide, whether DeMatteis is entitled to
any of these defenses. It may only assert a right of setoff to
the extent it can show it actually took a setoff prior to the
bankruptcy filing. Thus, on remand, DeMatteis should be
allowed to adduce proof of any setoffs taken prior to the
bankruptcy petition.17
IV.
For the reasons set forth above, we will reverse the
judgment of the District Court granting summary judgment
in favor of Folger and remand to the District Court for
further proceedings.
_________________________________________________________________
16. The Designation Notice specifically states that unless a non-debtor
counter party to an "Assigned Contract" filed a written objection to the
assumption/assignment by the deadline, the counter-party shall be
forever barred from asserting any default, loss or liability against the
assignee of such Assigned Contract (i.e., Folger) based on any event or
circumstance arising prior to the date of the assignment.
17. Because we have found that the bankruptcy sale did not extinguish
DeMatteis' affirmative defenses, we need not address DeMatteis'
additional argument that the District Court erred in calculating the
award of prejudgment interest.
24
STAPLETON, J., concurring:
I would resolve this appeal by answering a single
question: Does S 363(f) of the Bankruptcy Code authorize a
sale of a debtor's account receivable free and clear of any
defenses arising from the performance or non-performance
of the contract giving rise to the account receivable? Such
defenses, properly characterized as rights of recoupment,
are to be distinguished from rights of set-off, which consist
of offsetting claims arising under contracts other than the
one giving rise to the account receivable. There is no
occasion here to address the issue of whether S 363(f)
authorizes a sale of an account receivable free and clear of
a right to a set-off.1 DeMatteis concedes that under the
Bankruptcy Code the sale extinguished any set-off right
that was not exercised more than 90 days before thefiling
_________________________________________________________________
1. The effect of a S 363(f) "free and clear" sale on set-off rights is a
fundamentally different issue than the effect of such a sale on
recoupment rights. The Bankruptcy Code expressly preempts some state
laws regarding set-offs. See 11 U.S.C. SS 363(f), 506(a), 553. Moreover,
set-offs, which do not relate to the performance of the contract giving
rise to the account receivable, do not operate to define the property sold
in the same way that a right to recoupment does. See 13 U.S.C.
S 547(a)(3); 13 Pa. Cons. Stat. S 9106. Instead, "[s]etoff allows
adjustments of mutual debts arising out of separate transactions
between the parties." In re Harmon, 188 B.R. 421, 425 (B.A.P. 9th Cir.
1995) (emphasis added); accord Lee v. Schweiker , 739 F.2d 870, 875 (3d
Cir. 1984). This is an important distinction because it follows that a
person asserting a set-off, including even a previously exercised set-off,
against an account receivable that the Bankruptcy Court purported to
sell "free and clear" is not interpreting the Court's order to determine
what in fact was sold, but rather is essentially challenging the
Bankruptcy Court's authority to approve the sale of property that was
not part of the bankrupt's estate. Such an argument may well be barred
by S 363(m), which provides that reversal on appeal of an authorization
under S 363 does not affect the validity of the sale to a good faith
purchaser. See 11 U.S.C. S 363(m); see also In re Sax, 796 F.2d 994,
997-98 (7th Cir. 1986) (holding that failure to obtain the stay required
by S 363(m) moots question of whether bankruptcy court lacked
authority to sell property that did not belong to the debtor's estate). I
do
not address this issue, nor the related question of whether despite
S 363(m), sale of an exercised set-off may be challenged on notice
grounds, but simply note that set-offs present issues not implicated by
rights of recoupment.
25
of the petition, see 11 U.S.C. S 553(b), and the District
Court's decision regarding rights of set-off can be upheld on
the ground that DeMatteis has tendered no evidence of
such an exercise.2 Nor is there occasion here to address the
adequacy of the notice given by the trustee. Concluding, as
I do, that S 363(f) does not authorize a sale free and clear
of rights of recoupment, the judgment of the District Court
must be reversed without regard to the sufficiency of the
notice.
Section 363(f) authorizes the trustee, under specific
circumstances, to sell property of the estate "free and clear
of any interest in such property." 11 U.S.C.S 363(f). Here,
the property of the estate that was sold was accounts
receivable, and, accordingly, the issue for decision is
whether defenses arising out of the performance or non-
performance of the contract giving rise to the account
receivable are "interest[s] in such property."
"Property interests are created and defined by state law.
Unless some federal interest requires a different result,
there is no reason why such interests should be analyzed
differently simply because an interested party is involved in
a bankruptcy proceeding." Butner v. United States, 440 U.S.
48, 54 (1979); Integrated Solutions, Inc. v. Service Support
_________________________________________________________________
2. In response to Folger's motion for summary judgment, DeMatteis had
the burden of either coming forward with evidence that would support a
judgment in its favor, i.e. evidence that its set-offs were exercised more
than ninety days prior to the bankruptcy petition, or filing a Rule 56(f)
affidavit specifying that discovery was necessary to secure a basis for a
defense. See Fed. R. Civ. Proc. 56. DeMatteis did neither. "[U]nder
Pennsylvania law, a setoff is accomplished when a creditor gives
``sufficient evidence of intent' to make a setoff." IRS v. Norton, 717 F.2d
767, 772 (3d Cir. 1983). While there is evidence that DeMatteis
expressed dissatisfaction with Bayley and FAC's performance on each of
the various contracts at various times more than ninety days prior to the
bankruptcy petition, and, indeed, that it canceled its orders and refused
to make further payments, this is evidence only of an intent to exercise
its rights of recoupment. There is no evidence that DeMatteis expressed
any intention to set-off its rights under one contract against its
liabilities
under another. Indeed, the notice that was given to Bayley and FAC that
DeMatteis was refusing to make further payments on the contracts at
issue here referred only to Bayley and FAC's breach of those contracts;
it made no mention of any other contracts.
26
Specialities, Inc., 124 F.3d 487, 492 (3d Cir. 1997). Under
Pennsylvania law, the Uniform Commercial Code
(U.C.C.)--Secured Transactions (Chapter 9) governs"any
sale of accounts or chattel paper." 13 Pa. Cons. Stat.
S 9102(a)(2). "Account" is defined as"any right to payment
for goods sold or leased or for services rendered which is
not evidenced by an instrument or chattel paper, whether
or not it has been earned by performance." 13 Pa. Cons.
Stat. S 9106. The Code is consistent with this concept of an
account receivable. It defines a "receivable" as a "right to
payment, whether or not such right has been earned by
performance." 11 U.S.C. S 547(a)(3).
Thus, for present purposes, an account receivable is a
right to payment which arises upon the inception of the
contract at a point when no performance has been rendered
and no payment earned. This understanding of a receivable
is inconsistent with the notion that defenses arising from
the performance or non-performance of the contract giving
rise to it are "interests in" the receivable. A recoupment
defense simply does not constitute an interest in the right
to payment under the contract. Rather, it serves only to
define and limit that right. See 5 Collier on Bankruptcy
S 553.10 (explaining that "recoupment applies to define the
obligation in question").
Moreover, to construe S 363(f) to authorize a sale of a
receivable that would strip defenses based on performance
would run counter to the "fundamental principle[of the
Code] that the estate succeeds only to the nature and rights
of the property interest that the debtor possessed pre-
petition," Integrated Solutions, Inc., 124 F.3d at 495, and
that the estate should not receive a "windfall merely by
reason of the happenstance of bankruptcy." Butner, 440
U.S. at 55. Prior to bankruptcy, Bayley and FAC held rights
to payment that may or may not have been earned. If the
"free and clear" sale had extinguished defenses arising from
the debtor's performance, a fundamental transformation in
the nature of the debtor's property would have occurred
with a resulting windfall to the estate. While Bayley and
FAC on the filing date held only rights to payment subject
to the terms of the contracts, the estate would have been
able to sell the equivalent of negotiable instruments.
27
Because I find in S 363(f) and the remainder of the Code
no evidence of a congressional intent to authorize such a
windfall and because a recoupment defense is in no sense
an interest in the right to payment, I too would reverse the
judgment of the District Court and remand for further
proceedings.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
28