Dubious Opinion Says Automatic Stay Inapplicable to Setoff Against Exempt Property

June 15, 2017

A district judge in Detroit held that the government’s post petition setoff against a Social Security benefit did not violate the automatic stay because the payment was not property of the estate.

The opinion might be interpreted to mean that a creditor can exercise a valid right of setoff against exempt property without violating the automatic stay. It is unclear from the opinion whether the court would have reached the same conclusion if the prepetition debt owing to the government were dischargeable.

The Internal Revenue Service had a claim for almost $400,000 against a tax protester who did not file tax returns for more than a dozen years. Before the debtor filed a chapter 13 petition, the IRS had filed a notice of levy and was deducting about $1,300 a month from the debtor’s $2,100 monthly Social Security benefit.

After bankruptcy, the government evidently attempted unsuccessfully to freeze rather than offset the Social Security benefit. After the $1,300 offset was affected anyway, the government filed a motion asking the bankruptcy court to annul the stay or rule that the automatic stay did not bar offsetting a post petition obligation against a nondischargeable, prepetition debt.

The bankruptcy judge ruled that the setoff violated the automatic stay. On appeal, District Judge Mark A. Goldsmith reversed the bankruptcy court in an opinion on June 2 and found no stay violation.

Judge Goldsmith began by citing the proposition that Section 553 preserves the right to offset mutual prepetition debts and credits. Without citing Section 362(a)(1), he then analyzed other subsections in 362(a) to determine if there had been a stay violation. He said that Section 362(a)(3) did not apply because the Social Security payment “does not constitute property of the estate.” Further, he said that setoff is an affirmative defense and thus “differs from an act to obtain possession of estate property.”

Next, Judge Goldsmith said that Section 362(a)(4) – prohibiting the enforcement of a lien against estate property – is similarly inapplicable because the Social Security payment was not estate property. “Furthermore,” he said, “the government is not relying on any lien; it is instead asserting its right of setoff.” He said that Section 362(a)(5) was inapplicable for the same reason.

According to Judge Goldsmith, Section 362(a)(6) – which bars any action to collect a prepetition claim – did not apply because “a setoff cannot be characterized as either a personal solicitation or a legal proceeding to obtain a debt owed.” He said that a “setoff is simply the application of mutual debts against one another.” If that subjection were applicable, he said it would make Section 362(a)(7) superfluous.

Similarly, Section 362(a)(7) – prohibiting the “setoff of any debt owing to the debtor that arose before the commencement of the case . . . against any claim against the debtor” – only bars offsetting against a debt that arose before filing. Because the obligation to pay the Social Security benefit did not arise until after bankruptcy, that section did not apply, Judge Goldsmith said.

Judge Goldsmith also relied on a decision by a Michigan bankruptcy judge holding that actions against exempt property are not enjoined by the automatic stay.

In summarizing the holding at the end of the opinion, Judge Goldsmith said that the debt was nondischargeable. The opinion does not discuss how nondischargeability factored into the result.

For having failed to file tax returns for more than a dozen years, the debtor was not a sympathetic litigant. One wonders whether the judge would have reached a different result if the debtor were more appealing.

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