BEFORE: KEITH and MARTIN, Circuit Judges; and WEICK, Senior Circuit Judge
Robert H. Waldschmidt (Trustee), trustee for debtor Fulghum Construction Corp. (Fulghum/Debtor) appeals from the order of the district court which affirmed the decision of the bankruptcy court to allow the setoff claim of appellee Columbia Gulf Transmission Co. (Columbia). This appeal has been consolidated with a prior appeal in the same case, No. 82-5120, in which Columbia has appealed discovery sanctions imposed by the bankruptcy court.
The record reveals the following facts. In 1979, Columbia contracted Fulghum to construct, repair or replace pipelines owned by Columbia in Tennessee and Mississippi (Contract No. C-440), and in Louisiana (Contract No. C-447). Fulghum was a general contractor and was to arrange subcontracts for the pipeline work. The contracts provided, inter alia, that Fulghum would prevent the placing of liens or other encumbrances on Columbia's property as a result of any subcontractor claims against Fulghum. To that end, the Columbia contracts required Fulghum to furnish Columbia with evidence that all invoices were paid and, to promptly pay all claims against Fulghum arising from the contracts. In addition, Columbia was entitled to withhold a retainage from payments to Fulghum in order to cover any defaults by Fulghum on its obligations to subcontractors.
When the work waas completed in December 1979, Fulghum had failed to submit to Columbia the necessary evidence of payments to subcontractors on the projects. Accordingly, Columbia retained the money due Fulghum, which was stipulated to have been $223,305.07.Subsequently that month, Columbia was contacted by a number of Fulghum subcontractors relative to unpaid invoices. In early January 1980, Columbia contacted Fulghum's secretary-treasurer, James Gray (Gray),. who confirmed that Fulghum had failed to meet its financial obliations.
On January 23, 1980, an involuntary petition in bankruptcy was filed against Fulghum.
Beginning in February 1980, Columbia notified subcontractors to submit their unpaid invoices to it. The appellee examined and evaluated the invoices, and, according to the findings of the bankruptcy court, "[b]ased upon examination of the invoices, conversations with Mr. Gray, knowledge of the projects and experience in similar projects", determined that the invoices were valid and unpaid. Thereafter, Columbia learned of the bankruptcy proceedings and, verified the claimed debts against the schedule of debts filed in conjunction with the bankruptcy petition.
During May, 1980, Columbia paid out to Fulghum's subcontractors and suppliers a total of $262,142.21. On May 29, 1980 Columbia notified Fulghum that the payments had been made.
On June 18, 1980, the Trustee initiated this adversary action in the bankruptcy court seeking a turnover of the retainage to the estate. A hearing was held June 16, 1982 pursuant to which the bankruptcy court granted Columbia a setoff of its obligation to the Debtor in the amount of the May 1980 pay-outs to the Debtor's subcontractors. The district curt affirmed and there ensued this timely appeal.
Section 542(b) of the Bankruptcy Code requires an entity that owes the debtor money as of the petition date, or that holds money payable on demand to the debtor, pay the money to the debtor's trustee. 11 U.S.C. § 542(b). An exception is crafted to the extent that the creditor has a valid setoff under § 553 of the Code. Id. The issue joined by this appeal is Columbia's entitlement to a setoff under § 553 of the Code.
Relevantly, § 553 of the Code states as follows:
§ 553. Setoff
(a) 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 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, except to the extent that --
(1) the claim of such creditor against the debtor is disallowed other than under section 502(b)(3) of this title;
(2) such claim was transferred, by an entity other than the debtor, to such creditor --
(A) after the commencement of the case; or
(B)(i) after 90 days before the date of the filing of the petition; and
(ii) while the debtor was insolvent; or
(3) the debt owed to the debtor by such creditor was incurred by such creditor --
(A) after 90 days before the date of the filing of the petition;
(B) while the debtor was insolvent; and
(C) for the purpose of obtaining a right of setoff against the debtor.
Debts subject to setoff must have the characteristics of mutuality. This concept was articulated in In re Potts, 142 F.2d 883, 887 (6th Cir. 1944), cert. denied, 324 U.S. 868 (1945), on which the district court relied:
This section provides that in all cases of mutual debts or mutual credits between the estate of a bankrupt and a creditor, the account shall be stated and one debt shall be set off against the other and the balance only allowed or paid. It is settled law that parties interested in the estate may set off in reduction or extinguishment of the allowance a provable claim, any debt or counterclaim which passes to the trustee and which the bankrupt or any of his creditors might have asserted against the claimant. . . . The debt to be set off must ordinarily be a mutual one and must be of the same nature as the creditor's claim.
The determination as to whether a right of set-off exists . . . lies within the discretionary control of the [bankruptcy] court to be exercised in accord with the general principles of equity. The court has the "primary duty of determining for itself whether there are "mutual debts or credits' that should be set off one against the other."
Accord, e.g., Cooper-Jarrett, Inc. v. Central Transport Inc., 726 F.2d 93 (3rd Cir. 1984); In re Verco Industries, 704 F.2d 1134 (9th Cir. 1983); Gilbert v. First National Bank, 633 F.2d 686 (5th Cir. 1980), cert. denied, 454 U.S. 825, 102 S. Ct. 114, 10 L. Ed. 2d 99 (1981).
On appeal, the Trustee disputes the determination by the lower court that the debts at issue were mutual. The Trustee asserts that because there was not privity of contract between Columbia Gulf and the payees, Columbia could not setoff any payment not resulting from a successful lien against Columbia's property. The bankruptcy court characterized the contracts as creating the debt by permitting Columbia to "settle and pay such claim and recover from [Fulghum] the amount so paid". According to the bankruptcy court,
Columbia thus had a pre-petition claim against Fulghum for Fulghum's failure to pay subcontractors and suppliers, for the removal of liens against Columbia's property and for breach of contract.
Privity of contract is not a requirement of the doctrine of mutuality. Mutuality in this case arises from the contracts between Columbia and Fulghum which entitled Columbia, in the event of Fulghum's default, to avoid liens on its property by payment of Fulghum's debts to the subcontractors. Pursuant to the contracts, Fulghum became obligated to Columbia to the extent that the latter satisfied the subcontractor's invoices.The retainage provisions of the contracts effectuated Fulghum's obligation by allowing Columbia to reduce its obligation to Fulghum under the contract. This is a classic offset situation and is precisely the situation for which § 553 was designed.
Fulghum next asserts that mutuality was lacking also insofar as Columbia's payment to the subcontractors occurred after the filing of the petition. Fulghum is correct that debts owed as a result of claims against the debtor prior to bankruptcy cannot be offset by claims arising against the estate after the petition is filed because the prebankrupt debtor is legally distinct from the post-petition estate. In such circumstances the mutuality of obligation is lacking because there is no setoff "of "mutual credits' against "mutual debts". In re Allbrand Appliance & Television Co., 16 B.R. 10, 12 (Bkrtcy. S.D. N.Y. 1980). See Prudential Insurance Co. v. Nelson, 101 F.2d 441 (6th Cir.), cert. denied., 308 U.S. 583 (1939).
However, Fulghum misses the point by looking to the time of payment. Instead, the appropriate inquiry is the status of the mutual debts and credits as of the petition date. Here, the petition in bankruptcy was filed January 23, 1980. The work under the contracts had been completed in December 1979, at which time Columbia became obligated to Fulghum on the contract price. At the same time, Columbia was entitled to proof from Fulghum of satisfaction of all subcontractor invoices. When, in December 1979, Fulghum did not provide that proof and, in early January, conceded a failure and inability to pay the debts, Fulghum became obligated to Columbia to the extent of unpaid contractor invoices. Columbia did not offset debts incurred by the Trustee of the estate against debts incurred by Fulghum; the obligations were entirely mutual. The provisions of the contracts gave Columbia a claim against Fulghum on the unpaid subcontractor invoices. Thus, Columbia was neither setting off a third party claim against Fulghum, nor was it improperly setting off liens (filed or unfiled) on property against in personam contract claims.
The bankruptcy court's determination that, as a matter of fact, the claims were mutual was therefore not clear error. Accordingly, under the clearly erroneous standards of rule 810 of the bankruptcy rules, that finding must be affirmed.
The grant or denial of a setoff is not mandatory, but permissive and relegated to the sound discretion of the bankruptcy court acting in equity. See, e.g., In re Allbrand Appliance & Television Co., supra; In re U.S.N. Co., 2 B.R. 468 (Bkrptcy S.D.N.Y. 1979) See also In re Potts, supra. Fulghum asserts that the bankruptcy court abused its discretion because in paying out the claims Columbia had violated the automatic stay provisions of the Code relating to setoffs. Section 362 of the Code provides as follows:
§ 362. Automatic stay
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title operates as a stay applicable to all entities, of --
(7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and
(d) On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay --
(1) for cause, including the lack of adequate protection of an interest in property of such party in interest; or
(2) with respect to a stay of an act against property if --
(A) the debtor does not have an equity in such property and
(B) such property is not necessary to an effective reorganization.
(e) Thirty days after a request under subsection (d) of this section for relief from the stay of any act against property of the estate under subsection (a) of this section, such stay is terminated with respect to the party in interest making such request, unless the court, after notice and a hearing, orders such stay continued in effect pending, or as a result of, a final hearing and determination under subsection (d) of this section. A hearing under this subsection may be a preliminary hearing, or may be consolidated with the final hearing under subsection (d) of this section. If the hearing under this subsection is a preliminary hearing --
(1) the court shall order such stay so continued if there is a reasonable likelihood that the party opposing relief from such stay will prevail at the final hearing under subsection (d) of this section; and
(2) such final hearing shall be commenced within thirty days after such preliminary hearing.
(f) The court, without a hearing, shall grant such relief from the stay provided under subsection (a) of this section as is necessary to prevent irreparable damage to the interest of an entity in property, if such interest will suffer such damage before there is an opportunity for notice and a hearing under subsection (d) or (e) of this section.
(g) In any hearing under subsection (d) or (e) of this section concerning relief from the stay of any act under subsection (a) of this section --
(1) the party requesting such relief has the burden of proof on the issue of the debtor's equity in property; and
(2) the party opposing such relief has the burden of proof on all other issues.
Under the Code, unlike the predecessor Bankruptcy Act, setoffs are clearly subject to the automatic stay provisions. See, e.g., First National Bank v. Davis, 317 F.2d 770 (5th Cir. 1973); 2 Collier on Bankruptcy P362.04. Under the Code, as under the Act, violation of the stay provisions warrants a finding of contempt, however, where the violation is inadvertent, the contempt power is not generally invoked.
See, e.g., In re Intaco Puerto Rico, Inc., 494 F.2d 94 (1st Cir. 1974); 2 Collier on Bankruptcy P362.11. In this case the lower court appropriately did not utilize the contempt power against Columbia. At the time Columbia made the challenged payments, the application of the stay provisions to setoffs was of relatively recent origin and the permutations of §§ 542(b), 553, and 362 were not clear. Thus, Columbia proceeded under a demonstrated good faith belief that the payments were authorized by the contractual terms and not subject to the automatic stay provisions.
It is now clear, of course, that Columbia's right to setoff was stayed by operation of § 362. After having made the payments out of the retainage, Columbia was nevertheless subject to the bankruptcy court's discretion to grant a setoff, which could only be effected by an order of the court, and Columbia remained liable to the estate for the entire retainage until the court chose to offset the obligation. See Houdashell v. Missouri Public Service Co., 7 Bankr. 901 (W.D. Mo. 1981).
The bankruptcy court determined that Columbia's payment of the subcontractor invoices was a violation of the stay, but did not damage the estate: "Quite the contrary, the payments . . . minimized the damages caused by Fulghum's breach of its contracts and have benefited the estate by reducing the claims against Fulghum". The district court declined to hold that the bankruptcy court abused its discretion in permitting Columbia to assert a setoff. Because Columbia acted in good faith and, as noted by the bankruptcy judge, its actions did not injure the debtor's estate, this court holds that it was not an abuse of discretion by the bankruptcy court to grant Columbia a setoff of the invoices it honored.
Fulghum also argues that the evidence was insufficient to support bankruptcy court's conclusions as to the amount properly paid out by Columbia under the contracts.
At the setoff hearing, Columbia was permitted to introduce copies of Fulghum's unpaid invoices, upon which it based its payments to the subcontractors. The court accepted the documents for the limited purpose of showing that Columbia relied thereon in making the payments and not for the truth of the matters shown, i.e., that Fulghum actually owed those amounts. On appeal, Fulghum asserts that the court improperly relied on the invoices as evidence that Fulghum was indebted on the Columbia contracts for the amounts specified.
Examination of the record and opinions below reveals that the bankruptcy court's determination that the amounts paid out by Columbia represented Fulghum's debts was based on (1) the trustee's failure to contest Columbia's claim that the debts were letigimate, and (2) a comparison of the amounts paid by Columbia with the schedule of debts filed by Fulghum with the bankruptcy petition. There was therefore substantial evidence supporting the lower court's factual determination that the subcontractor debts were due and owing on the contracts and in the amounts paid by Columbia.
In accord with the foregoing, the judgment of the district court approving the setoff in favor of Columbia, is affirmed. Because the briefs of both parties to this appeal were wholly inadequate and failed to assist the court, each side shall bear their own costs and fees on the appeal.
Because Columbia has conceded that its earlier appeal (no. 82-5120) would be mooted by an affirmance of the setoff, that case is dismissed as moot.