Restructuring

Contributed by Amy B. Price
Since today is April 15, we thought we’d give taxpayers a much-needed boost by featuring a case in which everyone’s favorite governmental agency learns that it is no better than an average, run-of-the-mill creditor.  In In re Mirabilis Ventures, Inc., No. 6:08-bk-04327-KSJ (Bankr. M.D. Fla. Mar. 28, 2011), the court reminded the IRS that it, like every other creditor, must seek relief from the automatic stay before exercising setoff rights.  In fact, the court reprimanded the IRS for ignoring the automatic stay and playing “fast and loose with the well established rules governing setoff in bankruptcy proceedings.”  Sure it’s only a small victory for taxpayers, but today of all days, we’ll take it!  Not only did the court rebuke the IRS, but it also crystallized the tension between a debtor’s right to discharge and a creditor’s right to set off mutual debts.
In Mirabilis, the Bankruptcy Court for the Middle District of Florida explored whether the IRS waived its right to offset the debtor’s tax overpayments against the debtor’s tax liabilities by failing to assert the setoff prior to confirmation of the plan.  The court held that setoff rights were expressly preserved in the plan and confirmation order, but, under the terms of the plan, the IRS was required to seek relief from the automatic stay prior to exercising the setoff.  Thus, the IRS was forced to return the funds it had offset in violation of the stay to the debtor’s account, but it was not precluded from exercising setoff rights post-confirmation so long as it properly sought relief from the stay.  Overall, the plan and confirmation order provided the court with a roadmap to determine whether the IRS’s setoff rights survived confirmation.  But the decision sheds light on the murkier issue of whether post-confirmation setoff rights are automatically extinguished by confirmation of a plan that is silent on the preservation of setoff rights.  Indeed, had the plan not addressed setoff rights in Mirabilis, the IRS may have been unable to exercise this valuable right to effectuate a dollar-for-dollar credit on its debt.
The Mirabilis case involved a colorful set of facts, including an “openly hostile” relationship between the debtor and the IRS, the debtor’s primary creditor.  Prepetition, the debtor, Mirabilis Ventures, Inc., was involved with “one of the largest payroll-processing frauds in U.S. history.”  In relation to the tax fraud, Mirabilis and certain affiliates filed for bankruptcy protection in an attempt to liquidate their assets.  The debtors confirmed a plan of liquidation providing, among other things, that (i) the automatic stay would remain in effect until the issuance of a final decree or an order dismissing the debtors’ cases, (ii) the debtors would be substantively consolidated for purposes of determining their creditors’ setoff rights, such that debts due to any of the debtors could be offset against the obligations of another debtor, and (iii) pursuant to section 1141 of the Bankruptcy Code, all persons would be permanently enjoined from recovering on account of claims discharged under the plan.
Shortly after confirmation, Mirabilis requested a refund of overpayments it had made to the IRS.  Under the Tax Code, prior to issuing a refund, the IRS is entitled to offset overpayments against tax liabilities owed by the taxpayer.  Accordingly, the IRS deducted amounts owed by the debtor from the refund and filed an amended claim reflecting the setoff.  However, it did not seek relief from the stay before effectuating the setoff.  Among other things, the debtor argued that the IRS had waived its right to setoff by failing to assert it prior to confirmation.
Although the Mirabilis court chided the IRS for violating the stay, it was not convinced by the debtor’s argument.  The plan did not enjoin any creditor from exercising setoff rights, and, the court noted, the confirmation order expressly contemplated that setoff rights would be available after confirmation.  The Court distinguished In re Suncruz Casinos, LLC, 342 B.R. 370, 380 (Bankr. S.D. Fla. 2006) and In re Lykes Brothers Steamship Co., Inc., 217 B.R. 304, 310 (Bankr. M.D. Fla. 1997), cited by the debtor.  In those cases, creditors were precluded from asserting post-confirmation setoffs where the plans and confirmation orders specifically enjoined any claimants from exercising setoff rights after confirmation.  Moreover, because Mirabilis did not request its tax refunds from the IRS until after the confirmation hearing, the IRS could not have asserted its setoffs pre-confirmation.  Based on the facts before it, the court held that the IRS’s setoff rights survived confirmation.
In concluding the IRS’s setoff rights were preserved, the Court acknowledged that it, along with the SunCruz and Lykes Bros. courts, had dodged the harder question of how to reconcile sections 553 and 1141 of the Bankruptcy Code “in the abstract,” i.e. where the chapter 11 plan is silent as to post-confirmation setoffs.  Subject to certain exceptions, section 1141 of the Bankruptcy Code discharges prepetition debts and provides that assets retained by the debtor under the confirmed plan are free and clear of those.  On the other hand, section 553(a) of the Bankruptcy Code states that, “[e]xcept 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 . . .” (emphasis added).  Accordingly, section 553(a) suggests that section 1141 does not disturb a creditor’s setoff rights.  Nevertheless, allowing survival of setoff rights would trump the importance of the discharge in section 1141, which lies at the heart of the chapter 11 reorganization process.
Because the plan and confirmation order expressly addressed post-confirmation setoff rights, the Mirabilis court did not have to resolve the tension between these two sections of the Bankruptcy Code.  Like the Mirabilis court, bankruptcy courts generally conduct a case-by-case analysis and defer to the plan to determine whether setoff rights survive plan confirmation.  But where a plan is silent, the waters get muddied.  Indeed, courts in other jurisdictions have not resolved this issue uniformly.  In In re Continental Airlines, 134 F.3d 536, 542 (3d Cir. 1998), the Third Circuit held that, where the creditor made no attempt to assert its setoff pre-confirmation, confirmation of the chapter 11 plan extinguished the claimed setoff rights even though the plan was silent as to post-confirmation setoffs.  By contrast, where the plan was silent as to post-confirmation setoffs in In re BOUSA Inc., 2006 WL 2864964 (Bankr. S.D.N.Y. Sept. 29, 2006), the Bankruptcy Court for the Southern District of New York held that confirmation of the plan did not extinguish the creditor’s right of setoff.
Ultimately, the IRS got lucky in Mirabilis; the confirmed plan expressly contemplated setoff rights post-confirmation (subject, in that case, to obtaining relief from stay).  Had the plan been silent on the issue, the IRS may have been enjoined from offsetting the debtor’s tax obligations against the overpayment.  In another case, the IRS (or any other creditor, for that matter) might not fare as well.  Therefore, creditors must carefully examine a plan’s treatment of setoffs.  At stake for both debtors and creditors is the right of creditors to set off their mutual obligations and thereby receive a valuable dollar-for-dollar credit on their debt.