Opinion
No. 91 CVF 12771.
Decided December 19, 1991.
John E. Sullivan III, for plaintiff Laventhol Horwath.
Robert I. Zashin, for defendants Lawrence J. Rich Co., L.P.A., et al.
Upon due consideration and further review, the court hereby orders that the stay previously imposed on the prosecution of the plaintiff/bankrupt's claim herein be lifted.
The court further finds that the defendants' counterclaim sounds in recoupment, and as such is not precluded by the automatic stay provision of Section 362, Title 11, U.S.Code. Plaintiff's request to continue the stay as to the defendants' counterclaim is, therefore, not well taken and is denied. Consequently, this matter is ordered returned to the court's active trial calendar.
The court's reasoning is as follows:
Generally, when someone seeks protection under the federal bankruptcy laws by filing a petition in bankruptcy, the automatic stay provision contained in Section 362, Title 11, U.S. Code precludes any entity from continuing or initiating a claim against the bankrupt or the bankrupt's property.
A question arises when the bankrupt, in an attempt to liquidate the assets of his estate, files post-petition lawsuits in courts other than the bankruptcy court in an attempt to establish claims against other entities. For example, the bankrupt may proceed in state court to litigate outstanding, overdue accounts receivable, as in the instant case. Such suits, initiated by the bankrupt, are not precluded by the automatic stay of Section 362. Kuntz v. Lake Placid Olympic Organizing Commt., Inc. (N.Y.S.Ct. 1990), 148 Misc.2d 649, 561 N.Y.S.2d 518; In re Overmyer (S.D.N.Y.Bankr. 1983), 32 B.R. 597.
The question is whether a defendant, in a suit initiated by a bankrupt, may assert a counterclaim against the plaintiff/bankrupt, or whether the automatic stay precludes the counterclaim since it may be construed as a proceeding against the bankrupt debtor or his property in violation of Section 362.
The answer to this question depends upon the counterclaim asserted. Where the counterclaim is unrelated to the transaction giving rise to the plaintiff/bankrupt's claim, the courts have generally held that such counterclaims are precluded by the automatic stay unless they come within the strict confines of mutual setoff as permitted by the bankruptcy court rules.
Thus, in In re Lessig Constr. Co. (E.D.Pa.Bankr. 1986), 67 B.R. 436, the court held that a counterclaim filed by a creditor of the bankrupt in response to a claim by the bankrupt arising out of a different transaction would be precluded by the automatic stay of Section 362. Lessig involved a claim for breach of contract by the plaintiff/bankrupt, and a counterclaim for breach of contract asserted by the defendant, but the defendant's action arose out of a different contract than the one plaintiff's claim was based upon.
The court reasoned:
"It is not surprising that the concept of setoff would be applied restrictively in bankruptcy proceedings. One of the basic tenets of bankruptcy is that all creditors of a debtor must be treated equally in the disposition of their respective claims." Lessig at 441.
The reasoning behind prohibiting counterclaims in the nature of setoffs is that one creditor effectively recovers more from the bankrupt's estate than the other creditors, avoiding the law's attempt to treat all creditors equally. Action Drug Co., Inc. v. Overnite Transp. Co. (D.Del. 1989), 724 F. Supp. 269.
However, the concept of counterclaim under the Civil Rules is broad and encompasses the common-law concepts of setoff and recoupment. Both the Ohio and federal Civil Rules use the term "counterclaim" in the broad sense to include setoffs and recoupments. See 75 Ohio Jurisprudence 3d (1987), Pleading, Sections 232-234. The best discussion of the distinction between the types of counterclaims and the effect of Section 362 on those counterclaims is found in the recent case of In re Holford (C.A.5, 1990), 896 F.2d 176, 178:
"`Recoupment allows a defendant to reduce the amount of a plaintiff's claim by asserting a claim against the plaintiff which arose out of the same transaction to arrive at a just and proper liability on the plaintiff's claim. Collier on Bankruptcy para. 553.03 (15th ed. 1984). In contrast, setoff involves a claim of the defendant against the plaintiff which arises out of a transaction which is different from that on which the plaintiff's claim is based. Id.'" (Emphasis sic.)
In Holford, the defendant was sued by the bankrupt plaintiff for rent due on an office space the defendant was leasing from the plaintiff/bankrupt. The lease was entered into by the parties prior to the plaintiff's bankruptcy filing. Defendant counterclaimed on plaintiff's rent suit, alleging that the plaintiff committed fraud with regard to the lease agreement and that no further rent was due as a result of the damages caused by plaintiff's fraud.
The plaintiff filed a motion to show cause in the bankruptcy proceeding, alleging that the counterclaim violated the automatic stay of Section 362. The bankruptcy court held the defendant in contempt and the district court affirmed. The defendant successfully appealed the contempt finding to the Fifth Circuit, which determined that the counterclaim was, in fact, a recoupment and not an impermissible setoff.
The counterclaim filed in the instant case sounds in recoupment. It asserts that the accounting work performed by the plaintiff was inadequately done, resulting in taxes and penalties to the defendants in the approximate amount of $3,500. Plaintiff's claim is based upon the same work performed, and alleges an amount due of approximately $8,000. The counterclaim is an assertion by the defendants that the true liability of the defendants, if any, is about $3,500 less than the plaintiff alleges, due to the plaintiff's own breach of the agreement. Unlike a setoff, this counterclaim arises out of the same transaction upon which the plaintiff's claim is based. As recognized by the Holford court, this type of counterclaim is not precluded by the automatic stay provision of Section 362:
"The trustee of a bankruptcy estate `takes the property subject to rights of recoupment.' [ In re] Career Consultants, [ Inc. (E.D.Va.Bankr. 1988),] 84 B.R. [419] at 426.
"* * * Because we find that the transaction in question constituted a recoupment and not a setoff, and that a recoupment is not subject to the automatic stay of section 362(a), we REVERSE and RENDER the contempt order of the district court." Holford, 896 F.2d at 179.
The reasoning of Holford applies to the instant case. If a counterclaim asserts that the defendant has a claim against the plaintiff arising out of the same transaction, and that claim reduces the defendant's liability, then it is logical that this counterclaim would proceed so that the liability could be determined by the court hearing the plaintiff's complaint. Otherwise, the problems of res judicata and the rule as to compulsory counterclaims would arise.
Further, the reasoning behind prohibiting counterclaims in the form of setoffs does not apply to counterclaims in the form of recoupments. A recoupment does not entitle the pleader to an affirmative recovery from the plaintiff. Therefore, it is not a proceeding against the bankrupt or his estate. It is, as Holford recognized, an assertion of the true liability between the parties. To deny the defendant the right to have this liability fully adjudicated would be inequitable, and effectively preclude what amounts to an affirmative defense to the plaintiff/bankrupt's claim.
H.G. Hall Constr. Co. v. J.E.P. Ent. (App. 1984), 283 S.C. 196, 321 S.E.2d 267, provides a somewhat different analysis of the concepts involved herein, but yields a compatible result.
In Hall, the plaintiff/bankrupt filed a lawsuit for breach of contract against the defendant, seeking $150,500 in damages. The defendant filed a counterclaim for breach of the same contract and requested damages in excess of $500,000.
The plaintiff/bankrupt moved to dismiss the counterclaim as a violation of Section 362. The trial court dismissed the counterclaim as a violation of Section 362, but allowed the defendant to assert the matters contained in its counterclaim, up to the amount of plaintiff's claim, as an affirmative defense. The trial court was affirmed on appeal.
In fact, if the court had analyzed the nature of the counterclaim, it would have found that the counterclaim amounted to a recoupment, at least up to the amount of the plaintiff's demand. It then could determine that the recoupment was not prohibited by Section 362. However, the same result was achieved by allowing the defendant to present its counterclaim as an affirmative defense.
What the Hall case demonstrates is that courts recognize the obvious unfairness that would result if counterclaims in the nature of recoupments were stayed by Section 362, while the plaintiff/bankrupt was free to prosecute claims without fear of the counterclaims being raised. As cited in the numerous decisions permitting counterclaims:
"Where a debtor seeks affirmative relief as a plaintiff in a lawsuit and then invokes the protection of the automatic stay on a counterclaim, the situation warrants very careful scrutiny. In such instance, a court must be cautious to avoid a decision which would convert Code § 362 from a shield into a weapon. A debtor should not be permitted to reap the benefits of litigation in one court, but circumvent the burdens in another forum." In re Overmyer, 32 B.R. at 601, citing Bohack Corp. v. Borden, Inc. (C.A.2, 1979), 599 F.2d 1160.
For the foregoing reasons, the court hereby grants plaintiff's motion to lift the stay imposed in this matter, but denies plaintiff's motion to dismiss defendants' counterclaim.
So ordered.