The United States Bankruptcy Court for the Western District of Michigan recently issued an opinion in a case that involved mutual claims between the debtor and a creditor, and lifted the automatic stay to allow a creditor to exercise “setoff” rights provided by state law to recover its debt.1
The case involves a Chapter 13 debtor who owed Michigan State University Federal Credit Union (the “Credit Union”) approximately $11,000 in credit card debt. In 2006, the debtor and her two minor children opened two accounts at the Credit Union, which ultimately took the form of three certificates of deposit (the “CDs”) in the face amount of $11,000. The account documents described the debtor and her children as joint parties. As a joint owner, the debtor had the right to withdraw the funds in the CDs.
In light of its claim for credit card debt against the Debtor, the Credit Union administratively froze the CDs. It then filed a motion seeking relief from the automatic stay in order to offset the value of the CDs against the debt owed the Credit Union. The Credit Union relied on the account agreement, which the Credit Union argued granted it a security interest in the CDs, when seeking relief from stay. The Credit Union also relied on statutory lien rights, provided by MCL § 490.361(4), to substantiate cause to grant relief from stay.
The Parties’ Argument and Court’s Analysis
Pursuant to Section 553 of the Bankruptcy Code, bankruptcy "does not affect any right of a creditor to offset a mutual debt…" While there are limitations on this Code section, the general rule is that a creditor and debtor may setoff mutual pre-petition claims or mutual post-petition claims against each other.
The primary argument addressed by the bankruptcy court related to whether the Credit Union could exercise setoff despite the fact that the children were joint owners of the CDs but not indebted to the Credit Union. The debtor and the Chapter 13 trustee in the case objected to the relief sought by the Credit Union because, they argued, the CDs belonged to the children. They asserted that because there was no mutuality of obligations (that is, the Credit Union had no claim against the children), Section 553 did not authorize setoff. According to the debtor and the trustee, the automatic stay should therefore not be lifted.
The bankruptcy court ruled in favor of the Credit Union and granted its motion to lift the automatic stay to allow the Credit Union to exercise its setoff rights against the CDs. The court explained that the debtor’s and trustee’s argument that the children owned the CDs actually works in the Credit Union’s favor. If the children owned the CDs, then it would mean that the debtor had no equity in the CDs, and they were not needed for the debtor's reorganization. As the bankruptcy court explained, “[t]heir argument against granting relief from stay actually points in favor of lifting it.”
The debtor and trustee also argued that the co-debtor stay found in Section 1301(a) of the Bankruptcy Code, which protects a non-debtor jointly responsible for a debt, should not be lifted to allow the Credit Union to exercise setoff rights. The bankruptcy court dismissed this argument as well, explaining that since the CDs were created as multi-party accounts, the CDs “effectively secured” the debtor’s debt to the Credit Union, which would trigger the co-debtor stay. But since the debtor’s Chapter 13 plan does not identify the Credit Union as a secured creditor, the bankruptcy court inferred that the debtor proposed to treat the Credit Union as an unsecured creditor. Accordingly, because the plan did not propose to pay the Credit Union in full as an unsecured creditor, relief from the co-debtor stay was appropriate, even assuming the CDs belong to the children, in whole or in part.