CARLOS MURGUIA, District Judge.
This is an appeal of the final Memorandum Opinion and Judgment (Doc. 5-18) of the bankruptcy court. Appellant Philip Duane Lunt ("Debtor") appeals the bankruptcy court's decision denying Debtor's motion for summary judgment and granting the motion for summary judgment of intervenors Elaine L. Stelter ("Elaine") and Steven A. Lunt ("Steven"). Debtor claims that the bankruptcy court erred in three ways: (1) in deciding that Debtor's bankruptcy eliminated his personal liability for his pre-petition promissory note but
The following facts are uncontroverted and were set forth in the bankruptcy court's decision. For reasons of judicial efficiency, the court reproduces them in their entirety here.
The Amendment of Trust Agreement executed on November 7, 1985, the date of the Note, states in part:
By letter dated December 18, 2009, Richard Mullin responded to the allegations and also stated the following regarding distributions from the Trust:
(Doc. 5-18 at 3-8 (original formatting and citations retained).)
This court employs a de novo standard of review of the bankruptcy court's conclusions of law. Cohen v. Borgman (In re Borgman), 698 F.3d 1255, 1259 (10th Cir.2012) (citation omitted). Further, "[t]his [c]ourt must ... reach its own conclusions regarding state law legal issues, without deferring to the bankruptcy court's interpretation of state law." Id. (citation omitted).
As is stated above, on November 25, 1988, Debtor filed for Chapter 7 bankruptcy. Debtor received a discharge under 11 U.S.C. § 524(a)(2), which went into effect on July 19, 1989. The list of discharged debts included the Note. 11 U.S.C. § 524(a)(2) states that a discharge "operates as an injunction against ... an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived." The parties agree that the discharge injunction applies to Debtor's personal liability on the Note. The parties disagree, however, on whether the debt evidenced by the Note was discharged in bankruptcy.
A discharge in bankruptcy eradicates the debtor's personal liability on the obligation, but it does not eliminate the underlying debt. See Johnson v. Home State Bank, 501 U.S. 78, 84, 111 S.Ct. 2150, 115 L.Ed.2d 66 (1991) (stating that "a bankruptcy discharge extinguishes only one mode of enforcing a claim — namely, an action against the debtor in personam — while leaving intact another — namely, an action against the debtor in rem."); 3 William L. Norton, Jr., & William L. Norton III, Norton Bankr.Law & Practice 3d § 58:2 (Thomson Reuters/West 2012) (noting that discharge extinguishes personal liability on a debt, but does not "absolve the underlying debt retroactively"). Therefore, although Debtor's bankruptcy eliminated his personal liability on the Note, the underlying debt remains.
After determining that the debt evidenced by the Note was not discharged in bankruptcy, the court must determine whether the Trustee's actions in offsetting Debtor's interest obligation on the Note
As it applies in bankruptcy law, the equitable doctrine of recoupment allows a creditor to withhold funds owed to another party "to offset a claim that arises from the same transaction as the debtor's claim, without reliance on the setoff provisions and limitations of [11 U.S.C. § ] 553, because the creditor's claim ... is essentially a defense to the debtor's claim against the creditor...." Davidovich v. Welton (In re Davidovich), 901 F.2d 1533, 1537 (10th Cir.1990) (per curiam) (internal citations omitted). The doctrine essentially "allows a creditor to recover a pre-petition debt out of payments owed to the debtor post-petition." Beaumont, 586 F.3d at 780 (internal citation omitted).
In bankruptcy cases, courts narrowly construe the doctrine of recoupment "because it violates the basic bankruptcy principle of equal distribution to creditors." Conoco, Inc. v. Styler (In re Peterson Distrib., Inc.), 82 F.3d 956, 959 (10th Cir.1996) (citing Ashland Petroleum Co. v. Appel (In re B & L Oil Co.), 782 F.2d 155, 158 (10th Cir. 1986)). For the doctrine to apply, the two debts must arise out of the "same transaction." Id. (citation omitted). As the bankruptcy court noted, the Tenth Circuit has adopted the "single integrated transaction" definition of "same transaction." See id. at 960 (citing Univ. Med. Ctr. v. Sullivan (In re Univ. Med. Ctr., Inc.), 973 F.2d 1065, 1081 (3d Cir.1992)). This definition requires that "both debts arise out of a single integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations." Id. (citation omitted). In deciding whether offset violates a discharge injunction, courts must carefully consider the equities involved and "determine whether the claims `are so closely intertwined that allowing the debtor to escape its obligation would be inequitable.'" Beaumont, 586 F.3d at 781 (quoting Peterson Distrib., 82 F.3d at 960).
The bankruptcy court provided a thorough analysis of Tenth Circuit recoupment decisions employing the "same transaction" test. (Doc. 5-18 at 18-21.) This court will briefly analyze these cases as well. In Peterson Distributing, the Tenth Circuit adopted the Third Circuit's "single integrated transaction" test. 82 F.3d at 960. There, the Tenth Circuit put great emphasis on the equities of the case. The court found that — despite the existence of a single franchise agreement that covered both obligations at issue — the obligations were not "so closely intertwined" that it would be equitable to allow Conoco (the creditor) to recover its losses at the expense of the other creditors. Id. at 962. Further, as the bankruptcy court noted, the Tenth Circuit noted there was "no overriding equitable reason ... that compels the application
Davidovich involved an attorney (the debtor) who sued his former law partner to recover an amount awarded to him in an arbitration proceeding between the debtor and the former law partner. 901 F.2d 1533. The law partner attempted to set the debtor's claim off against two claims he himself had against the debtor. Id. at 1536. The Tenth Circuit applied the doctrine of recoupment and allowed offset of the law partner's claim arising out of the same arbitration proceeding; however, the claim arising from a separate partnership venture was not allowed. Id. at 1537-38. In explaining its decision, the Tenth Circuit noted that the debts from the arbitration proceeding originated from "a single integrated transaction ... such that it would be inequitable for [the debtor] to enjoy the benefits of that transaction without meeting its obligations." Id. at 1537. In contrast, recoupment did not apply to the claim arising from the separate partnership venture because the debt arose under a separate partnership agreement, and not the arbitration proceeding. Id. at 1538.
In Beaumont, the debtor, a disabled veteran, was receiving disability payments from the Department of Veteran Affairs ("VA"). 586 F.3d at 778. He failed to notify the VA — as he was required to do — after he received a large inheritance. Id. at 779-80. After learning of the inheritance, the VA determined it had overpaid the debtor and notified the debtor of its intention to recoup the claim by offsetting future disability payments owed to the debtor, as was explicitly allowed by statute. Id. The VA continued to offset the debtor's benefits even after the debtor filed for bankruptcy, and the debtor argued that this conduct violated the discharge injunction. Id. Applying the "single integrated transaction" test, the Tenth Circuit found that the debtor's "inheritance was directly related to or intertwined with the amount of benefits [the VA] was obligated to pay to him, and the resulting overpayment of benefits." Id. at 781. In determining that the doctrine of recoupment applied, the court found that "it would be inequitable for the [debtor] to receive his inheritance, continue to receive benefits as if his income was zero, then be able to discharge in bankruptcy the overpayments...." Id.
As is stated above, the discharge injunction did not eradicate Debtor's obligation to the Trust. Interest continues to accrue on the Note at the rate of $3,333.33 per year. Debtor's obligation to the Trust is his liability for interest on the Note. In June 2010, the Trustee applied Debtor's 2010 income distribution to the interest on the Note. Debtor's one-third share of the income totaled $4,811.
The court finds that — for the year in which the income distribution was made — Debtor's right to receive income distributions from the Trust and his obligation to the Trust are closely intertwined. Both are part of the same transaction: administration of the Trust. (Doc. 5-18 at 21 ("Both relate to the administration of the Trust during the same time period and to Debtor's then current rights and obligations.").) Further, Debtor's obligation to the Trust and his right to receive income distributions are so closely intertwined that it would be inequitable to allow him to receive distributions while at the same time failing to honor his obligation to the Trust.
Unlike the multiple creditors involved in Peterson Distributing, the rights of other creditors are not involved here, as this case deals with recoupment to the Trust from disbursements made by the Trust. See 82 F.3d at 961-63. Instead, it appears that only Elaine and Steven will be prejudiced
Considering the equities involved in this case, the court finds that Debtor's receipt of an income distribution for the same period of time for which he was not honoring his obligation to pay interest would be inequitable. Debtor's 2010 interest obligation of $3,333.33 and Debtor's 2010 income distribution were part of the same transaction and the doctrine of recoupment applies.
As to the Trustee's offset of the remaining $1,477.67 against Debtor's interest obligation for a prior year, the court agrees that the "single integrated transaction" test is still met and the Trustee did not violate the discharge injunction. As the bankruptcy court explained, the Note plus accrued interest would eventually total more than Debtor's one-third share in the principal of the Trust. Like in Beaumont, where the VA recouped past overpayments from current benefits, non-bankruptcy law supports recoupment here. The bankruptcy court provided a very thorough discussion of the authority of the Trustee under the Trust and state law
Although the court will not repeat in full that discussion here, the court — upon performing an independent review — concurs that the Trustee's application of Debtor's income distribution to the interest remaining on the Note was a valid method of carrying out the Grantor's intent that distributions of principal to the beneficiaries be equal when the Trust terminates in 2024. Article VI(C)(4) of the 1984 Trust Amendment states this intent. (See Doc. 5-3 at 11, 1984 Amendment to Trust Agreement, Article VI ("Upon termination, the Trustee shall distribute the principal and any accrued and undistributed income of the trust in equal shares to the children of the Grantor....").) This provision also directs the Trustee to consider all transfers to the Grantor's children in accomplishing equal distributions to the beneficiaries. (Id.) As is stated above, the Trustee realized in 2010 that if the Note remained unpaid and interest continued to accrue, then the Note plus
Debtor puts forth several arguments why the bankruptcy court erred in determining the doctrine of recoupment applies in this case. Each of these arguments fails. First, Debtor argues that the bankruptcy court's decision violates the bankruptcy code's policy of providing debtors with a "fresh start." Debtor is correct that affording debtors with a fresh start is one purpose under the bankruptcy code. In re Stewart, 109 B.R. 998, 1006 (D.Kan. 1990). But as the bankruptcy court aptly explained:
(Doc. 5-18 at 22.) The court agrees that the "interest in a fresh start pales when compared with the Trustee's interest in carrying out the Grantor's intent to equalize the principal distributions to the beneficiaries upon termination of the Trust." (Id.)
Second, Debtor contends that the 1984 and 1985 Amendments and the Note are all distinct contracts entered into at different times, and thus cannot be part of the same transaction for recoupment purposes. Debtor's argument falls short. The 1984 Trust Amendment contains the Grantor's intention that his children share equally in the principal of the Trust and authorized the Trustee to consider transfers to children and/or loans in making unequal distributions to achieve this goal. The Note bears a direct relation to the farmhouse Debtor received from the Trust. Moreover, the 1985 Trust Amendment expressly discusses the $33,333.33 obligation on the Note, and the requirement that the obligation be paid one-half each to Steven and Elaine. Thus, the 1984 Trust Amendment, the Note, the transfer of the farmhouse, and the 1985 Trust Amendment are all integrated into a single, integrated transaction — administration of the Trust.
Debtor's argument is overly simplistic. Just as the court in Peterson Distributing
Third, Debtor argues that the transfer of the farmhouse to Debtor and his wife was not a "loan" and therefore the Trustee cannot consider the transfer of the farmhouse when making distributions to the beneficiaries. Article VI(C)(4) of the 1984 Amendment provides:
(Doc. 5-3 at 11-12 (emphasis added).) Debtor focuses on the sentence regarding "[a]ny loans made by Grantor ..." to support his contention. (See id. at 11.) However, the sentence immediately preceding that one allows the Trustee to "consider all transfers to the Grantor's children that have been made by the Grantor and his wife by Will or otherwise." (Id.) The bankruptcy court correctly dismissed Debtor's argument, noting that the Trustee need not rely on the provision regarding "loans" and can instead "consider all transfers." (Doc. 5-18 at 16.) The Trust's conveyance of real property to Debtor and his wife on credit was a transfer and the Trustee properly considered it in exercising its discretionary authority to make unequal distributions. Debtor's reliance on the "loans" provision is misplaced.
Fourth, Debtor argues that even if the conveyance of the farmhouse was a transfer, the farmhouse was conveyed only to Debtor's spouse, Rose Ann, and not to Debtor, and thus was improperly considered by the Trustee. It is undisputed that the deed conveys the property only to Rose Ann Lunt. However, it is also undisputed that both Debtor and his wife executed the Note, and both signed the contract for purchase of the home from the Trust. How the deed was titled is not important; substance prevails over form. Debtor derived significant value from the transfer, as he has lived in the house for almost thirty years. And in signing the Note, Debtor acknowledged that he received value for the transfer of the farmhouse. As Steven and Elaine point out, "the farmhouse distributed to Debtor in exchange for the promissory note came from the Trust." (Doc. 12 at 14.) The Trustee properly considered the transfer of the farmhouse to Debtor and his wife, regardless of how the deed is titled. Debtor's argument fails.
As is stated several times throughout this opinion, one of the main purposes of the Trust was to treat the Lunt children equally. The Trustee properly exercised his discretion in distributing unequal income distributions in order to fulfill the Grantor's intent. The Trustee's actions complied with the statute cited by Debtor, which also requires a trustee to act "in accordance with the terms and purposes of the trust and the interests of the beneficiaries." K.S.A. § 58a-814. And because the doctrine of recoupment applies as set out above, there was no "improper setoff" or attempt to collect the debt. Debtor points to no evidence that the Trustee failed to act in good faith, and the court cannot find that the Trustee's actions were taken for any other purpose than to carry out the Grantor's intent. This argument fails.
After careful review, the court affirms that the bankruptcy court's well-reasoned decision. The bankruptcy court correctly determined that the discharge injunction did not extinguish the underlying debt on the Note, and that the doctrine of recoupment applied. Careful consideration of the facts and the equities of this case support that finding. The 1984 and 1985 Trust Amendments, the Note, and the transfer of the farmhouse all are part of a single, integrated transaction — administration of the Trust. The Trust documents and Kansas law support the Trustee's actions in applying Debtor's income distribution to his obligation on the Note. And carrying out the Grantor's intent — to treat the Lunt siblings equally — was also achieved by the Trustee's actions. For the reasons above, the bankruptcy court's order granting the motion for summary judgment by intervenors Steven and Elaine and denying Debtor's motion for summary judgment is affirmed.