Feltman v. Noor Staffing Group, LLC et al

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
In re:
Corporate Resource Services, Inc., et al.,
Debtors.
FOR PUBLICATION
Case No. 15-12329 (MG)
(Jointly Administered)
James S. Feltman, not individually but solely
in his capacity as Chapter 11 Trustee of the
Estate of Corporate Resource Services, Inc.,
et al,
Plaintiff,
v.
Noor Staffing Group, LLC, et al.,
Defendants.
Adv. Pro. Case No. 16-01037 (MG)
MEMORANDUM OPINION AND ORDER STRIKING DEFENDANTS’
DEFENSE UNDER BANKRUPTCY CODE § 553
A P P E A R A N C E S:
TOGUT, SEGAL & SEGAL LLP
Attorneys to James S. Feltman, not individually
but solely in his capacity as Chapter 11 Trustee of Corporate Resource
Services, Inc., et al.
One Penn Plaza, Suite 3335
New York, New York 10119
By: 	Steven S. Flores, Esq.
Lauren L. Peacock, Esq.
Minta J. Nester, Esq.
GRIFFIN HAMERSKY LLP
Attorneys for Noor Staffing Group, LLC and Noor Associates, Inc.
420 Lexington Avenue, Suite 400
New York, New York 10170
By: 	Scott A. Griffin, Esq.
Michael D. Hamersky, Esq.
David M. Smith, Esq.
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MARTIN GLENN
UNITED STATES BANKRUPTCY JUDGE
The issue before the Court is whether the defendants may assert a right of setoff under
Bankruptcy Code section 553 for admittedly contingent claims. The defendants assert setoff as a
defense in this adversary proceeding; they also assert a right to set off against any judgment
entered against them in this adversary proceeding the amount of any of their contingent claims
allowed in the claims allowance process. The parties have fully briefed the issue1 and both sides
now urge the Court to resolve it since it may substantially affect the course of this case. For the
reasons explained below, the Court grants the plaintiff’s motion to strike the setoff defense and
to disallow the claim to the extent it seeks setoff for contingent claims. The defendants’ proof of
claim for contingent general unsecured claims survives, at least for now, subject to a subsequent
claim objection.
I. 	BACKGROUND
James S. Feltman, as chapter 11 trustee (the “Trustee”) of the debtors,2 including Corporate
Resource Services, Inc. (“CRS”), has moved to strike the setoff defense of defendants Noor Staffing
Group, LLC and Noor Associates, Inc. (together with Noor Staffing Group, LLC, “Noor”) and
the separately filed setoff proof of claim. The Trustee argues that setoff fails as a matter of law to
1 	See Trustee’s Memorandum of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553
of the Bankruptcy Code (ECF Doc. # 80); Declaration of Minta J. Nester, Esq. in Support of Trustee’s Memorandum
of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553 of the Bankruptcy Code (ECF Doc. #
81); Noor Staffing Group, LLC and Noor Associates, Inc.’s Memorandum of Points and Authorites in Support of
Right to Setoff Claims Against Debtor Pursuant to Section 553 of the Bankruptcy Code (ECF Doc. # 82);
Declaration of Michael D. Hamersky in Support of Noor Staffing Group, LLC and Noor Associates, Inc.’s
Memorandum of Points and Authorities in Support of Right to Setoff Claims Against Debtor Pursuant to Section 553
of the Bankrutpcy Code (ECF Doc. # 83).
2 	The debtors in these chapter 11 cases are: (1) Corporate Resource Services, Inc.; (2) Accountabilities, Inc.;
(3) Corporate Resource Development Inc.; (4) Diamond Staffing Services, Inc.; (5) Insurance Overload Services,
Inc.; (6) Integrated Consulting Services, Inc.; (7) The CRS Group, Inc.; and (8) TS Staffing Services, Inc.
(collectively, the “Debtors”).
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the extent that Noor seeks to set off contingent claims. The issue is important to Noor and to
other unsecured creditors because to the extent Noor may set off its claims against CRS’s claims,
Noor receives a dollar-for-dollar reduction of any liability it is determined to have to CRS. 3 The
effect of setoff is to elevate an otherwise unsecured claim—unlikely to receive a substantial
recovery in the cases of these hopelessly insolvent debtors—to secured claim status, further
diminishing the recoveries of any other general unsecured creditors.
The Trustee’s claims against Noor, asserted in the adversary complaint, and Noor’s
defenses, arise out of CRS’s sale to Noor of substantially all of CRS’s assets (the “Purchased
Assets”) that closed on February 27, 2015. The sale was pursuant to an Asset Purchase
Agreement (the “APA”) governed by New York law. 4 Noor agreed to a purchase price (the
“Purchase Price”) of: (i) $1,000,000 reduced by CRS’s $95,761.07 real estate tax liability; (ii)
80% of the acquired accounts receivable; (iii) $2,000,000 in 40 equal monthly cash installments
beginning in July 2015; and (iv) $500,000 minus a purchase price reduction of up to
$360,000, payable on November 1, 2018. To date, Noor contends that it has paid CRS an
aggregate of approximately $7,250,000 in connection with the Purchase Price. The adversary
complaint alleges that Noor has failed to pay substantial amounts due to CRS under the APA. It
also alleges that Noor has collected, diverted to itself, and refused to turn over to the Trustee,
certain account receivables not sold to Noor, which therefore remain property of the estates. The
3 	Noor’s defense that a material breach of the contract by CRS partially or wholly excuses Noor’s
performance in failing to pay remaining amounts due under the APA is unaffected by the results of this decision.
Noor Staffing, LLC’s and Noor Associates, Inc.’s Amended Answer and Counterclaims ¶ 59 (ECF Doc. # 52). See
RESTATEMENT (S ECOND ) OF C ONTRACTS § 237 (1981) (“Except as stated in § 240, it is a condition of each party’s
remaining duties to render performances to be exchanged under an exchange of promises that there be no uncured
material failure by the other party to render any such performance due at an earlier time.”).
4 	The parties do not dispute that, to the extent state law governs, New York law governs.
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Trustee contends that Noor’s self-help in collecting and holding CRS’s property—purportedly as
a setoff—violates the automatic stay.
On July 23, 2015, CRS and certain of its affiliated Debtors commenced cases under
chapter 11 of the Bankruptcy Code. On September 22, 2015, James S. Feltman was appointed
as the Trustee for the Debtors. Some of the facts surrounding the filing are unclear, but it is
undisputed that the Debtors collected from their customers amounts due to governmental tax
collectors for employee tax withholding. Further, it is undisputed that CRS failed to pay to the
IRS and state tax authorities well over $100 million of employee withholding taxes. Almost
certainly, CRS is hopelessly insolvent, but whoever may be liable for these unpaid taxes has still
not been determined. Obviously, as successor to substantially all of CRS’s assets, Noor is
concerned that claims for unpaid taxes (or other amounts) may be asserted against it, but this has
not happened so far.
On March 4, 2016, the Trustee commenced this adversary proceeding against Noor,
alleging, among other causes of action, turnover, breach of contract, and avoidance of the sale
of the Purchased Assets as a constructive fraudulent transfer under section 548 of the
Bankruptcy Code (the “Complaint”). On August 19, 2016, Noor filed its amended answer to the
Complaint.
On September 2, 2016, the Trustee filed the Motion to Dismiss Noor’s Amended
Counterclaims and Strike Noor’s Affirmative Defenses and Recanted Admissions (the “Motion
to Dismiss,” ECF Doc. # 60.) Noor opposed the Motion to Dismiss. At a subsequent hearing on
October 13, 2016, the Court, inter alia: (i) found that Noor’s breach of contract and
misrepresentation claims had to be asserted in a proof of claim; (ii) denied the Trustee’s
motion to dismiss Noor’s unclean hands and in pari delicto defenses; and (iii) reserved ruling
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on Noor’s setoff and collateral source defenses. That same day, Noor filed its proof of claim
asserting, among other things, breach of contract, fraudulent inducement, and misrepresentation
against CRS. Noor’s Proof of Claim seeks: (i) $135,419.56 in fixed damages (the “Fixed
Claims”); (ii) $8,478,516.16 in contingent damages (the “Contingent Claims”); and (iii)
unliquidated damages in a yet to be determined amount.
Noor’s amended proof of claim, filed on December 23, 2016, contends that Noor is
entitled to recover approximately $8.4 million in “Contingent Liability Damages.” Noor
categorizes potential damages that Noor believes may be incurred in the future to government entities
or customers, none of which have even been asserted so far. These categories are:
(i) 	CRS’s Pre-Transaction U.S. Immigration Law Violations;
(ii) 	CRS’s Pre-Transaction New York State Labor Law Violations;
(iii) 	CRS’s Pre-Transaction Violations of DOE Contract and Medicaid Regulations;
and
(iv) 	CRS’s Pre-Transaction Federal and State Tax Liabilities
The focus of the Trustee’s current motion is on the Contingent Claims. As explained
below, New York law does not permit setoff of contingent claims; Noor does not dispute this
legal rule. The dispute here is whether applicable bankruptcy law creates a party’s right to set
off contingent claims, independent of New York law. Put another way, the issue is whether
anything in the Bankruptcy Code creates a right of setoff not available under state law.5 Noor
says yes; the Trustee says no. As explained below, the Court concludes that the Trustee is
correct and that Section 553 of the Bankruptcy Code merely preserves the right of setoff.
The Trustee also argues that even if setoff of contingent claims is permissible, Noor
cannot meet the additional requirements of section 553. The Trustee argues that:
5 	Noor does not contend that any other nonbankruptcy federal law creates a right to setoff applicable in this
adversary proceeding.
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even if there was a preexisting right to setoff under New York law
for 	contingent 	claims 	(there 	is 	not), 	Noor 	cannot 	meet 	the
additional requirements of § 553. Although bankruptcy law allows
contingent claims generally, a claim for setoff of a prepetition
debt—which allows a dollar for dollar recovery—only arises when
all transactions upon which the liability is premised occurred
before the petition date. 	Here, the transactions necessary to
establish liability still have not come to pass18 months after the
petition date and two years after the Transaction closed.”
(Trustee’s Memorandum of Law at 3 (emphasis in original).)
The starting point for the analysis is whether New York law permits setoff of
contingent claims; it does not. The analysis then shifts to whether the Bankruptcy Code
creates a right to set off contingent claims; it does not.
II. 	DISCUSSION
A. 	New York Law Does Not Allow Setoff of Contingent Claims
Section 151 of the New York Debtor and Creditor Law (“DCL”) codifies New York’s
equitable and common law right to setoff. It provides that a debtor has the right “to setoff and
apply against any indebtedness, whether matured or unmatured” any amount owing from the
debtor to the creditor. N.Y. Debt. & Cred. Law § 151; see Thai Lao Lignite (Thailand) Co. v.
Gov’t of the Lao People’s Democratic Republic, 2016 WL 958640, at *2–3 (S.D.N.Y. Mar. 8,
2016) (discussing section 151 of the DCL and its broad applicability). Neither section 151 of the
DCL nor its equitable roots allow setoff of contingent claims. See, e.g., Dunn v. Uvalde Asphalt
Paving Co., 175 N.Y. 214, 219 (1903) (holding that “there can be no such thing as a right to
setoff a possible but unestablished liability, unliquidated in amount, against a liquidated legal
claim that is due and payable”); Thai Lao, 2016 WL 958640, at *3 n.3 (“Both New York state
courts and courts in this Circuit are in agreement that DCL § 151 does not authorize the setoff of
a contingent obligation.”); Scherling v. Hellman Elec. Corp. (In re Westchester Structures, Inc.),
181 B.R. 730, 740 (Bankr. S.D.N.Y. 1995) (“[Under section 151 of the DCL,] the debts to be
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offset can be matured or unmatured but they cannot be contingent.”) (internal citation omitted).
A claim is contingent and ineligible to be set off under New York law when it is dependent on
some future event that may never happen or has not yet accrued. See, e.g., Trojan Hardware Co.
v. Bonarquisti Constr. Corp., 141 A.D.2d 278, 282 (3d Dep’t 2010) (“We do not believe that the
term indebtedness in [DCL] § 151 should be expanded to encompass such a contingent
situation.”); Spodek v. Park Prop. Dev. Assocs., 263 A.D.2d 478, 478–79 (2d Dep’t 1999)
(“[T]here is no right to setoff a possible, unliquidated liability against a liquidated claim that is
due and payable.”) (internal citations omitted); see also Westchester, 181 B.R. at 740 (“A
contingent liability, however, is measured by uncertainty as to whether any obligation will ever
arise.”) (internal citation omitted).
Even when a lawsuit has been filed, claims that are not finally adjudicated are contingent.
See Cytec Indus., Inc. v. Allnex (Luxembourg) & Cy S.C.A., 2015 WL 3762592, at *13 (S.D.N.Y.
May 15, 2015) (“Courts have declined to permit offsets directed toward damages in a pending
litigat io n.”); see, e.g., Hack v. Stang, 2015 WL 5139128, at *5 (S.D.N.Y. Sept. 1, 2015) (finding
that creditor’s pending litigation “in New Jersey is, at best, a potential unliquidated liability that,
as a matter of law, may not be used as a setoff”) (internal citation omitted); Correspondent Servs.
Corp. v. J.V.W. Inv. Ltd., 524 F. Supp. 2d 412, 424 (S.D.N.Y. 2007) (holding that a defendant
“has no right to setoff its pending disputed and unliquidated claim against [a plaintiff’s] present
entitlement to damages owed”). Similarly, debts that are incurred but cannot be calculated until
after the petition date are also contingent. See, e.g., Willett v. Lincolnshire Mgmt, 302 A.D.2d
271, 271 (1st Dep’t 2003) (affirming dismissal of setoff affirmative defense where obligation was
currently being disputed).
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Noor does not dispute that the bulk of its claims have not yet accrued and are dependent
on future events that may never occur. In other words, Noor concedes the vast majority of its
claims are contingent. See, e.g., Declaration of Minta J. Nester, Esq. in Support of Trustee’s
Memorandum of Law on Invalidity of Noor’s Setoff Defense and Claims Under Section 553 of
the Bankruptcy Code (ECF Doc. # 81), Ex. E (Claim at ¶¶ 13, 15(a)–(d), 16(c)) (describing six
categories of “Contingent Liability Damages” that total approximately $8.4 million); Ex. F
(Jacobson Report at ¶¶ 8, 30(b), 33–37) (discussing Noor’s “Contingent Liabilities Damages”
which “represent claims by Noor against the Plaintiffs [sic] related to liabilities that have not
been incurred by Noor through the writing of this report, but might be incurred in the future”)
(emphasis added). There is uncertainty whether liability will ever arise—no fines have been
levied; no court has found Noor responsible for CRS’s alleged wrongdoing before the sale
closed; and Noor has not paid any money to resolve any “contingent” liabilities.
B. 	The Bankruptcy Code Does Not Create a Right to Setoff
The Supreme Court has definitively resolved that the Bankruptcy Code does not create a
right of setoff; section 553, with certain exceptions not relevant here, preserves a right to setoff
created by state law or federal nonbankruptcy law. As the Supreme Court has stated:
The right of setoff (also called ‘offset’) allows entities that owe
each other money to apply their mutual debts against each other,
thereby avoiding “the absurdity of making A pay B when B owes
A.” 	Although 	no 	federal 	right 	of 	setoff 	is 	created 	by 	the
Bankruptcy Code, 11 U.S.C. § 553(a) provides that, with certain
exceptions, whatever right of setoff otherwise exists is preserved in
bankruptcy.
Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18 (1995) (citation omitted).
Strumpf involved a chapter 13 bankruptcy case. The debtor was in default on a loan from
the bank, and the bank’s account agreement expressly provided the bank with the right of setoff.
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Before the debtor filed the bankruptcy case,6 the bank froze the debtor’s checking account. After
the bankruptcy filing, the bank refused to unfreeze the account and turn over the funds in the
account to the debtor. The bank filed a motion for relief from stay under section 362(d); the
debtor countered with a motion to hold the bank in contempt for violating the automatic stay.
The automatic stay under section 362(a)(7) of the Bankruptcy Code bars a creditor from taking
various actions, including “the setoff of any debt owing to the debtor that arose before the
commencement of the case against any claim against the debtor.” 11 U.S.C. § 362(a)(7). The
bankruptcy court found that the account freeze violated the automatic stay and sanctioned the
bank. Several weeks later, the bankruptcy court granted the bank’s motion to lift the stay to
permit the setoff. See Strumpf, 516 U.S. at 17–18.
After stating the rule that there is no federal right to setoff under the Bankruptcy Code,
the Court went on to conclude that “the question whether a setoff under § 362(a)(7) has occurred
is a matter of federal law . . . .” Id. at 19 (emphasis in original). But the right to setoff was
determined by nonbankruptcy law. The Court discussed the interplay between sections
362(a)(7), 542(a) and (b), and 553.
Section 542(b) of the Code, which concerns turnover of property to
the estate, requires a bankrupt’s debtors to “pay” to the trustee (or
on his order) any “debt that is property of the estate and that is
matured, payable on demand, or payable on order . . . except to the
6 	Noor did not assert a right of setoff until after the petition was filed. “In the setoff context, timing may be
of critical importance in determining the creditor's right, for example, in determining whether the creditor's debt to
the debtor is pre- or postpetition in nature. As a general rule, checks deposited into the debtor's bank account are not
subject to setoff until they have ‘cleared.’ Thus, if a debtor deposits funds into his or her account the day before the
commencement of the case, but the funds do not clear until the day after, the bank's debt may be postpetition in
nature and therefore not subject to setoff against the bank's prepetition claim. In general, the burden of proof rests
on the creditor asserting the right of setoff to establish the relevant timing issues. Similarly, timing may be highly
relevant with respect to any alleged violation of the automatic stay. A setoff that occurred three hours before the
debtor's filing of the bankruptcy petition was determined to be a prepetition setoff and therefore not subject to the
stay. In addition, timing may be relevant under the avoidance provisions of section 553(b).” 5 COLLIER ON
BANKRUPTCY ¶ 553.05 (16th ed. rev. 2016). This Court need not address whether Noor properly timed its right of
setoff, because, no such right ever existed.
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extent that such debt may be offset under section 553 of this title
against a claim against the debtor.” 11 U.S.C. § 542(b) (emphasis
added). 	Section 553(a), in turn, sets forth a general rule, with
certain exceptions, that any right of setoff that a creditor possessed
prior to the debtor’s filing for bankruptcy is not affected by the
Bankruptcy Code. It would be an odd construction of § 362(a)(7)
that required a creditor with a right of setoff to do immediately that
which § 542(b) specifically excuses it from doing as a general
matter: pay a claim to which a defense of setoff applies.
Id. at 20 (emphasis in original); see also United States v. Whiting Pools, Inc., 462 U.S. 198, 206–
07 (1983) (“In effect, § 542(a) grants to the estate a possessory interest in certain property of the
debtor that was not held by the debtor at the commencement of the reorganization
proceedings.”).7
Strumpf is not alone in stating this very clear rule that the Bankruptcy Code does not
create a right of setoff. See In re Bennett Funding Grp., Inc., 146 F.3d 136, 138–39 (2d Cir.
1998) (“Section 553(a) of Title 11 of the United States Code does not create a right of setoff, but
rather preserves whatever right exists under applicable non-bankruptcy law.”) (footnote omitted);
Bank of Am. v. Lehman Bros. Holdings Inc. (In re Lehman Bros. Holdings Inc.) (Lehman I), 439
B.R. 811, 823 (Bankr. S.D.N.Y. 2010) (“Section 553 of the Bankruptcy Code does not provide
for an independent right of setoff[.]”); In re Delta Air Lines, 341 B.R. 439, 443 (Bankr. S.D.N.Y.
2006) (“Section 553 does not create a federal right of setoff, nor does it enhance, diminish or
otherwise modify any state law right of setoff.”); In re McLean Indus., Inc., 90 B.R. 614, 618
(Bankr. S.D.N.Y. 1988) (“Section 553 is, however, not an independent source of a right to setoff;
rather, it recognizes and preserves, but does not define, the common law right of setoff under
nonbankruptcy law. A creditor seeking to setoff a debt under Title 11, therefore, must establish a
claim and a right to setoff by applying the law of the state where the operative facts occurred . . .
7 	A creditor with a right to setoff is entitled to adequate protection before it turns over funds it holds that are
subject to setoff.
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. Section 553, moreover, does not expand nonbankruptcy rights and clearly provides that the
automatic stay provisions of section 362 limit post-petition setoff rights, requiring creditors to
obtain court permission before taking any action against the property of the estate.”) (internal
citations omitted).
In order to establish a right to setoff under section 553, a creditor must first demonstrate a
preexisting right of setoff under nonbankruptcy or state law. 8 See In re WL Homes LLC, 471
B.R. 349, 352 (Bankr. D. Del. 2012) (stating that creditor must “first establish its right to setoff
by finding an independent right of setoff under non-bankruptcy law”); Charles Russell, LLP v.
HSBC Bank USA, N.A. (In re Awal Bank, BSC), 455 B.R. 73, 87 (Bankr. S.D.N.Y. 2011)
(“[Section] 553 requires the court to analyze the applicable nonbankruptcy law before dealing
with a set-off[.]”); Lehman I, 439 B.R. at 823 (noting that section 553 incorporates any
preexisting setoff right that may exist under state law); see also 5 COLLIER ON BANKRUPTCY ¶
553.04 (16th ed. rev. 2013) (“Section 553 of the Bankruptcy Code does not create any setoff
right; it merely preserves certain rights of setoff that exist under nonbankruptcy law.”) (emphasis
added) (footnote omitted).
The creditor asserting the right to setoff has the burden to establish that the right to setoff
exists. See Geron v. Schulman (In re Manshul Contsr. Corp.), 2000 WL 1228866, at *56
(S.D.N.Y. Aug. 30, 2000); McLean Indus., Inc., 90 B.R. at 618 (“The burden of proof, moreover,
squarely rests with [the creditor] in demonstrating its entitlement to setoff in light of the facts of
this case.”) (citing Pester Refining Co. v. Mapco Gas Prods., Inc., 845 F.2d 1476, 1486 (8th Cir.
1988) (stating that burden is on creditors to establish valid rights of setoff)). See also Glob.
8 	“Federal rights of setoff exist principally to provide the government, as a creditor, with the ability to offset
mutual debts owing between the government and others.” 5 COLLIER ON B ANKRUPTCY ¶ 553.04[3] (Alan N.
Resnick & Henry J. Sommer eds., 16th ed. rev. 2016).
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Cable, Inc. v. Adelphia Commc’ns Corp. (In re Adelphia Commc’ns Corp.), 2006 WL 1559437,
at *4 (S.D.N.Y. June 7, 2006).
As already explained, New York law does not recognize a right of setoff for contingent
claims. Section 542(b) of the Code requires Noor to turn over CRS’s property to the Trustee.
Section 553 provides no exception to this requirement in the absence of a nonbankruptcy law
right of setoff. To permit Noor to retain CRS’s property and to claim a right to setoff when no
such right arises from New York law would have the effect of elevating its unsecured claim (if
any) to secured status. See 11 U.S.C. § 506(a)(1) (“An allowed claim of a creditor . . . that is
subject to setoff under section 553 of this title, is a secured claim to the extent of . . . the amount
subject to setoff . . . .”); 4 COLLIER ON BANKRUPTCY ¶ 506.03[1][b] (16th ed. rev. 2009) (“In
general, section 506(a) provides that the existence of a right of setoff under nonbankruptcy law
establishes the existence of a secured claim for purposes of the section if the setoff right under
nonbankruptcy law is preserved in section 553 of the Code.”).
Noor improperly relies on McCollum v. Hamilton National Bank of Chattanooga, 303
U.S. 245 (1938), for the proposition that there is a federal right of setoff. The Court in
McCollum, interpreting the old Bankruptcy Act and 12 U.S.C. § 85, had to determine whether
there was a right of setoff for a penalty imposed on a bank by a federal statute for knowingly
receiving illegal interest. After the bank’s borrower filed a bankruptcy case, the debtor’s trustee
brought an action in state court against the bank to recover the penalty. The bank sought to set
off the penalty against the debtor’s debt to the bank. The state supreme court held that setoff was
permissible under section 68a of the Chandler Act of 1938. The Supreme Court reversed,
addressing the “question whether [the bank] is entitled to have the amount of the judgment for
penalty credited on its claim against the bankrupt estate.” Id. at 247. The Court determined that
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setoff of the liability created by the federal penalty statute depended on the right to setoff under
section 68a, which provided that, “[i]n 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 setoff against
the other, and the balance only shall be allowed or paid.” Id. at 248. Because liability for the
penalty “is laid in invitum as a disciplinary measure . . . , [it] may be enforced only in a suit
brought exclusively for that purpose . . . [and] the payment of any debt owed by the plaintiff to
the bank may not be held a condition precedent to the determination of that issue.” Id. at 249.
Therefore, setoff could not apply. Nothing in McCollum suggests that there was a federal right
of setoff; rather, whatever state law may have provided, the bank’s liability under the federal
penalty statute was not a mutual debt that was subject to setoff.
Furthermore, the language of section 68a was changed when the Bankruptcy Code was
adopted. Section 553(a) now provides that:
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— . . . .
11 U.S.C. § 553(a). The Supreme Court in Strumpf read the language of this section together
with other sections of the Bankruptcy Code. It found no ambiguity—the Bankruptcy Code does
not create a federal right to setoff.
Noor also relies on In re Chestnut Co., Inc., 39 B.R. 519 (Bankr. D.S.C. 1984), decided
11 years before the Supreme Court’s decision in Strumpf. The court stated that “[the] right of
setoff does not depend upon local or state law, but upon the terms of § 553 of the Bankruptcy
Code.” Id. at 521. The right to apply setoff in bankruptcy most certainly depends on bankruptcy
law—section 553 preserves the right to setoff available under applicable nonbankruptcy law, but
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section 553 adds three conditions in subsections 553(a)(1), (2) and (3) to applying setoff in
bankruptcy. The court in Chestnut went on to say that “[h]owever, the nature, existence, and
enforceability of claims sought to be set off are to be determined by applying the law of the state
where the operative facts occurred.” Id. at 521. So long as that statement is understood to mean
that applicable state law determines whether state law permits setoff of the particular state law
claim, the statement is unremarkable. If the court intended something more—for example,
Noor’s argument that the Bankruptcy Code creates a federal right to set off any claim
enforceable under state law (even if state law would not permit setoff of the claim)—such a
ruling cannot be reconciled with the Supreme Court’s later decision in Strumpf.
Noor also relies on Elsinore Shore Assocs. v. First Fidelity Bank, 67 B.R. 926 (Bankr.
D.N.J. 1986), another decision that precedes Strumpf. The relevant language in Elsinore states
that “Courts may look to state law in order to determine whether a setoff has occurred . . . ,
however, the granting or denial of the right to a setoff depends wholly upon the terms of § 553,
and not upon the terms of state laws or statutes.” Id. at 942 (emphasis added). Noor selectively
omits a part of the sentence—the italicized words “granting or denial of the right to a . . . ”—
which, if read in its entirety, no longer supports Noor’s assertion. Granting or denial of setoff is
up to the judge’s discretion, but the setoff right must exist beforehand (i.e., allowed by state law
or nonbankruptcy law, and hence preserved in bankruptcy by section 553). If there is no right of
setoff under nonbankruptcy law, there is nothing for the judge to grant or deny.
Finally, Noor relies on In re Comm’n Dynamics, Inc., 382 B.R. 219, 232 (Bankr. D. Del.
2008), a case that is distinguishable from this case. The issue in Communication Dynamics was
whether a rejection damages claims should be considered a prepetition claim or a post-petition
claim. In order to be eligible for setoff, it was necessary to construe the claim as prepetition. Id.
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at 231–32. The court held that “for purposes of section 553, a rejection damages claim is a pre-
petition claim subject to setoff against any pre-petition debt owed by the creditor to the debtor.” 9
Id. at 232. That holding, of course, does not conflict with Strumpf.
Communication Dynamics does provide some support for the premise of Noor’s
argument—namely, the court appears to accept the argument that section 553 is ambiguous and
should not be read as preventing setoff of a claim arising under another section of the
Bankruptcy Code—in that case, under section 365(g) for rejection damages. The supposed
ambiguity is that section 553 speaks only of not affecting a right to setoff—“this title does not
affect any right of a creditor to offset a mutual debt . . . that arose before the commencement of
the case,” 11 U.S.C. § 553(a)—without identifying the sources for setoff rights.
Communication Dynamics did not hold that there is a federal right to set off contingent
state law claims, as Noor urges. The court cited an article that proposed that contingent claims
should be entitled to setoff regardless of state law because of what it perceived as an ambiguity
in section 553 of the Bankruptcy Code. See id. at 232; Daniel W. Linna, Jr., Contract Rejection
Damages May Not Be Eligible For Setoff After All, Says Delta Court, AM . BANKR. I NST . J., Sept.
25, 2006, at 53. The premise of the argument that setoff of contingent claims is permissible is
that section 101(5) of the Bankruptcy Code defines “claim” broadly to include a “right to
payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed,
contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured . . .
.” 11 U.S.C. § 101(5)(A) (emphasis added). Why, then, in light of the broad definition in
section 101(5), should contingent claims be excluded from setoff, even if state law does not
9 	But see In re Delta Air Lines, Inc., 341 B.R. 439, 448 (Bankr. S.D.N.Y. 2006) (concluding that rejection
damages claims are not prepetition claims for purposes of setoff). The Delaware court in Communication
Dynamics, in reaching the opposite result, declined to follow the New York Delta court.
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permit setoff? The answer here is that while Noor may have a claim against CRS under section
101(5), it does not mean that such a claim entitles Noor to setoff under section 553 where state
law would not permit setoff. Section 553 does not extend the right to setoff to any “claim”
falling within the definition in section 101(5).
Communication Dynamics does not discuss Strumpf or the numerous other cases that
make clear that setoff is only available to the extent that the right of setoff is available under
nonbankruptcy law. Sections 101(5) and 553 should not be read together to create a federal right
of setoff for contingent state law claims, unless setoff of such contingent claims is permissible
under applicable nonbankruptcy law. As already explained, the effect of doing so would be to
elevate unsecured claims to secured status to the disadvantage of all other unsecured creditors, a
result contrary to the Code’s policy promoting a distribution to unsecured creditors in pari passu.
Absent a clear indication that Congress intended that result, the Court cannot read the Code as
commanding a result that Strumpf and the many cases that follow it reject. As explained below,
the broad language of section 101(5) does mean that Noor’s contingent claim should not be
disallowed at this stage of the case (other than to deny the ability to set off the claim).
C. 	Noor Has Not Satisfied the Other Requirements of Section 553
1. 	Section 553 Requires Finality
After a creditor has established a right to setoff under applicable state law, the creditor
must then make an additional showing that mutual debts “arose before the commencement of
the [bankruptcy] case[.]” 11 U.S.C. § 553; see also Lehman I, 439 B.R. at 823.
“[F]or setoff purposes [under section 553], a claim—even a contingent one—arises
when ‘all transactions necessary for liability occur.’” WL Homes LLC, 471 B.R. at 352) (citing
United States v. Gerth, 991 F.2d 1428, 1433 (8th Cir. 1993)); In re Lehman Bros. Holdings Inc.
(Lehman II), 404 B.R. 752, 759–60 (Bankr. S.D.N.Y. 2009) (finding all transactions giving rise
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to liability had not arisen before the filing of the bankruptcy petition in disallowing setoff under
section 553); see also Adelphia, 2006 WL 1559437, at *4 (“The Bankruptcy Court’s denial of
setoff was based in part on the disputed and indefinite nature of the liability from the debtor to
the creditor. . . . Because it was Global’s [the party asserting setoff] burden to prove a
symmetry or reciprocity of obligation in order to meet the mutuality requirement for setoff . . .
Global has not satisfied this requirement for establishing a right to setoff under Section
553(a).”). Setoff “is permitted when, at the time the bankruptcy petition is filed, the debt is
absolutely owing but is not presently due, or when a definite liability has accrued but is not yet
liquidated.” In re Young, 144 B.R. 45, 46–47 (Bankr. N.D. Tex. 1992) (emphasis added)
(concluding that setoff was not permitted where the liability did not arise until a postpetition act
by Congress); see also Delta, 341 B.R. at 450 (finding that contractual “[c]redits are a function
of a calculation that cannot be made before the close of the [fiscal year] and therefore [a claim
to set them off] cannot exist or ‘arise’ before close of the [fiscal year].”); Trace, 284 B.R. at
38–40 (finding unmatured nature of the creditor’s claim was not fully owing and therefore
could not be used for setoff under section 553).
2. 	Noor’s Claim Does Not Relate Back to the Signing of the APA
Noor argues that the violation of the APA relates back to the time of its execution, and,
therefore, its claim arose before the commencement of these cases and is therefore eligible for
setoff. The law does not support this argument. As the Trustee correctly argues, to effectuate
setoff, Noor must show that “all transactions necessary for liability [have] occur[ed].” See
Lehman II, 404 B.R. at 759; WL Homes, 471 B.R. at 352. Only Noor’s alleged Fixed Claims
can meet this test.
Noor’s reliance on Communications Dynamics in support of its relation-back argument is
misplaced. The debtor in that case rejected a contract, triggering a rejection damages claim
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under section 365(g). 382 B.R. at 233–34. Because the contract was rejected, there was no
issue whether the claim was contingent. 	Here, the events triggering liability have not, and may
not, take place.
D. Noor’s General Unsecured Claim Survives
The Trustee’s motion requests that Noor’s general unsecured claim should be disallowed
and expunged. Section 101(5)(A) includes within its permissible scope claims that are
“contingent.” Noor’s claim fairly falls into that category. See 2 COLLIER ON BANKRUPTCY ¶
101.05[1] (16th ed. rev. 2011) (“Neither the contingency of the debt nor the immaturity of the
obligation affects whether a right to payment is a claim.”) (collecting cases). The contingent claim
(whether asserted as a defense to the adversary proceeding or as a stand-alone claim as part of the
claims allowance process) may not be used to set off against the Trustee’s claims against Noor, but
Noor is entitled to proceed with its claim. The Trustee may object to the claim, and it may be
subject to estimation under section 502(c)(1), but it is premature for the Court to rule on those
issues. Given that these Debtors appear to be hopelessly insolvent, the likelihood of any substantial
recovery on unsecured claims is remote.
III. 	CONCLUSION
For the reasons explained above, Noor may not set off its contingent claims, either as a
defense in the adversary proceeding or as a claim against these estates. Therefore, the Trustee’s
motion to strike the setoff defense, and the related claim to the extent it seeks setoff for contingent
claims, is GRANTED.
IT IS SO ORDERED.
Dated: 	March 1, 2017
New York, New York
_____Martin Glenn____________
MARTIN GLENN
United States Bankruptcy Judge
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