                                                                                                                           Opinions of the United
1998 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


1-20-1998

In Re: Continental
Precedential or Non-Precedential:

Docket 97-7109




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Recommended Citation
"In Re: Continental" (1998). 1998 Decisions. Paper 15.
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Filed January 20, 1998

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

No. 97-7109

IN RE: CONTINENTAL AIRLINES,

       Debtor

UNITED STATES OF AMERICA,

       Appellant

v.

CONTINENTAL AIRLINES

       THOMAS E. ROSS,

       Trustee

An Appeal from the United States District Court
for the District of Delaware
Civil Action No. 93-cv-00485

Argued December 2, 1997

Before: COWEN, McKEE and ROSENN, Circuit Judges.

(Opinion Filed January 20, 1998)

       Robert M. Loeb (Argued)
       Room 3617 Main
       United States Department of Justice
       Civil Division, Appellate Staff
       10th & Pennsylvania Avenue, N.W.
       Washington, D.C. 20530-0001
       Counsel for Appellant
       Gordon B. Conn, Jr. (Argued)
       Laura D. Jones
       Robert S. Brady

       Young, Conaway, Stargatt & Taylor
       P.O. Box 391
       Rodney Square North, 11th Floor
       Wilmington, DE 19899-0391
       Counsel for Appellee

OPINION OF THE COURT

ROSENN, Circuit Judge.

This appeal presents an issue pertaining to the right of
set-off by a pre-bankruptcy creditor after a plan of
reorganization has been approved by the bankruptcy court.
Continental Airlines and its affiliates (Continental or
Debtors) filed petitions for reorganization under Chapter 11
of the Bankruptcy Code. In April, 1990, the Bankruptcy
Court confirmed the Debtors' Joint Plan of Reorganization.
In addition to ten federal government agencies that had
timely filed proofs of claim, the General Services
Administration of the United States (GSA or Government)
filed an amended proof of claim on May 25, 1993, after the
confirmation of the plan, and specifically asserted a right of
set-off for the first time. The Bankruptcy Court held that
the Government could not exercise set-off rights with
respect to $4.8 million due the Debtor and ordered it to pay
the sum to the Debtors. The Government appealed to the
United States District Court for the District of Delaware
which affirmed. The Government then timely appealed to
this court.1 We also affirm.
_________________________________________________________________

1. The bankruptcy court had jurisdiction over this matter pursuant to 28
U.S.C. S 157(b). The district court had jurisdiction to review the
bankruptcy court's decision pursuant to 28 U.S.C.S 158(a). This Court
has appellate jurisdiction of the district court's order pursuant to 28
U.S.C. S 1291.

                               2
I.

On December 3, 1990, Continental filed for Chapter 11
reorganization in the United States Bankruptcy Court for
the District of Delaware. Subsequently, each of ten agencies
of the United States Government filed separate proofs of
claim with the bankruptcy court for monies owed to them
by Continental, which in aggregate totaled approximately
$14.5 million. Continental submitted its revisedfinal
reorganization plan to the bankruptcy court on January 13,
1993. Although the court resolved several objections by the
various agencies to Continental's proposed plan, no
government agency sought to amend its proofs of claim to
assert any additional claims, including a right to set-off the
$4.8 million owed by GSA. Accordingly, the bankruptcy
court entered its order confirming the plan on April 16,
1993 without any objection from the Government.

Under the confirmed plan, the federal agencies were
treated as general unsecured creditors, and were entitled to
recover approximately 4.8% of their total claims. The
Government did not appeal the confirmation order.
Meanwhile, in August 1992, in a suit unrelated to
Continental's bankruptcy petition, the United States
District Court for the District of Columbia ordered GSA to
return money it had wrongfully withheld from several
airlines, including approximately $4.8 million withheld from
Continental.2 The Government sought a stay of the district
court's order in the United States Court of Appeals for the
Federal Circuit. On April 12, 1993, the Federal Circuit
issued an order denying the Government's request for a
stay, but instead permitted it to deposit the disputed sum
into the registry of the bankruptcy court while the
Government attempted to set-off the $4.8 million it owed
against the $14.5 million in claims due its agencies.

Subsequently, on May 28, 1993, the GSA filed a motion
with the bankruptcy court seeking to set-off its claim
against the funds deposited in the bankruptcy court's
registry. On September 30, 1993, the bankruptcy court
_________________________________________________________________

2. Alaska Airlines, Inc. v. Austin, 801 F. Supp. 760 (D. D.C. 1992). The
facts of Alaska Airlines, Inc. v. Austin are not relevant to the issues
raised on this appeal.

                               3
denied the Government's motion, ruling that the
Government could not exercise its set-off rights with
respect to the $4.8 million and ordered it to pay the money
to the Debtor. After the Government appealed, the District
Court for the District of Delaware affirmed the bankruptcy
court's ruling.

II.

This Court's review of a district court's disposition of a
bankruptcy appeal is plenary. The Court of Appeals
exercises "the same review of the district court's decision as
that exercised by the district court. The bankruptcy court's
findings of fact are reviewable only for clear error. Legal
determinations are subject to plenary review." In re
Continental Airlines, 125 F.3d 120, 128 (3d Cir. 1997)
(internal citations omitted); accord In re Engel, 124 F.3d
567, 571 (3d Cir. 1997).

The Government argues that the $4.8 million it deposited
into the registry of the bankruptcy court and which the
Government alleged it was entitled to set-off3 against the
$14.5 million owed by Continental were not "property of
the [bankruptcy] estate." The Government contends that
the bankruptcy court's confirmation of Continental's
reorganization plan did not extinguish its right of set-off
vis-a-vis the $4.8 million held in the court's registry.4 The
Government principally bases its argument on Citizens
Bank of Maryland v. Strumpf, 116 S. Ct. 286 (1995), which
it argues overrules this Court's holding in United States v.
_________________________________________________________________

3. 11 U.S.C. S 553 which governs set-offs does not define the term. The
right of set-off, as generally understood, simply means that "the debts of
two persons who are mutually indebted may be set off against each
other." Brian A. Blum, Bankruptcy and Debtor/Creditor S 22.2, at 348
(1993). "Its central premise is an ancient one well-grounded in practical
logic: If A is indebted to B, and B is likewise indebted to A, it makes
sense simply to apply one debt in satisfaction of the other rather than
require A and B to satisfy their mutual liabilities separately." 5 Collier
on
Bankruptcy P 553.01 (Lawrence P. King ed., 15th rev. ed. 1997).

4. For purposes of this discussion it is unnecessary to determine
whether the Government did have a valid right of set-off; thus, the right
will be assumed.

                               4
Norton, 717 F.2d 767 (3d Cir. 1983), heavily relied on by
the bankruptcy court and the district court.

Norton held that a creditor's withholding of funds subject
to a set-off violated the Bankruptcy Code's automatic stay
provision,5 and also adopted the viewpoint that set-off is
not permitted after confirmation of a bankruptcy plan of
reorganization. In Norton, under facts similar to those
presented on this appeal, this court held that the
Government could not offset an outstanding tax refund
against an outstanding tax liability after confirmation of the
debtor's plan. In their plan, as here, the debtors made no
provision for set-off. Emphasizing that the Government
never objected to the plan, we concluded that it would be
unreasonable for the Government to retain the tax refund
as security for the debtors' obligation. Instead, we require
the Government to pay over the refund and accept
treatment under the plan as an unsecured creditor.

The Government primarily contends that this case is
closely analogous to and governed by the recent decision of
the United States Supreme Court in Strumpf and thus is
not controlled by Norton. In Strumpf, the Supreme Court
merely held that a bank's pre-confirmation temporary
withholding of a debt that it owed a depositor who was in
bankruptcy, in order to protect its set-off rights, did not
violate the automatic stay. The Court explained that the
bank's "temporary refusal to pay was neither a taking of
possession of [the depositor/debtor's] property nor an
exercising of control over it, but merely a refusal to perform
its promise." Id. at 290. Norton, therefore, is only
overturned to the extent that it held that "state law . . .
determine[s] when a set-off has occurred." 717 F.2d at 772
(emphasis added). Today, under Strumpf,"the question
whether a set-off . . . has occurred is [now] a matter of
federal law;" a bank's temporary withholding of funds on
_________________________________________________________________

5. The automatic stay, 11 U.S.C. S 362(a), is "an injunction that arises
by
operation of law immediately upon the commencement of the bankruptcy
case. . . . Its effect is to impose a wide-ranging prohibition on all
activity
outside the bankruptcy forum to collect pre-petition debts from the
debtor or to assert or enforce claims against the debtor's pre-petition
property or estate property." Blum, Bankruptcy and Debtor/Creditor
S 16.1, at 231.

                               5
deposit subject to a set-off does not violate the automatic
stay. 116 S. Ct. at 289 (emphasis added). The
Government's position, in this case, mischaracterizes and
overemphasizes both the relevance and importance of
Strumpf. It reaches this conclusion by incorrectly arguing
that pursuant to Strumpf, because the $4.8 million was still
held in the registry of the court at the time Continental's
reorganization plan was confirmed, "the funds plainly were
not `property of the estate' at that time." Thus, the
Government's argument continues, when the court
confirmed the plan, the funds did not vest "free and clear"
in Continental as property of the bankruptcy estate.
Building on this premise, the Government concludes that
the April 16, 1993 confirmation of Continental's plan did
not extinguish GSA's right to set-off the $4.8 million owed
to Continental against its $14.5 million in claims due its
agencies.

As Continental points out, however, the Supreme Court
in Strumpf expressly refused to address the issue of the
effect of confirmation on set-offs, which is dispositive to the
resolution of this appeal. In a footnote in Strumpf, the
Supreme Court unequivocally "decline[d] to address [the]
contention . . . that the confirmation of [a bankruptcy
reorganization plan] preclude[s] [the] exercise of [a] set-off
right." 116 S. Ct. at 290 n.**. This case, therefore, is not
controlled by Strumpf because the Government here filed its
motion to exercise its alleged set-off in the bankruptcy
court almost six weeks after confirmation of Continental's
reorganization plan (and over nine months after the district
court held the Government liable to Continental for the
$4.8 million in the Alaska Airlines case).

Finally, the Government's contention that the Norton
court "incorrectly considered the funds held by the creditor
to be property of the estate" which led to its"erroneous
ruling that confirmation of the plan extinguishes a
creditor's set-off rights" is without merit. (citing 11 U.S.C.
SS 1141(b), 1327 and Norton, 717 at 774). The
Government's argument makes two critical mistakes and
thus misses the cumulative effect of the Norton and Strumpf
holdings. First, although Norton implicitly held that the
funds withheld by the creditor subject to set-off were

                               6
"property of the estate," today under Strumpf, the relevant
"property of the estate" is instead the bankrupt debtor's
claim to the funds as opposed to the possession of the
physical funds themselves.

Second, the relevant funds at issue in this case are
clearly distinguishable from those in both Norton and
Strumpf. In both of those cases, the creditor retained
possession of the funds; here the Government deposited the
$4.8 million into the registry of the court pending an
appeal. As this Court has noted, such deposits are
comparable to the res of a trust. The "court acts as trustee
and is charged with the duty of determining the
beneficiaries pursuant to the appeal. . . . [T]he
[Government] has no beneficial interest (in the deposit[ ])
[while the court] holds the money as . . . trustee for the
rightful owners when and if they are determined by the
court." Mid-Jersey Nat'l Bank v. Fidelity-Mortgage Investors,
518 F.2d 640, 643-44 (3d Cir. 1975). Thus, contrary to the
Government's assertion, its set-off rights in the funds did
not remain unaffected by confirmation of the plan because
the Government no longer retained an interest in them;
under Norton, its set-off right was extinguished by the
confirmation of the plan. Although the actual funds
themselves may not have passed as property of the estate,
upon confirmation of the plan, Continental did acquire a
claim or interest in them subject only to final resolution of
the Government's appeal. Norton continues to have vitality
and survives Strumpf.

The Government argues before us, however, that to the
extent that Norton may control and hold that the
confirmation of the plan extinguishes all set-off rights not
provided for in the plan, it was wrongly decided. The
Government asserts that the Bankruptcy Code's set-off
provision in S 553 states in the clearest of terms that the
rest of the Bankruptcy Code "does not affect" a creditor's
right to set-off provided that the obligations between
creditor and debtor are mutual and that both obligations
arose prior to the commencement of the reorganization
proceedings. Relying on 11 U.S.C. S 553(a), the
Government, in effect, maintains that a pre-petition
creditor's right to set-off may be exercised without regard to

                               7
the status of the bankruptcy proceedings and the
confirmation of the debtor's reorganization plan. The
Government argues that In re De Laurentiis Entertainment
Group, Inc., 963 F.2d 1269 (9th Cir. 1992), supports its
position. In De Laurentiis, the court considered the tension
between 11 U.S.C. S 553 and 11 U.S.C. S 1141 of the
Bankruptcy Code. Section 1141 provides for the discharge
of pre-petition debts after completion of a bankruptcy
proceeding.6 It also provides that any assets retained under
the administration of reorganization are free and clear of
any pre-petition debts. 11 U.S.C. S 5537 protects the right
of a creditor to offset a mutual debt. After analyzing the
statutory sections and the applicable cases in other
jurisdictions, the De Laurentiis court concluded that S 553
must take precedence over S 1141. Although uncertain, it
also believed that the language of S 553 "seems intended to
control notwithstanding any other provisions of the
Bankruptcy Code." 963 F.2d at 1276-77. The court,
however, predicated its decision upon the particular facts in
_________________________________________________________________

6. 11 U.S.C. S 1141 provides in pertinent part:

       (a) Except as provided in subsections (d)(2) and (d)(3) of this
section,
       the provisions of a confirmed plan bind . . . any creditor . . .
whether
       or not such creditor . . . has accepted the plan.

       . . .

       (c) Except as provided in subsections (d)(2) and (d)(3) of this
section
       and except as otherwise provided in the plan or in the order
       confirming the plan, after confirmation of a plan, the property
dealt
       with by the plan is free and clear of all claims and interests of
       creditors. . . .
       (d)(1) Except as otherwise provided in this subsection, in the
plan,
       or in the order confirming the plan, the confirmation of a plan --

       (A) discharges the debtor from any debt that arose before the date
       of such confirmation . . . . (emphasis added).

7. 11 U.S.C. S 553 provides in pertinent part:

       (a) 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 . . . . (emphasis added).

                        8
the case before it, including the creditor's diligent pursuit of
its set-off claim before the bankruptcy court "during the
entire period the reorganization plan was being considered."
Id. at 1277. The court noted that the creditor, NBC, had
filed a proof of claim and petition for relief from stay.

We believe that the material facts in De Laurentiis
distinguish it from the case before us. We recognize that a
right of set-off is preserved under S 553 in a bankruptcy
proceeding but we believe that the right must be exercised
by the creditor in timely fashion and appropriately asserted
in accordance with other provisions of the Bankruptcy
Code. Unlike the Government in this case, NBC, the
creditor in De Laurentiis, timely filed its proof of claim in
the bankruptcy court and claimed its right of set-off against
its debt to the Debtor. NBC also filed a motion for relief
from the automatic stay prior to confirmation of the plan.
The Government did neither of these in this case. In the
instant case, the plan of reorganization proceeded on the
justifiable assumption that the reorganized debtor faced no
set-off claim. On the other hand, in De Laurentiis, the
bankruptcy court converted NBC's set-off claim into an
adversary proceeding and NBC "pursued its claim diligently
before the bankruptcy court at all times." Id. at 1271. There
was no adversary proceeding here prior to plan
confirmation, and the facts in both cases are materially
different.

The Government also cites to In re Davidovich, 901 F.2d
1533 (10th Cir. 1990) and two bankruptcy court cases.
Davidovich involved an arbitration debt to the debtor from
his former law partner, and the debtor, under the facts of
the case, had notice of the set-off claim. The court,
however, only discussed the right of set-off under S 553 but
made no analysis of the provisions of S 1141 of the
Bankruptcy Code. As to the bankruptcy court cases, In Re
Weigand, 199 B.R. 639, (Bankr. W.D. Mich. 1996) relies
largely on De Laurentiis only, and the facts of In re
Womack, 188 B.R. 259 (Bankr. E.D. Ark. 1995) are
distinguishable. Womack, unlike this case, involved a
secured debt of the Government, income tax liability,
payment of which was provided by the confirmed plan. The
debtors had a refund due from the Government for an

                               9
overpayment on a subsequent tax year. After the
confirmation of the plan, the Government sought to set-off
the refund against the debt due it under the plan and the
bankruptcy court permitted it. The bankruptcy court
concluded that the set-off might in fact be of benefit to the
debtors and to some of the creditors because the reduction
of the claim of the United States under the plan will permit
acceleration of payment to other creditors. Id. at 262.
Because the plan provided for the ultimate payment of the
debt due the Government, allowing the set-off merely
accelerated its payment, and there was no need to discuss
the conflict between S 553 and S 1141 of the Bankruptcy
Code.

Thus, we are not persuaded by the cases relied on by the
Government that S 1141 may be disregarded when a set-off
is asserted. Norton did not extinguish non-secured set-off
claims, nor do we, provided they are timely asserted. In the
instant case, the Government would have the court treat a
non-secured claim as a secured claim to the disadvantage
of all other general creditors. The Government here has no
statutory secured claims as it did in Womack for income tax
liability. Furthermore, allowing the Government under the
facts of this case to come forward after the plan of
reorganization has been confirmed and sua sponte decide
that it has a valid set-off without timely filing a proof of
claim and asserting the set-off in the reorganization
proceedings, has a probability of disrupting the plan of
reorganization. It may also unnecessarily protract the
bankruptcy proceedings and consume judicial resources.
Furthermore, it is unfair to other creditors and the debtor,
and can conceivably undermine the plan of reorganization
and the objectives and structure of the Bankruptcy Code.

Thus, because the Government attempted to exercise its
set-off right after confirmation of the plan, the
Government's remaining arguments are unpersuasive.
Norton still controls in this Circuit and precludes the
Government's exercise of any set-off right it may have had
once Continental's plan was approved. As the Government
correctly notes, "a panel of this court is bound to follow the
holdings of published opinions of prior panels of this court
unless overruled by the court en banc or the holding is

                               10
undermined by a subsequent Supreme Court case."
Nationwide Ins. Co. v. Patterson, 953 F.2d 44, 46 (3d Cir.
1991).

III.

To summarize, we reaffirm the ruling in Norton and hold
that the right of a creditor to set-off in a bankruptcy
reorganization proceeding must be duly exercised in the
bankruptcy court before the plan of reorganization is
confirmed; the failure to do so extinguishes the claim.

Accordingly, the judgment of the district court upholding
the bankruptcy court's ruling that the Government's set-off
rights, if any, were extinguished upon confirmation of
Continental's Plan of Reorganization will be affirmed. Costs
taxed against the appellant.

A True Copy:
Teste:

       Clerk of the United States Court of Appeals
       for the Third Circuit

                                11
