1. AUTOMATIC STAY
1.1 Covered Activities
1.1.a The debtor violated numerous state court orders in actions to recover amounts he misappropriated. The state court held him in contempt and imposed monetary sanctions and ordered him to stop managing property he did not own and to turnover proceeds from the illegal management. The debtor filed his bankruptcy petition the day before a state court hearing on sentencing the debtor to jail for contempt. Section 362(a) stays any prepetition action or proceeding against the debtor, but section 362(b)(4) excepts from the stay any action by a governmental unit to enforce its police or regulatory power.” The exception applies when the government's action is to effectuate a public policy to protect public safety and welfare or is to further its own interest but not if the government proceeds for a pecuniary purpose to recover property from the estate. The state court is a governmental unit, and its order to stop managing the property was in the interest of public safety. Its order to turn over money that the debtor collected in violation of the state court's order does not reflect a pecuniary purpose, even though money is involved, because it seeks redress of the violation of a court order and therefore comes within the police power exception. Kupperstein v. Schall (In re Kupperstein), ___ F.3d ___, 2021 U.S. App. LEXIS 11944 (1st Cir. Apr. 22, 2021).
1.1.b Automatic stay does not apply to state enforcement of COVID-19 protection measures. The state enacted measures to limit restaurant operations during the COVID-19 pandemic. The debtor disregarded those measures, claiming they were unconstitutional. The county sued in state court to shut down the debtor's operation. The debtor filed chapter 11, invoking the automatic stay. 28 U.S. C. § 959(b) requires a debtor in possession to manage and operate its property “according to the valid laws of the State.” Therefore, the safety measures apply to the debtor in possession. Section 362(b)(4) excepts from the automatic stay an action by a governmental entity to enforce its police or regulatory powers. In determining whether an action falls within this exception, the court may not determine the merits of a debtor's challenge to the legality of the state law. Nothing in section 362(b)(4) authorizes the court to examine the legality of the governmental unit's action, which is left to the state court, lest the bankruptcy courts are to scrutinize every governmental regulatory action for legality. Therefore, the county's enforcement action may proceed. Cty of Allegheny v. Cracked Egg, LLC (In re Cracked Egg, LLC), 624 B.R. 84 (Bankruptcy W.D. Pa. 2021).
1.2 Effect of Stay
1.2.a Government may seek stay annulment to validate postpetition setoff in violation of the stay. The debtors owed HUD on a guaranteed, defaulted housing loan. HUD notified the Treasury, which then offset the debt against the debtors' tax overpayment, which the debtors attempted to exempt, after the petition date. Section 6402(d) requires the Treasury Secretary to offset tax overpayments against any amounts the taxpayer owes to the government. Section 553(a) preserves the setoff right in bankruptcy. The debtors' exemption claim does not supersede the setoff right. However, the postpetition setoff violated the automatic stay, which HUD might remedy by seeking annulment of the stay. Wood v. U.S. Dept. of Housing & Urban Devel. (In re Wood), ___ F.3d ___, 2021 U.S. App. LEXIS 10029 (4th Cir. Apr. 7, 2021).
2. AVOIDING POWERS
2.1 Fraudulent Transfers
2.3 Postpetition Transfers
2.4.a Creditor may not offset claim against breach of fiduciary duty claim against the creditor. The debtor's director loaned the debtor money. When he learned that the debtor had failed to disclose substantial other debts, he called the loan and sued to collect. The debtor brought a breach of fiduciary duty action against him. The jury found in favor of both claims. The debtor later filed bankruptcy. The director sought to offset the two judgments. Section 553(a) preserves the right to offset mutual debts and claims, subject to equitable considerations. A claim arising from a breach of fiduciary duty is not a mutual claim against a contract debt, because the liability on the claim arises from the defendant's acts in a fiduciary capacity. Moreover, allowing such a creditor to offset of judgment for breach of fiduciary duty would allow the creditor to benefit from his own wrongdoing. Therefore, the court denies setoff. In re E. Coast Custom Coaches, Inc.), 624 B.R. 390 (Bankr. E.D. Va. 2020).
2.4.b Mutuality requirement defeats contractual triangular setoff. The debtor sold goods to the counterparty and contracted with the counterparty's affiliate to perform marketing services for the debtor. The sale contract provided that amounts owing to the counterparty could be offset against any amounts the counterparty or any of its affiliates owed to the debtor. When the debtor filed bankruptcy, it owed the affiliate $7 million, and the counterparty owed the debtor $9 million. The counterparty sought permission to offset the debts so it would pay only $2 million to the estate. Section 553(a) provides the Code “does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor … against of claim of such creditor against the debtor,” subject to three enumerated exceptions, which do not include an exception for non-mutual debts. The mutuality requirement is embedded in the statutory authorization and does not require a separate exception to make it effective. Mutuality requires that the creditor and debtor owe each other directly, not through a third party. A contractual right to a triangular setoff enforceable under state law does not create mutuality; more generally, parties may not contract around the mutuality limitation. Here, the debts were not owing between the same parties, so the setoff was denied. However, the court notes some alternatives the counterparty could have used to preserve a setoff right, including joint and several liability among the parties or the granting of a security interest in the accounts receivable. In re Orexigen Therapeutics, Inc., 990 F. 3d 748 (3d Cir. 2021).
2.5 Statutory Liens
2.6 Strong-arm Power
3. BANKRUPTCY RULES
3.1.a Certified mail is not adequate for service of process. The plaintiff served the complaint and summons on the defendant by certified mail but did not receive a receipt of delivery from the defendant. Bankruptcy Rule 7004 permits service by first class mail. Certified mail imposes additional requirements on the Postal Service and on the recipient. Because certified mail differs from ordinary first class mail, service was ineffective. Ratliff v. Dept. of Educ. (In re Ratliff), ___ B.R. ___, 2021 Bankr. LEXIS 599 (Bankr. S.D.W. Va. Mar. 15, 2021).
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