A recent ruling by a bankruptcy judge in Kansas City demonstrated the interplay of a contractually-derived “right of recoupment” in a bankruptcy setting. It is an issue we have written about in this blog before. On March 16, 2014, here on our blog, in an article on overpayments of Social Security Disability payments we discussed the circumstances under which such overpayments were dischargeable in bankruptcy. (You can click here to see it).  We stated the following:

Recoupment is a common law doctrine. It is basically an equitable exception to the automatic stay of bankruptcy. It is “the setting up of a demand arising from the same transaction as the plaintiff’s claim or cause of action, strictly for the purpose of abatement or reduction of such claim.” In Re Caldwell, 350 B.R. 182 (E.D. Penn. 2006); see also In Re Mewborn, 367 B.R. 529 (D. N.J. 2006). Recoupment “does not require a mutuality of obligation, but rather countervailing claims or demands arising out of the same transaction under which the initial claim was asserted.” In Re Hiler, 99 B.R. 238, 241 (Bankr. N.J. 1989). See also In Re Irby, 359 B.R. 859 (Bankr. N.D. Ohio 2007). The key phrase here “arising out of the same transaction.”  Both the Hiler and the Caldwell courts stressed that a debtor must accept the burdens of a contract if he wants to continue to receive benefits under it. If overpayments are made under a contract which provides for recoupment prior to the filing of a bankruptcy petition, the debtor should not be allowed to avoid the reimbursement of money by having them discharged in a bankruptcy while at the same time he continues to receive the benefits under the same contract. A debtor, basically, cannot assume part of an agreement and reject another. Recoupment allows for offsetting the amount a person owes from the ongoing benefit received.

Basically, the point we were trying to make is that there are situations in bankruptcy where contract-based overpayments can continue to be collected by a creditor. These situations do not often arise, but they do exist. Judge Somers, in the Kansas City Division of the US Bankruptcy Court for the District of Kansas, made this point emphatically in a ruling issued October 6, 2014. The case was In Re Amelia Rock.

In this case, the debtor had become disabled in 2010 and was receiving long-term disability payments under a plan sponsored by the Kansas Public Employees Retirement System (KPERS). It was a contractually-based plan, which gave the plan administrator the right to recoup overpayments. The plan administrator did just that in 2011, and set up a “recoupment” when it found out that the debtor had received a large payment from a collateral source (workers’ compensation). The plan administrator (called “UHCSB”) reduced the debtor’s future disability payments by $100 per month in order to recoup the alleged workers’ comp overpayment.

The debtor filed a Chapter 13 bankruptcy in 2013, and assumed that the automatic stay imposed after the filing of the case would require UHCSB to terminate its recoupment debit of the debtor’s disability payments. Such language was included in the plan, and the plan was confirmed. The creditor, UHCSB, received notice of the plan and apparently did not object to it. The creditor continued to withhold the money from the debtor. The debtor then filed a motion to compel turnover of the withheld money, for sanctions for violations of the automatic stay, and for costs and expenses. The creditor actually did agree to stop the withholding, refund the money taken, and waive the remaining balance owed. The only remaining issue was that of the debtor’s litigation expenses, and this required the court to determine if the creditor had violated the automatic stay.

The court ruled that precedent in the Tenth Circuit showed that the creditor was not required to get relief from the automatic stay before continuing to withhold the $100 from the debtor’s monthly benefit payment. “Recoupment originated as an equitable rule of joinder, allowing adjudication in one suit of two claims that the common law had required to be brought separately.” The relevant test is whether the debtor’s obligation to repay arises out of the “same transaction” as the right to receive the continuing disability payments. Essentially, equity is the controlling issue.

A debtor should not be able to continue to receive benefits, as well as an overpayment, since such an outcome would amount to cherry-picking favorable terms out of one contract, while avoiding others. The court relied heavily on In Re Beaumont, 586 F.3d 776 (10th Cir. 2009) in arriving at its decision. Thus, ruled the court, there was no violation of the automatic stay, and therefore the debtor was not entitled to its litigation costs.

It should be stressed here that the “recoupment” doctrine only applies in certain situations.  As we noted in our earlier article on Social Security Benefits overpayment, not every benefit is contractually-based.  So, presumably, the outcome here would have been different if the benefit had been one of a different type.  Each case is different, and each situation needs to be examined on its own merits.

Read More:  Bankruptcy Debtors Can’t Be Discriminated Against