Baker v. Gold Seal Liquors, Inc.
417 U.S. 467 (1974)

Annotate this Case

U.S. Supreme Court

Baker v. Gold Seal Liquors, Inc., 417 U.S. 467 (1974)

Baker v. Gold Seal Liquors, Inc.

No. 73-804

Argued April 23, 1974

Decided June 17, 1974

417 U.S. 467




Petitioners, trustees of a railroad in a § 77 reorganization proceeding, brought suit for freight charges against respondent shipper, and respondent counterclaimed for cargo loss and damage. The District Court granted petitioners' motion for summary judgment for entry of one judgment on their claim and another on the counterclaim, but set off one judgment against the other, resulting in a net judgment against petitioners for some $11,000. The Court of Appeals affirmed.

Held: The Court of Appeals erred in allowing the setoff, since it thereby granted a preference to the claim of one creditor that happened to owe freight charges over other creditors that did not, and thus interfered with the Reorganization Court's duty under § 77e, 11 U.S.C. § 205(e), to approve a "fair and equitable plan" that duly recognizes the rights of each class of creditors and stockholders and does not discriminate unfairly in favor of any class. Pp. 417 U. S. 468-474.

484 F.2d 950, reversed.

DOUGLAS, J., wrote the opinion of the Court, in which BURGER, C.J., and BRENNAN, MARSHALL, WHITE, and BLACKMUN, JJ., joined. STEWART, J., filed an opinion concurring in the result, in which POWELL, J., joined, post, p. 417 U. S. 474. REHNQUIST, J., filed a dissenting opinion, post, p. 417 U. S. 478.

Opinion of the Court by MR. JUSTICE DOUGLAS, announced by MR. JUSTICE WHITE.

The Penn-Central Transportation Co. is in bankruptcy reorganization under § 77 of the Bankruptcy Act, 11

Page 417 U. S. 468

U.S. C § 205. Petitioners are its trustees authorized to collect its assets, one of which is a claim for freight charges against respondent owed the bankrupt debtor. The claim on which this suit was brought was $8,256.61, and the amount is undisputed. Respondent filed a counterclaim for $19,319.42 for loss and damage to shipments over the debtor's lines. Its amount is also not disputed.

The trustees filed a motion for summary judgment, asking the District Court to enter one judgment covering the amount of freight charges admittedly due and another for the amount claimed by respondent.

Previously, the Reorganization Court in the Third Circuit had prohibited the various bank creditors from offsetting their claims against the trustees of the debtor. 315 F.Supp. 1281. Prior to the decision of the instant case, that bank setoff case was affirmed by the Court of Appeals, 453 F.2d 520. Also prior to the ruling of the Court of Appeals in the instant case the Reorganization Court prohibited some shippers from setting off freight loss and damage claims against amounts owed for transportation claims. That order, 339 F.Supp. 603, was affirmed by the Court of Appeals, 477 F.2d 841, and by this Court, sub nom. United States Steel Corp. v. Trustees of Penn Central Transp. Co., 414 U.S. 885.

The District Court in the instant case granted the trustees' motion for summary judgment, but set off one judgment against the other, which resulted in a net judgment in favor of respondent against the trustees in the amount of $11,017.01. The Court of Appeals affirmed, 484 F.2d 950, and we granted certiorari to resolve the conflict.

We reverse.

Ordinarily, where a court has primary jurisdiction over the parties and over the subject matter, the power to resolve the amount of the claim and the counterclaim is

Page 417 U. S. 469

clear. Indeed, under the Federal Rules of Civil Procedure, the counterclaim may be compulsory. Rule 13(a). [Footnote 1] That is the procedure under § 68 of the Bankruptcy Act, 11 U.S.C. § 108. [Footnote 2]

Page 417 U. S. 470

The problem of the bankruptcy Reorganization Court is somewhat different. Liquidation is not the objective. Rather, the aim is by financial restructuring to put back into operation a going concern. [Footnote 3] That entails two basic considerations:

Page 417 U. S. 471

First is the collection of amounts owed the bankrupt to keep its cash inflow sufficient for operating purposes, at least at the survival levels. The second is to design a plan [Footnote 4] which creditors [Footnote 5] and other claimants will approve, which will pass scrutiny of the Interstate Commerce Commission, which will meet the fair and equitable standards required by the Act for court approval, and which will preserve an ongoing railroad in the public interest. [Footnote 6]

Section 77a gives the Reorganization Court "exclusive jurisdiction of the debtor and its property wherever located." [Footnote 7] 11 U.S.C. § 205(a). In furtherance of its

Page 417 U. S. 472

long-range responsibilities the Reorganization Court enjoined secured creditors from selling collateral to reduce their claims. [Footnote 8] It then went on to bar enforcement of liens against the debtor, taking possession of its property, or obtaining judgments against the debtor, except for specified purposes. [Footnote 9] One court seized upon the last provision in the order which says

"that suits or claims for damages caused by the operation of trains, buses, or

Page 417 U. S. 473

other means of transportation may be filed and prosecuted to judgment in any Court of competent jurisdiction,"

to adjudicate the merits of a counterclaim, but declined to allow the setoff. [Footnote 10] But proof of the claim against the debtor is a distinct preliminary stage to a determination of what priority, if any, the claim that is proved receives in a reorganization plan.

There is a hierarchy of claims, the owner of the equity coming last. Wages owing workers running the trains have a high current priority. Secured creditors have, by law, a priority in the hierarchy. Unsecured creditors usually are pooled together. They may receive new securities, perhaps stock. Allowance of a setoff that reduces all or part of the debtor's claim against them is a form of priority. The guiding principle governing priorities is stated in § 77e(1), 11 U.S.C. § 205(e)(1): the Reorganization Court shall approve a plan if it

"is fair and equitable, affords due recognition to the rights of each class of creditors and stockholders, does not discriminate unfairly in favor of any class of creditors or stockholders, and will conform to the requirements of the law of the land regarding the participation of the various classes of creditors and stockholders."

The term "fair and equitable" has a long history going back at least to Northern Pacific R. Co. v. Boyd,228 U. S. 482, and Kansas City Terminal R. Co. v. Central Union Trust Co.,271 U. S. 445, whose fixed principle has been carried over into § 77e by our decisions. [Footnote 11] The plan

Page 417 U. S. 474

is, by the terms of § 77, a product of the Interstate Commerce Commission and the Reorganization Court working cooperatively together, New Haven Inclusion Cases,399 U. S. 392, 399 U. S. 431. The public interest, as well as the interests of creditors and stockholders, is at issue. [Footnote 12] RFC v. Denver & R. G. W. R. Co.,328 U. S. 495, 328 U. S. 535.

The allowance or disallowance of setoff may seem but a minor part of the architectural problem. But to the extent that it is allowed, it grants a preference to the claim of one creditor over the others by the happenstance that it owes freight charges that the others do not. That is a form of discrimination to which the policy of § 77 is opposed. As a general rule of administration for § 77 Reorganization Courts, the setoff should not be allowed. [Footnote 13]


[Footnote 1]

Rule 13(a), the compulsory counterclaim rule, requires a defendant to plead any counterclaim which

"arises out of the transaction or occurrence that is the subject matter of the opposing party's claim and does not require for its adjudication the presence of third parties of whom the court cannot acquire jurisdiction."

The claim is not compulsory if it was the subject of another pending action at the time the action was commenced, or if the opposing party brought his suit by attachment or other process not resulting in personal jurisdiction but only in rem or quasi in rem jurisdiction. A counterclaim which is compulsory but is not brought is thereafter barred, e.g., Mesker Bros. Iron Co. v. Donata Corp., 401 F.2d 275, 279.

If a counterclaim is compulsory, the federal court will have ancillary jurisdiction over it even though ordinarily it would be a matter for a state court, e.g., Great Lakes Rubber Corp. v. Herbert Cooper Co., 286 F.2d 631. Under Rule 13(a)'s predecessor, this Court held that "transaction" is a word of flexible meaning which may comprehend a series of occurrences if they have logical connection, Moore v. New York Cotton Exchange,270 U. S. 593, and this is the rule generally followed by the lower courts in construing Rule 13(a), e.g., Great Lakes, supra; United Artists Corp. v. Masterpiece Productions, 221 F.2d 213, 216.

Rule 13(b) permits as counterclaims, although not compulsory,

"any claim against an opposing party not arising out of the transaction or occurrence that is the subject matter of the opposing party's claim."

Thus, the court may dispose of all claims between the parties in one proceeding whether or not they arose in the "same transaction."

[Footnote 2]

Title 11 U.S.C. § 108 provides:

"(a) In 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 set off against the other, and the balance only shall be allowed or paid."

"(b) A set-off or counterclaim shall not be allowed in favor of any debtor of the bankrupt which (1) is not provable against the estate and allowable under subdivision (g) of section 93 of this title; or (2) was purchased by or transferred to him after the filing of the petition or within four months before such filing with a view to such use and with knowledge or notice that such bankrupt was insolvent or had committed an act of bankruptcy."

If the trustee in ordinary bankruptcy goes into a court that has jurisdiction and asserts a claim, the debtor of the bankrupt may raise as a setoff any claim he has against the bankrupt and the court ordinarily issues only one judgment for the difference.

In a straight bankruptcy case, Cumberland Glass Co. v. De Witt,237 U. S. 447, the Court construed § 68 as "permissive, rather than mandatory," and as to which the bankruptcy court "exercises its discretion . . . upon the general principles of equity." Id. at 237 U. S. 455. And see Susquehanna Chemical Corp. v. Producers Bank & Trust Co., 174 F.2d 783.

[Footnote 3]

The dissent places mistaken reliance on subsection l of § 77 of the Bankruptcy Act, 11 U.S.C. § 205(l), to argue that the setoff provision of § 68, 11 U.S.C. § 108, necessarily applies to all reorganization proceedings under § 77. No authority is cited for this novel construction of subsection l, and indeed the very wording of the subsection itself makes clear that it applies only when "consistent with the provisions" of § 77. We have long held that the distinctive purposes of § 77 may require different procedures than would be followed in ordinary bankruptcy. For example, in holding that, under § 77, the Reorganization Court had authority to enjoin the sale of collateral if it would hinder or obstruct the preparation of a reorganization plan, we stated:

"It may be that, in an ordinary bankruptcy proceeding, the issue of an injunction in the circumstances here presented would not be sustained. As to that it is not necessary to express an opinion. But a proceeding under § 77 is not an ordinary proceeding in bankruptcy. It is a special proceeding which seeks only to bring about a reorganization if a satisfactory plan to that end can be devised. And to prevent the attainment of that object is to defeat the very end the accomplishment of which was the sole aim of the section, and thereby to render its provisions futile."

Continental Bank v. Rock Island R. Co.,294 U. S. 648, 294 U. S. 676. And see New Haven Inclusion Cases,399 U. S. 392, 399 U. S. 420.

Ordinary bankruptcy aims at liquidation of a business. Reorganization under § 77 aims at a continuation of the old business under a new capital structure that respects the relative priorities of the various claimants.

[Footnote 4]

Section 77b, 11 U.S.C. § 205(b), defines a "plan of reorganization." The provisions for filing a "plan" with the court and with the Interstate Commerce Commission are governed by § 77d, 11 U.S.C. § 205(d).

[Footnote 5]

Unsecured creditors have the priority they would have had "if a receiver in equity of the property of the debtor had been appointed by a Federal court on the day of the approval" of the bankruptcy petition, and shall be treated as a separate class or classes. 11 U.S.C. § 205(b). As to that, priority see Gregg v. Metropolitan Trust Co.,197 U. S. 183. In St. Louis & S. F. R. Co. v. Spiller,274 U. S. 304, 274 U. S. 311, the Court said:

"[B]y long established practice, the doctrine has been applied only to unpaid expenses incurred within six months prior to the appointment of the receivers. . . . The cases in which this time limit was not observed are few in number and exceptional in character."

[Footnote 6]

New Haven Inclusion Cases, supra, at 399 U. S. 420.

[Footnote 7]

Section 77a provides in relevant part:

"If the petition is so approved, the court in which the order is entered shall, during the pendency of the proceedings under this section and for the purposes thereof, have exclusive jurisdiction of the debtor and its property wherever located, and shall have and may exercise in addition to the powers conferred by this section all the powers, not inconsistent with this section, which a court of the United States would have had if it had appointed a receiver in equity of the property of the debtor for any purpose. Process of the court shall extend to and be valid when served in any judicial district."

As MR. JUSTICE STEWART correctly notes, infra at 417 U. S. 476, it is settled that "property" within the meaning of this section includes intangibles such as choses in action.

[Footnote 8]

The order provided in part:

"All persons, firms and corporations, holding collateral heretofore pledged by the Debtor as security for its notes or obligations or holding for the account of the Debtor deposit balances or credits be and each of them hereby are [sic] restrained and enjoined from selling, converting or otherwise disposing of such collateral, deposit balances or other credits, or any part thereof, or from offsetting the same, or any [sic] thereof, against any obligation of the Debtor, until further order of this Court."

[Footnote 9]

"All persons and all firms and corporations, whatsoever and wheresoever situated, located or domiciled, hereby are restrained and enjoined from interfering with, seizing, converting, appropriating, attaching, garnisheeing, levying upon, or enforcing liens upon, or in any manner whatsoever disturbing any portion of the assets, goods, money, deposit balances, credits, choses in action, interests, railroads, properties or premises belonging to, or in the possession of the Debtor as owner, lessee or otherwise, or from taking possession of or from entering upon, or in any way interfering with the same, or any part thereof, or from interfering in any manner with the operation of said railroads, properties or premises or the carrying on of its business by the Debtor under the order of this Court and from commencing or continuing any proceeding against the Debtor, whether for obtaining or for the enforcement of any judgment or decree or for any other purpose, provided that suits or claims for damages caused by the operation of trains, buses, or other means of transportation may be filed and prosecuted to judgment in any Court of competent jurisdiction. . . ."

[Footnote 10]

Baker v. Southeastern Michigan Shippers Assn., 376 F.Supp. 149.

[Footnote 11]

Ecker v. Western Pacific R. Corp.,318 U. S. 448, 318 U. S. 477-483; Group of Investors v. Milwaukee R. Co.,318 U. S. 523, 318 U. S. 539-541; RFC v. Denver & R. G. W. R. Co.,328 U. S. 495, 328 U. S. 516-520. The same is true under § 101 et seq. (now c. X) of the Bankruptcy Act, 11 U.S.C. § 501 et seq.Consolidated Rock Products Co. v. Du Bois,312 U. S. 510.

[Footnote 12]

And see New Haven Inclusion Cases, 399 U.S. at 399 U. S. 420.

[Footnote 13]

Lowden v. Northwestern National Bank & Trust Co.,298 U. S. 160, is not to the contrary. The Court there refused to answer the certified question because it did not know the factual setting in which the question had been raised. Much law has been fashioned in the reorganization field since 1936, the date of that decision. The contours of plans have emerged which have given new meaning and insight into the statutory words "fair and equitable." The preference sought here shows no exceptional circumstances which in equity justify the discrimination.

MR. JUSTICE STEWART, with whom MR. JUSTICE POWELL joins, concurring in the result.

The Court concludes that, since the allowance of a setoff in a § 77 reorganization would grant "a preference to the claim of one creditor over the others by the happenstance that it owes freight charges that the others do not," such setoffs should be disallowed "[a]s a general rule of administration." Ante this page. While I agree that the District Court should not have permitted a setoff in this case, I think that the broad rule adopted by

Page 417 U. S. 475

the Court is unnecessary to reach this result, and I prefer to rest my conclusion on a narrower ground.

While judicial setoffs are specifically authorized in straight bankruptcy cases, § 68 of the Bankruptcy Act, 11 U.S.C. § 108, no express approval of them appears in the statute governing § 77 reorganizations. [Footnote 2/1] In Lowden v. Northwestern National Bank & Trust Co.,298 U. S. 160 (1936), this Court stated that the approval of setoffs in § 68 did not control in railroad reorganizations, but "governs, if at all, by indirection and analogy according to the circumstances. The rule to be accepted for the purpose of such a suit is that enforced by courts of equity, which differs from the rule in bankruptcy chiefly in its greater flexibility, the rule in bankruptcy being framed in adaptation to standardized conditions, and that, in equity varying with the needs of the occasion, though remaining constant, like the statute, in the absence of deflecting forces." Id. at 164-165. [Footnote 2/2]

Page 417 U. S. 476

By announcing a doctrine barring judicial setoffs as a "general rule" the Court in the present case adopts a rationale inconsistent with Lowden, which quite clearly envisioned a case-by-case analysis of the propriety of each attempted setoff in the light of equitable considerations. Rather than replacing this principle with a new and wholly inconsistent rule to be applied in all cases involving judicial setoffs, I would rest this decision on the particular facts before us, which adequately distinguish this case from the situation in Lowden. [Footnote 2/3]

Section 77a gives the Reorganization Court "exclusive jurisdiction of the debtor and its property wherever located." (Emphasis added.) It has been commonly accepted in the federal courts that "property" within the meaning of this section includes intangibles such as choses in action. See 2 W. Collier, Bankruptcy 1123.05[4], p. 485 (1971), and cases there cited. It follows, therefore, that respondent's debt to the Penn Central fell within the "exclusive jurisdiction" of the Reorganization Court immediately upon the approval of the petition for reorganization. While such jurisdiction may not empower the Reorganization Court to enforce the cause of action, see id. at 489-490; In re Roman, 23 F.2d 556 (CA2 1928) (L. Hand, J.), it certainly does empower the

Page 417 U. S. 477

court to protect the "property" and to immunize it from diminution through setoff or counterclaim. To hold otherwise would be inconsistent with the function of the Reorganization Court to consolidate and protect the assets of the petitioning corporation. Callaway v. Benton,336 U. S. 132, 336 U. S. 147 (1949); Warren v. Palmer,310 U. S. 132, 310 U. S. 139-141 (1940); Ex parte Baldwin,291 U. S. 610, 291 U. S. 615 (1934).

While the matter is not wholly free from doubt, I am persuaded that the Reorganization Court in this proceeding did, in fact, enjoin the allowance by any other court of judicial setoffs against any debts owed to the Penn Central. [Footnote 2/4] On this basis, I join the judgment of the Court.

Page 417 U. S. 478

[Footnote 2/1]

I am unable to conclude, as does the dissent, post at 417 U. S. 479-480, that subsection I of § 77 mandates allowance in § 77 reorganizations of all setoffs allowed by § 68 in straight bankruptcies. While the dissent's ingenious reading of the statute would provide an easy semantic solution to the problem presented in this case, I am impressed with the fact that neither this Court in Lowden v. Northwestern National Bank & Trust Co.,298 U. S. 160 (1936), nor, apparently, any other federal trial or appellate court has considered subsection l to have any bearing whatsoever on the setoff problem. In the absence of any showing based on legislative history that such was the intent of Congress, and particularly in the absence of any briefing or oral argument on the matter, I would not, therefore, give this less than pellucid provision the force ascribed to it by the dissenting opinion.

[Footnote 2/2]

These statements of the Court concerning allowance of judicial setoffs in § 77 cases were, in a technical sense, dicta. The Lowden case came to the Court on questions certified by the Court of Appeals for the Eighth Circuit, and the Court dismissed the certificate without formally answering the questions because of the "defective form of the certificate. . . ." 298 U.S. at 298 U. S. 166. The Court's reasoning as to the availability of setoffs, however, has been viewed as authoritative. See, e.g., In re Lehigh & Hudson River R. Co., 468 F.2d 430, 433 (CA2 1972); In re Yale Express System, 362 F.2d 111, 116-117 (CA2 1966); Susquehanna Chemical Corp. v. Producers Bank & Trust Co., 174 F.2d 783, 787 (CA3 1949). See also 4 W. Collier, Bankruptcy

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