Counterclaims in Avoidance Actions? Are We Sure We Know Why Not?

If you have defended a few preference actions, I’ll bet that you’ve heard this one from your client more than once: “Can I countersue them for what they owe me?" The obvious (to a bankruptcy lawyer) and correct response is “no,” but you might not have been 100% glib if called upon to explain why. Now the Ninth Circuit has come to your rescue, and you can just say “In re Adbox, Inc., 2007 WL 1584582 (9th Cir. June 4, 2007).

Adbox was a preference action by a chapter 7 trustee. The Metcalfs as defendants filed a counterclaim seeking damages for pre-petition torts by the debtor. The Ninth Circuit ruled that this was impermissible because a counterclaim may only be brought against an “opposing party” under Federal Rule of Civil Procedure 13. The Court reasoned:

The question presented here, however, is whether the trustee is an “opposing party” when he has brought a preference action that belongs to the bankruptcy estate and not to the debtor, but the counterclaim alleges causes of action that could have been brought against the debtor prior to its bankruptcy filing. We hold that he is not. The Metcalfs styled their counterclaim as against Golden “in his capacity as Chapter 7 trustee for the estate of Adbox,” but their allegations concerned the conduct of . . . Adbox prior to Adbox's bankruptcy filing. While the Metcalfs presumably sought to recover from Adbox's assets in bankruptcy, the trustee would have to stand in the shoes of the debtor to defend against the counterclaim. This would be a representative capacity different from the representative capacity in which a trustee brings a preference action, because a preference action belongs specifically to the bankruptcy trustee and could not have been brought by the debtor prior to its bankruptcy filing.
To me, this explanation sort of begs the question. After all, isn’t the pre-petition claim a liability of the bankruptcy estate? Or at least, I thought that the bankruptcy estate "stands in the shoes of the debtor." Another way of looking at this is that the creditor is prevented by the automatic stay from bringing a counterclaim, and is required to proceed via a proof of claim unless relief from stay is granted. But wait, that argument doesn’t dispose of the setoff issue, which isn’t directly addressed by Adbox. Is the only reason that a creditor can’t offset a claim against preference liability the prohibition of 11 U.S.C. §502(d), which prohibits allowance of claim until the preference is repaid? See, e.g., In re Allegheny Health, Education and Research Foundation, 292 B.R. 68, 94-95 (Bankr. W.D.Pa. 2003). What if the creditor doesn’t file a claim and just asserts offset?

Does it ever strike you that the more obvious a proposition seems to be to you, the harder it is to find authority for it? Sometimes its also hard to come up with reasons for these obvious rules when we are forced to go beyond our own peremptory judgments or innate sense of bankruptcy logic. I have little doubt that I’m missing something here, so please help me out. That’s what Comments are for.

Copyright Dean T. Kirby 2007. All rights reserved.