Consumer Finance Insights
December 22, 2016

Bankruptcy Court: Exercise of Post-Petition Right to Setoff Without Court Permission Violated Automatic Stay

On November 16, 2016, the United States Bankruptcy Court for the Western District of Kentucky found that a creditor exercising its post-petition right to setoff without bankruptcy court permission had violated the automatic stay in the case.

The Debtor in the case, In re Parrish, Case No. 16-32030, was an active duty member of the United States Military who defaulted on two lines of credit with the Army and Air Force Exchange Service (“Exchange”).  As an agency of the United States government, the Exchange placed the delinquent debts into the Treasury Offset Program.  As the opinion explains, the Treasury Offset Program allows the United States Treasury to “offset any amount owed to a federal agency against any eligible federal payments, including tax refunds.”  In February 2015, the Exchange asserted a claim against the debtor’s income tax refund of $5,352.

On June 30, 2016, the Debtor filed a Chapter 7 Bankruptcy Petition and listed the debt owed to the Exchange on her Bankruptcy Schedules.  The collection agency for the Exchange flagged the Debtor’s account upon receiving notice of the bankruptcy filing.  Due to delay in processing, the Exchange intercepted the Debtor’s income tax refund from the Internal Revenue Service and posted it to the Exchange’s account.  The Exchange never sought relief from the automatic stay pursuant to 11 U.S.C. § 362 to pursue its right to setoff.  In challenging the Exchange’s actions, the Debtor alleged that by exercising its right to setoff the Exchange violated the automatic stay.  The Exchange responded by asserting its right to setoff under 11 U.S.C. § 553.  The Bankruptcy Court found that although the Exchange is entitled to its right to setoff under the Bankruptcy Code “it does not excuse the Exchange’s failure to first seek relief from the automatic stay.”  The Bankruptcy Court allowed the Exchange to keep the tax refund but awarded the Debtor $200 in sanctions plus attorneys’ fees of $250.

This case serves as a reminder to creditors that although the right to setoff is preserved in the Bankruptcy Code, it is still the safest course of action for creditors to seek permission from the Bankruptcy Court before exercising that right.