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10-13712 Lunt (Doc. # 241)

In Re Lunt, 10-13712 (Bankr. D. Kan. Aug. 31, 2012) Doc. # 241

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SO ORDERED.
SIGNED this 31st day of August, 2012.

 

Designated for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
PHILIP DUANE LUNT, CASE NO. 10-13712
CHAPTER 7
DEBTOR.

MEMORANDUM OPINION AND JUDGMENTS
DENYING DEBTOR'S MOTION FOR SUMMARY JUDGMENT AND
GRANTING ELAINE L. STELTER AND STEVEN A. LUNT’S
CROSS MOTION FOR SUMMARY JUDGMENT


In this re-opened Chapter 7 case, Debtor Philip Duane Lunt requests the Court to
hold The Peoples Bank as Trustee (Trustee) of the Harry B. Lunt Trust (Trust) in
contempt for violation of the discharge injunction.1 The basis for the alleged violation is
the Trustee’s offsetting of a 2010 distribution of Trust income to Debtor to satisfy
Debtor’s obligation to the Trust for interest on a November 7, 1985, note (Note), even

1 Dkt. 160.

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though Debtor’s personal liability on the Note was discharged by an order entered in this
case on July 19, 1989. The Court has jurisdiction.2 Debtor moves for summary judgment
on his motion to find the Trustee in contempt for violation of the discharge injunction,
seeking an award of actual damages of $4,811.00 and his attorney fees for the Trustee’s
alleged willful violation of the discharge injunction, plus punitive damages for the
Trustee’s alleged bad faith violation of the discharge injunction.3 The Trustee opposes
Debtor’s motion.4 Debtor’s sister, Elaine L. Stelter (Elaine), and his brother, Steven A.
Lunt (Steven), beneficiaries under the Trust, were granted leave to participate in summary
judgment briefing.5 They oppose Debtor’s motion for summary judgment and move for
summary judgment,6 contending that the Trustee’s actions were authorized by the Trust
and did not violate the discharge injunction.

UNCONTROVERTED FACTS.

The parties agree which documents and events are relevant to this controversy.
The Court finds the following facts are uncontroverted for purposes of the cross motions

2 This Court has jurisdiction pursuant to 28 U.S.C. § 157(a) and §§ 1334(a) and (b) and the
Standing Order of the United States District Court for the District of Kansas that exercised authority
conferred by § 157(a) to refer to the District’s bankruptcy judges all matters under the Bankruptcy Code
and all proceedings arising under the Code or arising in or related to a case under the Code, effective July
10, 1984. A motion for contempt for violation of the discharge injunction is a core proceeding which this
Court may hear and determine as provided in 28 U.S.C. § 157(b)(2)(A). There is no objection to venue or
jurisdiction over the parties.

3 Dkt. 211.

4 Dkt. 222.

5 Dkt. 228.

6 Dkt. 233.

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for summary judgment.

The Trust was established in 1978 by Harry B. Lunt (Harry or Grantor), the father
of Debtor, Elaine, and Steven (the Lunt Children). On November 7, 1985, the Trust
entered into a contract with Debtor and Debtor’s wife, Rose Ann Lunt, for the sale of a
farmhouse to Debtor and Rose Anne. The purchase price was $50,000.7 In partial
payment for the home, Debtor and Rose Ann executed the Note, dated November 7, 1985,
for $33,333.33 payable to The Peoples Bank as Trustee. The Note provides for interest at
the rate of 10% per annum, payable from the date of the transfer of the property. The
principal is due in five years. Although the contract provides for transfer of the
farmhouse to Debtor and Rose Ann, the deed dated November 7, 1985, conveyed the farm
house only to Rose Ann. But it is uncontroverted that Debtor has lived in the farm house
since the transfer.

Debtor filed for relief under Chapter 7 on November 25, 1988. The Peoples Bank
and the Trustee were listed as creditors. A proof of claim for payment of the Note was
filed. Debtor was granted a discharge on July 19, 1989. The parties agree that the Note
was within the scope of the discharge order.

The Grantor created the Trust, which is governed by Kansas law, by an instrument
dated December 27, 1978. The Peoples Bank of Pratt is named as the Trustee. The Trust
agreement was amended in its entirety by an Amendment to Trust Agreement dated

7 The Note was therefore for two-thirds of the purchase price. There is no evidence that Debtor
paid the Trust the other one-third of the value. In essence therefore, through the Note, Debtor agreed to
pay the Trust Elaine and Steven’s share of the value of the home.

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March 29, 1984, and by a limited Amendment of Trust Agreement signed on November
7, 1985, addressing the Note. A purpose of the Trust was to provide for the Grantor
during his lifetime. Upon his death, a marital trust and a non-marital trust were created,
and distributions from the marital trust were made to Christine Lunt, Harry’s wife and the
mother of the Lunt Children. The Trust provides that upon the death of Christine, which
occurred in 2004, the two trusts are to be administered as one for twenty years, after
which the Trust will terminate. Upon termination, the Lunt Children are entitled to
distributions of all principal and accrued and unpaid income.

The following specific terms of the Trust are relevant. The Trustee is given “all
powers expressly set forth in the Uniform Trustees Power Act (K.S.A. 58-1201, et seq) as
may be amended from time to time” and other powers set forth in the 1984 Amendment to
Trust Agreement.8 After Christine’s death, Article VI(A)(3)(b) of the 1984 Amendment
to Trust Agreement, a subsection of the martial trust provisions, gives the Trustee
discretion to make distributions of income to the Lunt Children as follows:

[T]hen upon the death of Grantor’s wife, the Trustee shall

continue to hold any accumulated income and principal in

trust and shall administer the same as follows:

. . . .

b. All or any part of the income of this trust
may be distributed at any time and from time to time
and for any reason for the benefit of the Grantor’s
children in such proportions and amounts as the
Trustee may determine, it being the intention hereof to
8 1984 Amendment to Trust Agreement, Article VII.
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vest in the Trustee the sole and absolute power to
distribute or not distribute amounts of income at such
times and in such proportions among said individuals
as it deems appropriate.

Also, under Article VI(C) of the 1984 Amendment to Trust Agreement, after the death of

Christine, the marital trust and the non-marital trust are treated as one and administered as

provided in the Amendment for a period of twenty years, when the Trust terminates.

Upon termination of the Trust, Article VI(C)(4) provides for equal distributions to the

Lunt Children, as follows:

Upon termination, the Trustee shall distribute the
principal and any accrued and undistributed income of the
trust in equal shares to the children of the Grantor, provided,
the Trustee is authorized and empowered to make unequal
distribution of the principal and any accrued and undistributed
income in cash or in kind in order to carry out the desires of
the Grantor for the Trustee to consider all transfers to
Grantor’s children that have been made by the Grantor or his
wife by Will or otherwise. Any loans made by Grantor or his
wife which have not been repaid shall be treated as transfers
by the Trustee, whether or not the statutes of limitation have
run.

The Amendment of Trust Agreement executed on November 7, 1985, the date of

the Note, states in part:

The Trustee is hereby directed to enter into the
attached contract on behalf of the Trust, to accept the notes as
required in such contract . . . and to execute the deed in the
form as attached hereto, to carry out the terms of the contract.

The Trustee is further directed that upon the death of
the survivor of myself and my wife . . . and collection of the
note to the Trustee in the amount of . . . $33,333.33 . . . ,
whichever event shall last occur, to distribute one-half (½) of
the principal of such note to my son, Steven A. Lunt and one


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half (½) to my daughter, Elaine Lunt Stelter.

As found above, the home transferred from the Trust to Debtor and his wife was valued at

$50,000. Since the Note, the only consideration which Debtor paid for the home, was for

two-thirds of the home’s value, Debtor received his one-third interest in that portion of

the Trust assets at the time of the transfer, and the other two beneficiaries, Elaine and

Steven, were to receive their share through distributions after payment of the Note.

Ted Loomis was The Peoples Bank trust officer primarily responsible for the Trust
from 1984 until 2006 or 2007. Thereafter, Richard Mullin was the primary trust officer for
the Trust, until he retired in December 2010. No distributions from the Trust to the Lunt
Children were made in 2004, 2005, or 2006. Beginning in 2007, equal cash distributions
were made on behalf of each child.9

By an e-mail to Richard Mullin, copied to Ted Loomis, dated December 16, 2009,
Debtor complained about the administration of the Trust as it related to Luntacres Farm,
Inc., a family farming operation, the stock of which is held at least in part by the Trust.
Debtor stated that he believed that his sister and Ted Loomis were “calling the shots” and
alleged that Ted Loomis was “running money through the Trust,” or laundering money
through the Trust. Debtor concluded the correspondence by stating that he had been
thinking about what type of legal action could be taken. The following day, Debtor sent to
the same individuals another e-mail concerning similar allegations of mismanagement and

9 Adjustments were made to the cash distributions to Elaine and Steven to account for
withholding of taxes, but these adjustments are not relevant to this case.

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stating that he firmly believed that Steven and Elaine “are managing the Harry B. Lunt

Trust.”

By letter dated December 18, 2009, Richard Mullin responded to the allegations

and also stated the following regarding distributions from the Trust:

Historically, we have tried to make distribution of the net
income of the trust to the three current beneficiaries. As you
know, the trust agreement gives the trust the full discretion as
to whether or not to make such distributions and, if so, in what
amounts. In other words, the trust agreement does not require
us to make distributions of income, nor must any such
distributions necessarily be equal between beneficiaries.

The reason I point this out is that we are quite concerned
regarding your failure, since 1985, to make any payments on
the note that had a face value of $33,333.33. Under its terms
and with accrued interest, you now owe over $112,000. In
accordance with the terms of an amendment to the trust, your
Father wanted for us to distribute the cash from the note
payment to Elaine and Steve after the death of your Mother.
Not only are we not able to do that since you have not made
payments on the note, but the note continues to accrue interest.
While we intend to carry out the terms of the trust regarding
any discretionary distribution of principal and/or interest to
you, we must begin making any income payments that have
historically been paid to you and use those amounts to make
payments on your liability to the trust. If your circumstances
would warrant a reconsideration of making a distribution
directly to you, please, at any time, make application for us to
reconsider our position.10

On December 19, 2009, Debtor again sent an e-mail to Richard Mullin and Ted

Loomis in which he referred to a “civil law suit’ against the bank. By an e-mail dated

10 Dkt. 211-2 at 27-28.

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April 15, 2010, to Ted Loomis, Debtor’s attorney threatened to sue the bank for breach of
fiduciary duty and conversion relating to the farm corporation.

In 2010, Richard Mullin recognized that Debtor’s failure to make payments on the
Note would preclude the express purpose of the Trust to divide the Trust assets equally
among the three children. He testified in a deposition as follows:

The primary thing was that I’d run an amortization
schedule of that note plus its accrued interest, and I don’t
remember whether it had already reached but it was not too far
from reaching a one-third share of the trust as it was valued at
that time. And I was concerned that if we waited until 2024
that we would not be able to satisfy a one-third distribution of
the trust to the three beneficiaries.11

On June 2, 2010, the Trustee determined to distribute $4,811 in accrued income to
each beneficiary. But Debtor’s distribution of $4,811 was not paid to him in cash. Instead
it was applied to “interest on Notes.” At the same time, cash distributions of $4,811 were
made to Elaine and Steven, and the $4,811 to which Debtor would have been entitled was
divided into two additional cash distributions of $2,405.50 that were made to Steven and
Elaine.

ANALYSIS.

A. The Nature of the Controversy.
Debtor’s memorandum in support of his motion for summary judgment presents
four issues: (1) whether the discharge injunction applies to the Note; (2) whether the

11 Dkt. 211-5 at 3.
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doctrine of recoupment applies to the Trustee’s setoff of interest on the Note against the
June 2010 income distribution; (3) whether the Trust agreement gives the Trustee
authority to exercise the setoff; and (4) if the bankruptcy injunction was violated willfully
and in bad faith, whether Debtor is entitled to actual damages, attorney fees, and punitive
damages. According to Debtor, the material facts are uncontroverted and based upon the
foregoing issues, he is entitled to judgment as a matter of law.

The Trustee responds that: (1) setoff was authorized by the terms of the Trust and
applicable law; and (2) the doctrine of recoupment does not allow Debtor to be enriched
by his discharge in bankruptcy. Elaine and Steven respond to Debtor’s motion and also
move for summary judgment, contending that: (1) through the doctrine of recoupment, the
Trustee could offset the interest against the distribution notwithstanding Debtor’s prior
discharge; and (2) in the alternative, the Trust granted the Trustee inherent authority to
exercise setoff.

Although the parties contest the manner in which some of the facts are presented in
the opponents’ briefs, the material facts of this controversy, as found above, are
uncontroverted. Under Rule 56,12 made applicable to this contested matter by Bankruptcy
Rules 9014(c) and 7056,13 the Court is therefore authorized to grant the motion of a
movant who is entitled to judgment as a matter of law.

B. The Discharge Injunction of 11 U.S.C. § 524(a)(2) Applies to the Note, But
12 Fed. R. Civ. P. 56.

13 Fed. R. Bank. P. 9014(c) and 7056.

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the Doctrine of Recoupment Is a Recognized Exception to the Injunction.

As stated above, Debtor filed for relief under Chapter 7 on November 25, 1988.

The Peoples Bank and the Trust were listed as creditors. A proof of claim for payment of

the Note was filed. Debtor was granted a discharge on July 19, 1989. The Note was

included in the discharged debts. The effect of a discharge is addressed by § 524(a)(2) as

follows:

(a)
A discharge in a case under this title —
. . .
(2) operates as an injunction against the
commencement or continuation of an action, the employment
of process, or an act, to collect, recover or offset any such debt
as a personal liability of the debtor, whether or not discharge
of such debt is waived.
The parties agree that the foregoing injunction applies to Debtor’s personal liability on the

Note.

However, as the parties recognize, under the doctrine of recoupment, the discharge

injunction does not prohibit a creditor’s defensive use of the discharged debt.14 The

controlling question in this case is whether the recoupment doctrine applies to the

Trustee’s offset. Recoupment originated as an equitable rule of joinder, allowing

14 Beaumont v. Dept. of Veteran Affairs (In re Beaumont), 586 F.3d 776, 781 (10th Cir. 2009) (“If
the recoupment doctrine applies, then there is no ‘debt’ or ‘claim’ here as defined in the Bankruptcy
Code, and Defendant has not violated the automatic stay nor the discharge injunction”); Anthem Life Ins.
Co. v. Izaguirre (In re Izaguirre), 166 B.R. 484, 493 (Bankr. N.D. Ga. 1994) (“Recoupment used as a
defense does not contravene the fresh start policy implicit in the discharge provisions of the Bankruptcy
Code.”); Harry Bradford Barrett Residuary Trust v. Barrett (In re Barrett), 410 B.R. 113, 122 (Bankr.

S.D. Fla. 2009) (“Further, recoupment is not affected by the automatic stay, nor is exercising the equitable
right a violation of the discharge injunction.”).
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adjudication in one suit of two claims that the common law required be brought
separately.15 “Under recoupment, a defendant could meet a plaintiff’s claim with a
countervailing claim that arose ‘out of the same transaction.’”16 In bankruptcy,
“‘[r]ecoupment’ is an equitable doctrine . . . that allows one party to a transaction to
withhold funds due another party where the debts arise out of the same transaction. In
other words, the doctrine ‘allows a creditor to recover a pre-petition debt out of payments
owed to the debtor post-petition.’”17 Determination of whether the doctrine applies in this
case depends upon whether Debtor’s obligation to pay interest on the Note arose out of the
“same transaction” as his right to receive income distributions from the Trust.

To determine whether recoupment applies, the Court will reverse the order of issues
two and three presented by the Debtor. It will first examine the two debts involved in the
offset and their relationship under the Trust and Kansas law. Then the Court will examine
recoupment in more detail.

C. The Trustee’s Offset Was Authorized under the Trust and Kansas Law.
The transaction which Debtor contends was not authorized by the Trust agreement
and violated the discharge injunction is the Trustee’s application of Debtor’s June 2010
income distribution from the Trust to his interest obligation to the Trust under the Note.

15Ashland Petroleum Co. v. Appel (In re B & L Oil Co.), 782 F.2d 155, 157 (10th Cir. 1986).

16 Id. (citing J. Moore, 3 Moore’s Federal Practice ¶ 13.02, at 13-13 n. 1 (2d ed. 1985) and 20
Am. Jur. 2d Counterclaim, Recoupment, and Setoff, §§ 16-18 (1965)).


17 Beaumont, 586 F.3d at 780 (quoting Conoco, Inc., v. Styler (In re Peterson Distributing, Inc.),
82 F.3d 956, 959 (10th Cir. 1996), and City of Fort Collins v. Gonzales (In re Gonzales), 298 B.R. 771
(Bankr. D. Colo. 2003)).

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To address Debtor’s contentions, the Court must examine the Trustee’s offset authority
under Kansas state law.

Neither the Debtor nor any of the other parties challenge the authority of the
Trustee to enter into the Note and to collect the amount due under the Note. Indeed, the
Trustee had such authority. The Note was authorized by the 1985 Amendment of Trust
Agreement. Authority to enforce the Note is found in K.S.A. 58a-815(a)(2)(A), a
subsection of the Kansas Uniform Trust Code,18 which grants to trustees of express trusts
“[a]ll powers over the trust property which an unmarried competent owner has over
individually owned property.”

Likewise, neither the Debtor not any of the other parties challenge the authority of
the Trustee to make the June 2010 income distribution. Kansas law allows the Trustee to
apply Debtor’s income distribution to payment of interest on the Note. Under the law of
trusts, “[a] trustee who has a duty to pay or distribute property to a beneficiary should be
able to set off against the sum due . . . (2) a liability of the beneficiary to the trustee in his
representative capacity.”19 K.S.A. 58a-816(18) provides a trustee of an express trust may
“make loans out of trust property, including loans to a beneficiary on terms and conditions
the trustee considers to be fair and reasonable under the circumstances, and the trustee has

18 The 1984 Amendment to Trust Agreement provides that the Trustee has “[A]ll powers
expressly set forth in the Uniform Trustees Powers Act (K.S.A. 58-1201, et seq) as may be amended from
time to time.” The referenced act was repealed in 2002 and replaced by the Kansas Uniform Trust Code,

K.S.A. 58a-101, et seq.
19 George Gleason Bogert, George Taylor Bogert, and Amy Morris Hess, The Law of Trusts and
Trustees, § 814, text associated with footnote 56 (current through 2011 update) (available under database
identifier BOGERT at www.westlaw.com).

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a lien on future distributions for repayment of those loans.”

Under Kansas probate law, which is similar to the law of express trusts, an heir “is
entitled to his distributive share of real property belonging to the estate only after all
equities in favor of the estate against him personally have been satisfied.”20 The debt of a
distributee to an estate and interest thereon may be offset as a deduction from the
distributee’s share of the estate, even though the statute of limitations has run on
enforcement of the note.21 Such offset is an equitable right, not the technical right of setoff
available in actions at law.22

Under the Bankruptcy Code, discharge eliminates the debtor’s personal liability on
the obligation but does not “absolve the underlying debt retroactively.”23 “[A] bankruptcy
discharge extinguishes only one mode of enforcing a claim — namely an action against
the debtor in personam.”24 As a matter of state law, discharge of the debt, like the running
of the statute of limitations, does not provide the beneficiary a defense to offset. Reported
decisions from at least two states have upheld offset by a trustee to satisfy a discharged
debt to a trust. The Minnesota Court of Appeals has held that the trustee of an express

20 Blackwood v. Blackwood, 120 Kan. 72, 72 Syl. ¶ 1, 242 P.451, 452 Syl. ¶ 1 (1926).

21 In re Estate of Wernet, 226 Kan. 97, 108-09, 596 P.2d 137, 147 (1979).

22 Blackwood, 120 Kan. at 74-75, 242 P. at 452 (quoting Webb v. Fuller, 85 Me. 443, 27 A. 346

(1893)).
23 3 William L. Norton, Jr., and William L. Norton III, Norton Bankr. Law & Practice 3d, § 58:2
at 58-6 (Thomson Reuters/West 2012).
24 Johnson v. Home State Bank, 501 U.S. 78, 84 (1991).
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trust may exercise discretion granted by the trust documents to offset distributions to a

beneficiary to satisfy a discharged debt.25 The Massachusetts Supreme Court has held a

trust provision directing that if any beneficiary is indebted to the donor at the time of

distribution, such indebtedness must be deducted from the beneficiary’s distributive share,

applies to debts which have been discharged in bankruptcy, reasoning that discharge does

not extinguish the obligation 26

Further, the Court finds that the Trustee’s application of Debtor’s income

distribution to the interest under the Note was a proper method to effect the Grantor’s

intent that distributions of principal to the beneficiaries upon termination of the Trust in

2024 be equal. This intent is stated in Article VI of the 1984 Amendment to Trust

Agreement, which also provides that to accomplish this goal, the Trustee should consider

all transfers to the Grantor’s children. Article VI(C)(4) provides:

Upon termination, the Trustee shall distribute the
principal and any accrued and undistributed income of the trust
in equal shares to the children of the Grantor, provided, the
Trustee is authorized and empowered to make unequal
distribution of the principal and any accrued and undistributed
income in cash or in kind in order to carry out the desires of
the Grantor for the Trustee to consider all transfers to
Grantor’s children that have been made by the Grantor and his
wife by Will or otherwise. Any loans made by Grantor or his
wife which have not been repaid shall be treated as transfers
by the Trustee, whether or not the statutes of limitation have
run. The decision of the amounts of the transfers shall be in
the Trustee’s sole and absolute discretion and the decision of

25 Hurtig v. Gabrielson, 525 N.W.2d 612 (Minn. App. 1995).

26 Groden v. Kelley, 382 Mass. 333, 415 N.E. 2d 850 (1981).
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the Trustee shall be final.

In 2010, the Trustee determined that if the Note was not paid and interest continued
to accrue, then upon termination of the Trust, the amount of the “transfer” to Debtor
arising from the Note and accrued interest would exceed the anticipated principal available
for distribution to Elaine and Steven. In an attempt to remedy this problem in part, the
Trustee in his discretion determined to use income payments, which had historically been
paid to Debtor, to make payment on Debtor’s liability to the Trust. Debtor was advised of
this position in a letter to him from Richard Mullin dated December 18, 2009, and in June
2010, Debtor’s share of the 2010 income distribution was applied to interest on the Note.
Debtor’s one-third share of the income to be distributed was $4,811. Annual interest
under the Note was $3,333.33 and the accrued interest was approximately $79,000.

Debtor contends that the Trustee’s reliance upon the foregoing provision of the
Trust regarding distribution of principal at termination is improper because: (1) the Note
was discharged; (2) the Note is not a loan; (3) the distribution was of interest, not
principal; and (4) the sale of property which gave rise to the Note was not a transfer by the
Grantor or his wife. The foregoing discussion disposes of Debtor’s first argument; as a
matter of state law, the discharge does not bar offset. Debtor’s second argument, that the
Note is not a loan, rests upon the fact that the Note is for payment of the value of property
transferred to Debtor and his wife by the Trust, not for cash advanced to them. The Court
rejects this restrictive construction of the Trustee’s authority. It is only the second
sentence of the foregoing provision of the Trust which refers to loans, and reliance on that

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sentence is not necessary to support the Trustee’s actions. The Trust directs the Trustee to
consider “all transfers” and gives the Trustee full power to decide the “amounts of the
transfers.” The Trust’s conveyance of real property to Debtor and his wife on credit was a
transfer; the Trustee has determined that the projected credit of the transfer on the date of
termination of the Trust will be the amount of principal and accrued interest on the Note,
and that determination is final. Debtor’s third argument, that offset was not authorized by
Article VI(C)(4) because the distribution was of interest, not principal, also fails. The
Trustee relies upon that article as providing a reason to exercise offset, not as providing
the express authority for doing so. That authority is discussed above. Debtor’s fourth
argument, that the Trustee’s action is unauthorized because the transfer of the real property
was by the Trust, rather than the Grantor and his wife, likewise fails. The Trust provision
is broadly written to apply to “all transfers to Grantor’s children that have been made by
the Grantor and his wife by Will or otherwise.” The use of the broad term “otherwise” is
sufficient to cover transfers by the Trust established by the Grantor.

The Court therefore concludes that the Trustee’s action in offsetting the Debtor’s
interest obligation under the Note against the income distribution was in accord with the
Trust provisions and applicable Kansas law.

D. The Offset Did Not Violate the Discharge Injunction Because the Doctrine
of Recoupment Applies.
Whether the Trustee’s actions, even though in accord with state law and his
authority under the Trust, constituted a violation of the discharge injunction is a matter of

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federal law. Section 524(a)(2) of the Bankruptcy Code provides that a discharge “operates
as an injunction against . . . an act, to collect, recover or offset any such debt as a personal
liability of the debtor, whether or not discharge of such debt is waived.” But if the
recoupment doctrine apples, then there is no “debt” as defined in the Bankruptcy Code,
and there is no violation of the injunction.27

Recoupment applies only when the two debts arose out of the “same transaction.”
The Tenth Circuit has adopted the Third Circuit’s “single integrated transaction”
definition of the phrase “same transaction.28 Under this construction, “same transaction”
means that “‘both debts must arise out of a single integrated transaction so that it would be
inequitable for the debtor to enjoy the benefits of that transaction without also meeting its
obligations.’”29 When adopting this test, the Tenth Circuit emphasized the equitable basis
for the narrow construction. The Circuit reasoned that the “‘same transaction’ requirement
acts as a mechanism to ensure that equitable reasons for recoupment are present.”30 Under
this test, when the issue is whether offset violates the discharge injunction, the Circuit

27 Beaumont, 586 F.3d at 781.

28 Peterson Distributing, 82 F.3d 956, 960 (10th Cir. 1996) (citing University Medical Ctr. v.
Sullivan (In re Univ. Medical Ctr., Inc.), 973 F.2d 1065, 1081 (3rd Cir. 1992)).


Elaine and Steven urge this Court to construe the same transaction requirement for recoupment
using the “logical relationship” test. Dkt. 233 at 12-16. This is a less strict test of relationship than the
“single integrated transaction” test. But the “logical relationship” test was expressly rejected by the Third
Circuit in University Medical Center, 973 F.2d at 1081, when it adopted the “single integrated
transaction” test, and the Tenth Circuit has expressly adopted the Third Circuit’s narrow construction.
Peterson Distributing, 82 F.3d at 960-61.

29 Peterson Distributing, 82 F.3d at 960 (quoting University Medical, 973 F.2d at 1081).

30 Id. at 960-61.

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examines the “equities of the case, and determine[s] whether the claims ‘are so closely
intertwined that allowing the debtor to escape its obligation would be inequitable.’”31

Examination of Tenth Circuit recoupment decisions illuminates the test. In
Davidovich,32 the debtor, an attorney, brought an action against his former law partner to
recover an amount awarded to him in an arbitration proceeding. Debtor’s former partner
responded by seeking to set the debtor’s arbitration award off against two claims he held
against the debtor, one arising from the same arbitration proceeding as the debtor’s claim
and the other for funds that the former partner had paid into the law partnership when the
debtor failed to make a capital contribution. The Tenth Circuit allowed recoupment as to
the claims arising from the arbitration proceeding; both debts arose from “a single
integrated transaction, the binding arbitration proceeding . . . such that it would be
inequitable for Davidovich to enjoy the benefits of that transaction without meeting its
obligations.”33 However, recoupment was not allowed as to the partnership contribution,
because the right to compensation arose under the partnership agreement and not the
arbitration award which was the basis for the debtor’s claim.34

In Peterson Distributing,35 the Tenth Circuit expressly adopted the Third Circuit’s

31 Beaumont, 586 F.3d at 781 (quoting Peterson Distributing, 82 F.3d at 960).

32 Davidovich v. Welton (Davidovich), 901 F.2d 1533 (10th Cir. 1990).

33 Id. at 1537.

34 Id. at 1538.

35 Peterson Distributing, 82 F.3d at 960.

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“single integrated transaction” test and emphasized the equitable foundation of the
doctrine which had been recognized in prior Tenth Circuit opinions. In Peterson
Distributing, the Chapter 7 debtor was a franchisee of creditor Conoco and opposed
Conoco’s attempt to offset or recoup $69,370.49 worth of credit card invoices owed to the
debtor against Conoco’s $245,159.06 claim against the debtor for purchases of Conoco
products. The credit card invoices had been accepted by the debtor from its customers
who purchased Conoco and other products and services. Under the franchise agreement,
Conoco agreed to accept the invoices and pay the debtor the face amount of the invoices,
less three percent. The Tenth Circuit held that the two obligations did not arise from a
single integrated transaction.36 Although both obligations were governed by a single
franchise agreement, that agreement attempted to set forth the entire business relationship
between Conoco and Peterson and therefore governed many transactions. Further, the
Circuit found that “no overriding equitable reason exists that compels the application of
the doctrine of recoupment;”37 in that case; rather, allowing recoupment would have
unjustly enriched Conoco to the detriment of other creditors.

In Beaumont,38 the Tenth Circuit held that recoupment by the Department of
Veteran Affairs (VA) of prepetition overpayments of disability benefits to the debtor from
postpetition benefits owed to the debtor did not violate the automatic stay or the discharge

36 Id. at 961-63.

37 Id. at 962.

38 Beaumont, 586 F.3d 776.

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injunction. The debtor was a disabled veteran who began receiving disability benefits in

1993. In 2001, he received a probate distribution. Pursuant to federal law, the debtor’s

benefits were subject to being reduced by the amount of any income he received, including

an inheritance. In the spring of 2005, after learning of the inheritance, the VA advised the

debtor that he owed $18,448 because of the inheritance and that it intended to collect the

claim by offsetting future disability payments owed to the debtor, as was expressly

permitted by statute. The debtor responded by filing for bankruptcy relief, and the VA

continued to offset his benefits during the bankruptcy proceedings. The debtor contended

this conduct violated the automatic stay and the discharge injunction. The Tenth Circuit

disagreed.

This Court finds that the obligations of both parties did

arise from the “same transaction.” Plaintiff’s [debtor’s] claim

for and award of pension benefits generated the Defendant’s

[VA’s] obligation to pay those benefits. The Defendant’s

obligation to pay benefits was and is contingent upon

Plaintiff’s financial situation, his annual income, and his

responsibility to keep the Defendant informed of his financial

situation. Plaintiff’s inheritance had the effect of reducing the

amount of benefits he could receive from the Defendant.

Therefore, Plaintiff’s inheritance was directly related to or

intertwined with the amount of benefits Defendant was

obligated to pay to him, and the resulting overpayment of

benefits. It is unlawful for Plaintiff to keep any overpayments

so long as the Defendant, through its own administrative

procedures, has properly determined the amount of

overpayment and properly considered Plaintiff’s disagreement

with that determination. The Court believes that it would be

inequitable for the Plaintiff to receive his inheritance, continue

to receive benefits as if his income was zero, then be able to

discharge in bankruptcy the overpayments once it was

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determined that he had been overpaid.39

In this case, Debtor’s obligation to the Trust involved in the setoff is his liability for
interest on the Note. As discussed above, the effect of discharge is limited to Debtor’s
personal liability under the Note. Section 524 “does not address the continuing validity of
the discharged debt.”40 Therefore, discharge did not extinguish the obligation to the Trust
or affect the accrual of interest.41 Interest continues to accrue on the Note at the rate of
$3,333.33 per year. With respect to the year for which the income distribution was made,
there is no doubt that Debtor’s obligation for that interest and the Debtor’s right to an
income distribution are intertwined. Both relate to the administration of the Trust during
the same time period and to Debtor’s then current rights and obligations. The recoupment
here is very similar to the recoupment in Davidovich, where both debts arose from the
same arbitration award. It would be inequitable for the Debtor to receive an income
distribution for the same period of time for which he was not honoring his obligation to
pay interest.

This leaves the question whether the Trustee violated the discharge injunction by

39 Id. at 781.

40 3 Norton Bankruptcy Law & Prac. 3d, § 58:2 at 58-6.

41 See Bank of Prairie v. Picht (In re Picht), 428 B.R. 885, 891 (10th Cir. BAP 2010) (after
discharge of a secured debt, the secured debt continues to exist and is enforceable against the property
securing the debt; the lien survives and its value is not in any way limited or stripped by the discharge);
Hagemann v. Chemical Mortgage Co. (In re Hagemann), 86 B.R. 125 (Bankr. N.D. Ohio 1988) (holding
that discharge did not bar mortgage foreclosure action to enforce in rem rights to recover principal and
interest for the period of time before and after discharge, up to the value of the collateral).

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offsetting the remaining $1,477.6742 against Debtor’s interest obligation for a prior year.
The Court finds there was no violation. Although these two transactions are not as closely
related in time as are Debtor’s 2010 interest obligation of $3,333.33 and a portion of the
2010 trust distribution equal to that amount, they still satisfy the “single integrated
transaction” test. The distribution of income is related to the accrued interest because,
absent recoupment, the Note plus accrued interest would exceed Debtor’s one-third
interest in the principal of the Trust. Here, as in Beaumont, where past overpayments were
offset against current benefits, the offset is authorized by non-bankruptcy law. Unlike
Peterson Distributing, there are no creditors whose rights will be adversely affected, so the
only bankruptcy policy impacted is Debtor’s fresh start as implemented by the discharge
injunction. This interest in a fresh start pales when compared with the Trustee’s interest in
carrying out the Grantor’s intent to equalize the principal distributions to the beneficiaries
upon termination of the Trust. And allowing recoupment promotes equity. Because of
Debtor’s discharge, the Trustee is prohibited from enforcing the Note as a personal
liability of Debtor. As a result, Elaine and Steven will not receive their distributions of the
Note principal, which distributions are specifically provided for in the Trust amendment
authorizing the Note. Application of the discharge injunction as a shield to prevent the
offset of income distributions against Debtor’s interest obligations would compound the
injustice by allowing Debtor to benefit from current distributions from the Trust without

42 Calculated by subtracting $3,333.33, one year’s interest, from the $4,811 income distribution.
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having to comply with his duties to the Trust.

E. Debtor’s Motion for Summary Judgment on his Motion for Contempt Is
Denied.
The linchpin of Debtor’s motion to hold the Trustee in contempt is the contention
that the June 2010 offset of his income distribution to satisfy a portion of the accrued
interest on the Note was a violation of the discharge injunction of § 524(a)(2). The
material facts concerning the setoff are uncontroverted. And, for the reasons stated above,
the Court has found that the doctrine of recoupment applies to the offset, so that there was
no violation of the discharge injunction. Debtor’s motion for summary judgment on his
motion for contempt is therefore denied.

Denial of the motion for for summary judgment on the motion for contempt renders
moot Debtor’s allegations, based upon Debtor’s correspondence with the Trustee in late
2009 and 2010, that the Trustee willfully violated the discharge injunction and acted in
bad faith. The Court therefore does not address the Debtor’s fourth issue.

F. Elaine Stelter’s and Steven Lunt’s Motion for Summary Judgment Is
Granted.
Elaine and Steven filed a cross motion for summary judgment. They contend that
the material facts are uncontroverted and as a matter of law, judgment should be entered
against Debtor, since the Trust is entitled to recoup Debtor’s interest obligation. For the
reasons stated above, the Court agrees. The motion for summary judgment filed by Elaine
Stelter and Steven Lunt is granted.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rules

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7052 and 9014(c) of the Federal Rules of Bankruptcy Procedure, which make Rule 52(a)
of the Federal Rules of Civil Procedure applicable to this matter.
JUDGMENTS.


Judgment is hereby entered denying Debtor’s Motion for Summary Judgment43 and
granting Elaine L. Stelter’s and Steven A. Lunt’s Cross Motion for Summary Judgment.44
The judgments based on this ruling will become effective when the ruling is entered on the
docket for this case, as provided by Federal Rule of Bankruptcy Procedure 9021.

IT IS SO ORDERED.
# # #


43 Dkt. 211.
44 Dkt. 233.
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