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Where There is a Valid Setoff, Requirements of Section 553 Govern Over Section 547.

October 10, 2017, California – Prepetition, Debtor Jubilee Faasoa incurred credit card debt to Defendant Army & Air Force Exchange Service. Subsequently, the Debtor filed his 2016 federal income tax return, expecting a refund, but the U.S. Department of the Treasury intercepted the tax overpayment and applied it to the debt he owed the Defendant. No funds remained once the setoff was complete. Consequently, the Debtor did not receive a tax refund and despite repeated demands, the Defendant declined to issue one. The Plaintiff brought an adversary proceeding to seek immediate turnover of the tax refund under Sections 522, 541, 542 and 547 and Section 362(k)(1) damages, including punitive damages, for the Defendant’s alleged ongoing stay violation. The Defendant brought a motion to dismiss under Rule 12(b)(6).

The Court ruled that there was no merit in the Debtor’s claims that the Defendant was required under Sections 522, 541, 542, and 547 to turn over the alleged amount of $2,865 plus interest which the IRS withheld from his tax refund and paid to the Defendant less than 90 days before he declared bankruptcy. The Court found that the Defendant had non-bankruptcy law setoff rights that were recognized and enforceable in bankruptcy under Section 553. The Court held that although the Plaintiff had the standing to bring the adversary proceeding since nothing remained of his tax overpayment once setoff was complete, he was not entitled to a tax refund. Since he had no interest in the tax refund on the petition date; it never became exemptible estate property. Further, since the tax refund was a disputed debt and not estate property subject to exemption, Section 542 was not an available remedy. Further, no compelling circumstances were identified by the Debtor to justify disallowing setoff. The Court granted the Defendant’s motion and dismissed the complaint without leave to amend.

(Faasoa v Army & Air Force Exch. Serv. (In re Faasoa), 2017 Bankr. LEXIS 3595 [Bankr SD Cal Oct. 10, 2017, Nos. 17-02558-CL7, 17-90153-CL].)


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