Opinion
600766/97.
Decided June 22, 2004.
Plaintiffs Masterwear Corporation, Master Trouser Corporation, Master Slack Corporation, Master Casual Wear Corporation, Master Apparel Corporation, and Lexington Apparel Corporation move for summary judgment dismissing the counterclaim of defendant Norman Bernard, their former Chief Executive Officer. Plaintiff Signal Capital Corporation is not represented in this motion.
In 1987, defendant purchased half of plaintiffs' (referring only to the movants) common stock for $500,000. In May 1991, defendant and plaintiffs entered into a personal services agreement (the PSA). The PSA provided that if defendant died or became incapacitated, or if plaintiffs terminated his employment without cause, plaintiffs would buy back all of defendant's stock at a price determined according to the PSA.
On June 18, 1997, defendant tendered his resignation, citing incapacitation as the reason, and requesting that plaintiffs buy his stock. That September, plaintiffs terminated defendant's employ, purportedly for cause. Plaintiffs proceeded to sue defendant, claiming, among other things, that he paid himself excess compensation over the amount agreed to in the PSA, and that he unlawfully retained a $500,000 incentive bonus after being terminated. Defendant alleges that plaintiffs breached the PSA by refusing to buy his stock. Defendant's eighth affirmative defense, the only one that relates to these plaintiffs, is that any damages that they win against defendant should be offset by the damages that he wins against them for their breach of the PSA. Defendant claims that his damages amount to $500,000. Plaintiffs now move to dismiss the affirmative defense, which they refer to as a counterclaim.
In October 1997, plaintiffs filed for reorganization under Chapter 11 of the Bankruptcy Code. They claim that the counterclaim should be dismissed because the Bankruptcy Code and the reorganization plan bar any recovery by defendant. By its express terms, 11 USC § 510 (b) subordinates claims arising from the sale or purchase of the debtor's securities. Pursuant to section 510 (b), general creditors must be paid in full before shareholders and investors receive any payment from the bankrupt entity ( In re Stylesite Mktg., Inc., 253 BR 503, 510 [SD NY 2000]; In re Granite Partners, L.P., 208 BR 332, 342, 344 [SD NY 1997]). Plaintiffs claim that defendant is an investor whose claim is subordinated under section 510 (b).
Plaintiffs' reorganization plan provides that the holders of common stock will only be paid what remains after other creditors are paid (Notice of motion, Ex. B, reorganization plan, ¶ 5.9). According to plaintiffs, nothing will be left after the general creditors are paid, none of whom will be paid in full. Defendant, as an investor and shareholder, will receive nothing from the bankrupt estate. Therefore, plaintiffs argue, defendant's counterclaim should be dismissed.
Defendant points out that there is a difference between seeking affirmative recovery from the assets of a bankrupt entity and asserting the full amount of his claim as a setoff. Defendant is not seeking to have plaintiffs pay him damages, which, apparently, is why his breach of contract claim is styled as an affirmative defense, rather than as a counterclaim. He asserts that a creditor is entitled to assert offsets against the debtor, even though the offsets derive from discharged or subordinated claims.
The Bankruptcy Code generally allows the creditor of an estate to set off its claim against the debtor with the debtor's claim against the creditor if (1) both debts arose before the bankruptcy filing, (2) the two debts are "mutual obligations," and (3) the creditor has a right of setoff under nonbankruptcy law ( 11 USC § 553 [a]). New York has codified the common law right to setoff (Debtor and Creditor Law § 151).
At the time that plaintiffs made this motion, the Bankruptcy Court had confirmed the reorganization plan. For the purposes of this motion, the court will assume that defendant's counterclaim would be subordinated under 11 USC § 510 (b) and/or that plaintiffs have since been discharged from the counterclaim under 11 USC § 524.
In In re Saxon Indus., Inc. ( 43 BR 64 [SD NY 1984]), in an action commenced by the debtor, the defendant moved to lift the automatic stay in order to file counterclaims against the debtor. The debtor argued against lifting the automatic stay on the ground that the counterclaims against it would be subordinated as claims arising from the purchase or sale of securities, or under principles of equitable subordination, under 11 USC § 510 (b) and (c), respectively. The court stated that, where a debtor brings a lawsuit and then invokes the automatic stay to prevent the defendant from asserting counterclaims, "`the situation warrants a very thoughtful scrutiny'" ( In re Saxon Indus., Inc., 43 BR at 67, quoting Matter of Bohack Corp. v. Borden, Inc., 599 F2d 1160, 1168 [2d Cir 1979]). Given that the debtor commenced the lawsuit, the court found that it would be inequitable to prevent the defendant from pressing counterclaims, even if defendant would not be entitled to any recovery ( id.). The court granted the defendant's motion to lift the stay ( id.).
Similarly, in Bohack Corp. ( 599 F2d 1160), the debtor, which initiated the lawsuit, invoked the protection of the automatic stay to prevent defendant from pressing a counterclaim for a setoff. Deciding against the debtor, the court stated:
Just as the court has discretion to deny setoffs in appropriate cases, so the court has an equitable duty to grant a setoff when a debtor moves outside the confines of the bankruptcy court in an attempt to reap the benefits but circumvent the burdens in another forum
( Bohack Corp., 599 F2d at 1168; see also In re Wedtech Corp., 87 BR 279, 289 [SD NY 1988]; In re Overmyer, 32 BR 597, 601-602 [SD NY 1983]).
Unlike the actions cited, this one does not involve an automatic stay. However, the principles that led to the federal courts' decisions apply equally here. In light of the litigation initiated by plaintiffs, in which they seek damages from defendant, it would clearly be inequitable to prevent defendant from attempting to absolve himself from having to pay damages. Plaintiffs are incorrect in asserting that the law automatically bars an offset that is based on a subordinated claim.
Nor does the debtor's discharge in bankruptcy preclude a defendant from seeking an offset for debts ( Friedlander v. Doherty, 851 F Supp 515, 518 [ND NY 1994]; Posey v. United States Dept. of Treasury — Internal Revenue Serv., 156 BR 910, 915 [WD NY 1993]). In a related context, where the defendant was the debtor, and his counterclaims were closely related to the plaintiff's causes of actions, the defendant was not allowed to use his discharge in bankruptcy to prohibit the plaintiff from recovering, and, at the same time, assert a counterclaim against the plaintiff ( George Strokes Elec. and Plumbing Inc. v. Dye, 240 AD2d 919, 920 [3rd Dept 1997]).
As plaintiffs are incorrect about the law, and as they offer no other reason that defendant should not be allowed to assert an offset, it is
ORDERED that the motion for summary judgment dismissing the eighth affirmative defense/counterclaim is denied.