Memorandum of Decision Re: Setoff

IN THE UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re HUMBOLDT BAY GRAVEL, INC.,                                                 No. 92-11592      Debtor. ___________________________/ HUMBOLDT BAY GRAVEL, INC.,      Plaintiff,    v.                                                                                                   A.P. No. 92-1185 KENNETH and ELAINE DRAKE,      Defendants. ______________________________/
Memorandum of Decision
     Defendants Kenneth and Elaine Drake operate a business known as Drake Sand & Gravel on leased premises in Humboldt County. In 1991, they entered into a written agreement with plaintiff Humboldt Bay Gravel, Inc., whereby HBG obtained the rights to remove, process, and store gravel on the Drakes' premises.      Before HBG filed its Chapter 11 petition, a dispute arose between it and the Drakes as to who owed whom money under the agreement. In litigation which this court permitted the state court to hear during the course of the Chapter 11 proceedings, the state court found HBG liable to the Drakes for damages. Although several months have passed since the state court made its ruling, no judgment has been entered yet because of a dispute over its wording.      This adversary proceeding dealt with issues not resolved by the state court, including ownership of aggregate material stored by HBG on the Drake premises. At the time of trial, with encouragement from the court, the parties hammered out an agreement. After a further hearing due to a dispute as to the wording of the agreement, the court entered a judgment on February 2, 1994. The judgment has become final.      Under the terms of the judgment, HBG was deemed to have rejected its agreement with Drake, giving Drake a prepetition claim. Instead of HBG removing its gravel, Drake was given the right to purchase it from HBG at a favorable price. The judgment provides, in pertinent part, that "Drake shall pay [$1.70 per ton] to HBG as unprocessed materials are removed and shipped from the stockpile and shipped by truck."      Since the judgment, Drake has removed considerable material but has not paid HBG anything. At a hearing held by the court, Drake admitted that he was willfully refusing to pay. He has decided, unilaterally, that he will set off his obligations under the judgment against HBG's prepetition obligation to him as determined by the state court.      Drake's prepetition claims were fully understood by all parties at the time they agreed to the judgment. Drake has no right to decide for himself that he is entitled to an offset. Such secret intentions are entirely contrary to a good faith settlement, and are forbidden both by principles of res judicata and by federal bankruptcy law. "To be eligible for setoff, both the mutual claim of the creditor and debt of the debtor must have arisen prior to the commencement of the case." 4 Collier on Bankruptcy (15th Ed.), section 553.08[1].      Accordingly, the court finds Drake to be in bad faith violation of the judgment. HBG shall have its injunctive relief as prayed in order to stop Drake from removing any more material. It may apply for such further relief as is necessary by ex parte application served on Drake's counsel.      Lest HBG feel entirely vindicated, the court feels the need to state that it is by no means convinced that HBG is treating Drake fairly as to this entire matter; it is only the court's compelling need to preserve the integrity of its judgments which compels this ruling. If, as HBG asserts, it can pay its creditors in full, then it may well be bad faith for HBG to refuse to allow a setoff if such refusal will put Drake out of business. Additionally, Drake's prepetition claim, which includes both the state court damages and a yet-undetermined amount for rejection of the executory contract with HBG, may well put Drake in the position of being able to block confirmation of the HBG plan. While reorganization is generally to be preferred to liquidation, in this case it may be justice for both sides to lose their businesses if they cannot see their way clear to reach a fair and open compromise.      Counsel for HBG shall submit a form of injunction. THe court will review it before signing it, but will brook no further dispute from Drake as to its wording.
Dated: May 5, 1994                                                                                                  _______________________                                                                                                                                                    Alan Jaroslovsky                                                                                                                                                    U.S. Bankruptcy