The opinion of the court was delivered by: Judge Conner
Presently before the court is an appeal from the decision of the United States Bankruptcy Court for the Middle District of Pennsylvania limiting allocation of Appellant-creditor's setoff of certain federal income tax refunds against some of Appellee-debtors' pre-petition federal tax liabilities to priority tax liabilities only. Appellant, the United States Internal Revenue Service ("IRS"), concedes that setoff is within the discretion of the bankruptcy court, but argues that once the bankruptcy court decides to allow setoff, the IRS is statutorily permitted to apply the setoff against any of the debtors' liabilities to the IRS. Appellees, Angel and Evangelina Martinez, counter that the decision regarding how to apply setoff, like the decision whether to permit setoff in the first instance, is committed to the discretion of the bankruptcy court.
The question presented is two-fold. First, the court must determine whether the bankruptcy court's equitable discretion regarding setoff extends to the allocation of setoff. Second, the court must determine whether the bankruptcy court's decision to restrict application of the setoff to the IRS's priority claim was proper given the governing standard of review. The court finds that decisions regarding setoff allocation lie within the equitable discretion of the bankruptcy court; however, the existing record fails to provide an adequate basis to assess whether the bankruptcy court properly exercised its discretion here. Accordingly, the court will remand this matter to the bankruptcy court for a more detailed explanation of its reasoning.
Appellees filed a voluntary joint petition for relief pursuant to Chapter 13 of the Bankruptcy Code ("the Code"), 11 U.S.C. §§ 101-1330, on January 6, 2005. (Doc. 2-2.) After various filings, the IRS held a pre-petition claim totaling $128,674.80 against the debtors (Doc. 2-8 ¶ 2), consisting of a $92,439.88 unsecured priority claim and a $36,234.92 unsecured general claim (Doc. 7 ¶ 2). (See also Doc 8 at 2.)
The debtors filed federal income tax returns for 2002, 2003, and 2004, claiming refunds for overpayments of $2,128, $2,565, and $2,362, respectively. (Doc. 2-8 ¶ 3.) On February 22, 2006, Appellant filed a motion for relief from Chapter 13's automatic stay to permit setoff of the debtors' pre-petition overpayments against their outstanding pre-petition tax liabilities.*fn1 (Doc. 2-8.) Debtors filed an answer to the motion on March 6, 2006, stating they had no objection to the setoff, as long as it was applied to the IRS's unsecured priority claim only. (Doc. 2-12.)
On April 25, 2006, the bankruptcy court held a hearing regarding the motion. (See Doc. 7, Ex. 101, Mot. for Relief from Stay Hr'g Tr., Apr. 25, 2006.) At that hearing, the bankruptcy court considered § 553 of the Code, 11 U.S.C. § 553, and found that it did not "necessarily compel the finding that the IRS has the discretion to decide [how to allocate setoff] in every situation." (Id. 2:8-3:19.) The bankruptcy court indicated that "under the facts of this case" it was inclined to grant the IRS relief from the automatic stay to setoff the debtors' pre-petition refunds against their pre-petition tax liabilities, but only against the IRS's unsecured priority claim. (Id. 3:19-22.) On April 27, 2006, the bankruptcy court issued an order to that effect. (Doc. 2-14.) The bankruptcy court's general statement at the April 25, 2006 hearing that its decision was based on "the facts of the case" was the only reason provided by the court for electing to allocate setoff solely to the IRS's priority claim. (See id.; Hr'g Tr.) The instant appeal followed. (Doc. 1.)
An appeal from an order of a bankruptcy court places the district court in the posture of an appellate tribunal, requiring it to accord the appropriate level of deference to the decision of the bankruptcy judge. In re Sharon Steel Corp., 871 F.2d 1217, 1222 (3d Cir. 1989). The factual findings of the bankruptcy court should not be overturned unless "clearly erroneous." Fed. R. Bankr. P. 8013. The district court should overrule issues committed to the discretion of the bankruptcy court only if a manifest abuse of discretion is apparent. Sharon Steel, 871 F.2d at 1222. In contrast, the bankruptcy court's resolution of legal issues receives plenary review. Id. After completing its review of the record, the district court may "affirm, modify, or reverse" the order of the bankruptcy court, or remand any portion of its decision "with instructions for further proceedings." Fed. R. Bankr. P. 8013.
The threshold question before the court concerns the standard of review applicable to the bankruptcy court's determination regarding setoff allocation. As both parties acknowledge, the setoff decision lies within the equitable discretion of the bankruptcy court. Norton, 717 F.2d at 772. Section 553 of the Code, which the parties agree applies to the instant setoff decision, provides in part:
Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case . . . .
11 U.S.C. § 553(a). Section 553 refers to exceptions in §§ 362 and 363, and includes language setting forth certain other exceptions, none of which are issues before the court on appeal.*fn2 The language of § 553 is "permissive, not mandatory" and "[i]ts application, when properly invoked before a court, rests in the discretion of that court, which exercises such discretion under the general principles of equality." Norton, 717 F.2d at 772 (internal quotations omitted).
However, § 553 of the Code does not create an independent right to setoff; rather, it preserves setoff rights that arise out of non-bankruptcy law. Id. The IRS's instant right to setoff arises from § 6402 of the Internal Revenue Code ("IRC"), 26 U.S.C. § 6402, which provides in part that "[i]n the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment." 26 U.S.C. § 6402(a). It is the interplay between Code § 553 and IRC § 6402 that guides Appellant's argument that once the bankruptcy court exercises its § 553 discretion to lift the stay and permit setoff, setoff is governed by the language ...