The opinion of the court was delivered by: Christopher C. Conner United States District Judge
Presently before the court is an appeal from the decision of the United States Bankruptcy Court for the Middle District of Pennsylvania allocating appellant's setoff*fn1 of federal income tax refunds to priority tax liabilities only. For the reasons that follow, the court will affirm the decision of the bankruptcy court.
On January 6, 2005, appellees, Angel and Evangelina Martinez (hereinafter "the debtors"), filed a voluntary joint petition for relief pursuant to Chapter 13 of the Bankruptcy Code ("the Code"). (Doc. 2 at 5.) Appellant, the United States Internal Revenue Service ("IRS"), holds a pre-petition claim totaling $121,619.80 against the debtors, consisting of an $85,384.88 priority claim and a $36,234.92 general claim. (See id. at 51.) The IRS also owes the debtors a pre-petition tax refund totaling $7,055. (Id. at 18-19, 28.) On February 22, 2006, the IRS filed a motion for relief from the automatic stay to permit setoff of the debtors' pre-petition tax refund against their outstanding pre-petition tax liabilities.*fn2 (Id. at 18-19.) The debtors filed an answer to the motion on March 6, 2006, stating that they had no objection to the setoff provided that it was applied to the IRS's priority claim only. (Id. at 28-29.) The debtors contended that the Code mandates full payment of priority claims in a Chapter 13 plan, but does not apply a similar mandate to general claims. See 11 U.S.C. § 1322(a)(2). Accordingly, allocating the setoff to priority debts would decrease the amount that the debtors would be required to tender to the IRS pursuant to their rehabilitation plan.
On April 25, 2006, the bankruptcy court held a hearing regarding the motion. (See Doc. 3.) At the hearing, the bankruptcy court considered § 553 of the Code, 11 U.S.C. § 553,*fn3 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. at 3.) The bankruptcy court indicated that "under the facts of this case," it would grant the IRS relief from the automatic stay to permit setoff, but would allocate the right of setoff to the IRS's priority claim. (Id.) An order to that effect followed on April 27, 2006. (Doc. 2 at 31.) The IRS appealed the bankruptcy court's decision on May 5, 2006, arguing that it was statutorily permitted by § 6402 of the Internal Revenue Code ("IRC") to apply the setoff against any of the debtors' liabilities.*fn4 (Doc. 2 at 32-33.) After conducting a thorough analysis of the interplay between Code § 553 and IRC § 6402, this court held that a decision regarding setoff allocation falls within the discretion of the bankruptcy court.*fn5 See In re Martinez, No. 06-1130, 2007 WL 295406, at *2-4 (M.D. Pa. Jan. 29, 2007). Given the standard of review for discretionary rulings, the court determined that an abuse of discretion standard was appropriately applied, but that it was unable to conduct such a review because of the bankruptcy court's circumscribed rationale. Id. at *4. Accordingly, the court remanded the case to the bankruptcy court for further consideration.
On remand, the bankruptcy court issued an opinion dated March 7, 2007, which set forth the court's reasons for its setoff allocation. (Doc. 2 at 49-51.) The bankruptcy court explained that its allocation was prompted by a concern that the debtors' "plan would not be feasible if the refunds were not earmarked to satisfy priority claims." (Id. at 50.) The court cited numerous reasons why confirmation of the debtors' plan was "tenuous," including: (1) the "significant disparity between proposed priority payments under the plan and the amount of priority debt for which proofs of claim were filed," and (2) the debtors' "difficulties in making required post-petition payments." (Id. at 51.) The IRS filed the instant appeal of the bankruptcy court's decision on March 14, 2007, arguing that the bankruptcy court's opinion constituted an abuse of discretion. (Doc. 1.)
The issue presented by the instant appeal is whether the bankruptcy court appropriately exercised its discretionary authority when allocating the right of setoff to the IRS's priority claims only. Discretionary provisions place the authority to decide whether the final decision is "correct" in the hands of the lower court. See Washington v. Phila. County Court of Common Pleas, 89 F.3d 1031, 1035 (3d Cir. 1996). The appellate tribunal serves only to ensure that discretion was exercised rationally, that all relevant factors were considered, and that no clear analytical error was made. Oddi v. Ford Motor Co., 234 F.3d 136, 146 (3d Cir. 2000). The focus is on the means, not the end. A manifest abuse will generally be found only when the lower court failed either to comprehend the nature of its discretion or to employ it reasonably. See Cleary ex rel. Cleary v. Waldman, 167 F.3d 801, 804 (3d Cir. 1999); Ray v. Robinson, 640 F.2d 474, 478 (3d Cir. 1981).
In the instant case, the court finds that the bankruptcy court's setoff allocation decision did not constitute an abuse of discretion. Applying its equitable discretion, the bankruptcy court elected to limit setoff to priority claims because an alternate setoff allocation would weaken an already tenuous plan. The bankruptcy court's decision was supported by numerous facts suggesting that the debtors' plan was faltering, including the debtors' inability to make scheduled payments. The purpose of Chapter 13 bankruptcy filings, namely, to facilitate the debtor's successful completion of a rehabilitation plan, is jeopardized when setoff allocations threaten the viability of the plan. Therefore, the bankruptcy court was well within its discretion when basing its setoff allocation decision upon the soundness of the plan. Accordingly, the court will affirm the March 7, 2007 opinion and the April 27, 2006 order of the bankruptcy court.
An appropriate order will issue.
AND NOW, this 12th day of February, 2008, upon consideration of the bankruptcy appeal filed by appellant (Doc. 1), and for the reasons stated in the accompanying memorandum, it is hereby ORDERED that:
1. The March 7, 2007 opinion and the April 27, 2006 order of the United States Bankruptcy Court for the Middle District of Pennsylvania in the case docketed as ...