2009 Chapter 11 Recent Developments (Part I)

owed the Debtor around $5.3 million under their service contracts. When it declared bankruptcy, the Debtor got post-petition DIP financing from Citizens Bank. However, to "facilitate the financing," certain of the Debtor's customers, including TRW, purchased participations pursuant to a Subordinated Participation Agreement ("SPA") in the DIP loan (the "Loan") under which TRW held a subordinated interest in the Loan. Once the Loan was repaid to Citizens Bank, it transfers the Loan Documents to BBK as agent for the participating customers. Until such transfer, the participating customers have no rights to enforce the Loan. The Debtor consummated a sale of its assets, the proceeds of which went to repay the Loan. However, although the Loan was repaid, certain subordinated positions, including TRW's, were only partially repaid and TRW asserts that it is owed $1.6 million (the "TRW Loan Balance").

Issues:

(1)

Whether the Debtor anticipatorily repudiated its prepetition service contracts with TRW and, therefore, whether TRW Loan Balance is cover under the UCC or is recoverable due to the anticipatory repudiation.

(2)

Whether TRW can recoup or setoff any amounts it owes the Debtor from the TRW Loan Balance.

Rules:

(1)

Michigan law allows a party to a contract to either cover its losses and/or seek incidental and consequential damages for the counterparty's anticipatory repudiation of a contract.

(2)

"Recoupment allows one party to deduct monies owed to it by another party, from monies owed by it to the other party, as long as the two obligations arise out of the same contract or transaction." (Recoupment is different than setoff, which requires mutuality.)

(3)

Section 553 of the Bankruptcy Code preserves a right to setoff prepetition claims and debts to the extent it otherwise existed under nonbankruptcy law. A setoff requires mutuality of debt - enforceable opposing claims - between the same parties. Here, because "TRW's claim against the Debtor is a post-petition claim, it is not covered by § 553 and § 553 does not permit TRW to set it off against the pre-petition debt owing by TRW to the Debtor."

Holding:

(1)

Under Michigan law, the Debtor anticipatorily repudiated its prepetition contracts with TRW. And, also under Michigan law, TRW is thus entitled to either cover and/or incidental and consequential damages. However, TRW's participation in the Loan does not constitute either cover or a measure of TRW's available damages.

(2)

TRW may not recoup nor setoff the TRW Loan Balance from the amounts it owes to the Debtor under the pre-petition service contracts.

Reasoning:

(1)

The plain language of the Loan documents, the financing order, and the SPA is such that none of the documents show in any way that TRW's participation in the Loan was intended as a cover of the Debtor's prepetition repudiation. Also, TRW received additional rights and benefits under the terms of the SPA that had nothing to do with covering the prepetition breach. Although the repudiation may help explain why TRW chose to participate in the Loan, TRW's participation is not a liquidation of its damages.

(2)

As for recoupment, TRW's participation in the Loan cannot be said to be a part of the same transactions as the pre-petition service contracts. Not only did the Loan have nothing to do with the Debtor's cost of production or parts or any other cost associated with the Debtor's service contracts, but the Loan was actually made by Citizens Bank, which had not had any previous business dealings with the Debtor.