PUBLISHED

UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT

No. 20-1161

In re: LARRY EDWARD WOOD; JESSICA ANN WOOD,

Debtors.

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LARRY EDWARD WOOD; JESSICA ANN WOOD,

Plaintiffs – Appellees,

v.

UNITED STATES DEPARTMENT OF HOUSING & URBAN DEVELOPMENT (HUD),

Defendant - Appellant.

Appeal from the United States District Court for the Southern District of West Virginia, at Beckley. Irene C. Berger, District Judge. (5:19-cv-00302)

Submitted: March 12, 2021 Decided: April 7, 2021

Before WILKINSON, NIEMEYER, and QUATTLEBAUM, Circuit Judges.

Reversed and remanded by published opinion. Judge Wilkinson wrote the opinion, in which Judge Niemeyer and Judge Quattlebaum joined. Richard E. Zuckerman, Principal Deputy Assistant Attorney General, Bruce R. Ellisen, Bethany B. Hauser, Tax Division, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C.; Michael B. Stuart, United States Attorney, OFFICE OF THE UNITED STATES ATTORNEY, Charleston, West Virginia, for Appellant. William R. Wooton, WOOTON & WOOTON, Beckley, West Virginia, for Appellees.

2 WILKINSON, Circuit Judge:

The Roman deity Janus was celebrated in ancient times for an ability to look

simultaneously in two directions. The Bankruptcy Code performs a Janus-like function in

our legal system. It must look forward, to preserve some modicum of material security as

debtors begin their financial lives anew. At the same time, however, it must also look

backward, to ensure that the debts of bankruptcy petitioners’ “past lives” are discharged as

equitably as circumstance allows. This case presents a typical clash between these two

faces of the Code. Larry and Jessica Wood, the bankruptcy petitioners, both owe and are

owed a debt respecting the United States. Looking ahead, the Woods wish to place the tax

overpayment the government owes them outside the reach of all creditors, including the

government itself. Looking back, the Treasury claims it is bound by statute to seek setoff

of those funds against a past debt that the Woods owed another department of the

government.

Because this court ruled in Copley v. United States,

(4th Cir. 2020),

that the Code accords a special priority to the Treasury’s right of setoff as against a

bankrupt’s right of exemption, we hold that the protections typically accorded properly

exempted property under

(c) do not prevail over the government’s

(d) right to offset mutual debts. Furthermore, although the government

exercised this right too hastily, before first requesting relief from the automatic stay, we

can see no reason to abridge the government’s right under

(d) to file a

motion seeking the stay’s annulment. We therefore remand the case for further

proceedings in accordance with this decision.

3 I.

To finance the purchase of a mobile home in 2008, the Woods borrowed $39,739.44.

J.A. 55. A little under six years later, however, the Woods defaulted on their home loan,

leaving behind an unpaid balance of $23,066.66. The United States Department of

Housing and Urban Development (HUD), which had insured the Woods’ loan, paid the

amount outstanding and, shortly thereafter, issued the Woods a demand for payment in the

same amount.

HUD then sent the Woods a Notice of Intent to Collect by Treasury Offset. This

Notice informed the Woods that the Treasury could offset their income tax overpayments

against the debt they owed to HUD. In 2017, the Treasury adopted this course, offsetting

the Woods’ federal tax overpayment of $9,961 toward the satisfaction of their debt.

On March 21, 2018, the Woods filed a Chapter 7 bankruptcy petition, opting to

exempt any potential 2017 income tax overpayment. A few days later, on March 26, 2018,

they filed their federal income taxes. And the returns on this filing did, in fact, show an

overpayment of $6,086. Again, though, the Treasury offset this overpayment, on April 4,

2018, against the Woods’ debt to HUD.

In response, the Woods filed suit in bankruptcy court. They requested that the court

void HUD’s lien and order a return of the $6,086 remitted to HUD. The court identified

the following two questions as essential to the disposition of the case: “(1) whether a

debtor’s tax overpayment becomes property of the estate and hence protected by the stay,

and (2) whether, if part of the debtor’s estate, the debtor may exempt the overpayments and

defeat a governmental creditor’s § 553 right to setoff.” J.A. 59. Relying on the reasoning

4 of In re Sexton,

(Bankr. W.D. Va. 2014), and In re Addison,

(Bankr. W.D. Va. 2015), the bankruptcy court answered both questions in the affirmative.

It accordingly entered a Judgment Order against the United States, requiring the

government to repay the $6,086.

The United States timely appealed to the district court, seeking reversal of the

bankruptcy court’s judgement on the aforementioned questions and requesting permission

to seek relief from the automatic stay. Like the bankruptcy court, the district court found

that the $6,086 overpayment had been the property of the Woods’ bankruptcy estate when

the Treasury offset it and that the Woods’ exemption of the overpayment under § 522

preempted any setoff under § 553 and § 6402. J.A. 83, 86. The district court also found

that the Woods’ overpayment was further protected by the Code’s automatic stay

provisions, and that, because the Treasury had knowingly intercepted the overpayments

after the Woods filed for bankruptcy, equity did not favor granting the government

permission to seek relief from the automatic stay. J.A. 86–87.

The United States timely appealed, maintaining that the government’s setoff rights

superseded the Woods’ exemption rights under § 522(c). It also appealed the district

court’s denial of permission to seek relief from the automatic stay. Because these are

purely questions of law, we review them de novo. In re Harford Sands Inc.,

,

639 (4th Cir. 2004).

5 II.

A.

A review of some basics is in order. When the Woods filed for Chapter 7

bankruptcy, an automatic stay issued against a variety of acts that otherwise might have

been taken against them.

. This automatic stay bars almost all attempts by

creditors to pursue the payment of debts owed by the bankruptcy petitioner. It is one of the

“fundamental debtor protections provided by the bankruptcy laws,” giving “the debtor a

breathing spell from his creditors.” H. Rep. No. 95-595, 95th Cong., at 340 (1977),

reprinted in 1978 U.S.C.C.A.N. 5787, 6297. In addition to preventing creditors from

harassing debtors, the automatic stay “enables debtors to resolve their debts in a more

orderly fashion.” In re Soares,

(1st Cir. 1997). Creditors also benefit.

The stay preempts a “race to the courthouse” and provides procedures for the fair allocation

of the bankrupt’s assets. See Thomas H. Jackson, Bankruptcy, Non-Bankruptcy

Entitlements, and the Creditors’ Bargain,

, 862 (1982).

Along with the issuance of an automatic stay, the debtor’s bankruptcy estate is

created. This estate includes almost all of the debtor’s property, broadly construed to

encompass “all the interests in property, legal and equitable, possessed by the debtor at the

time of filing, as well as those interests recovered or recoverable through transfer and lien

avoidance provisions.” Copley, 959 F.3d at 122 (quoting Owen v. Owen,

(1991)). The Woods’ bankruptcy estate, for example, includes their tax overpayment,

even though the government currently holds those funds. See In re Sexton, 508 B.R. at

662–63; In re Addison, 533 B.R. at 528–29. Ultimately, most of the property in such an

6 estate will be allocated to creditors according to the priority rules of the Bankruptcy Code.

Like Janus, the Bankruptcy Code thus looks backward in time, imposing order in what

would otherwise be a chaotic situation by settling past debts according to clear procedures.

But bankruptcy also looks to the future, seeking to rehabilitate debtors and provide

them a fresh start. See Daniel J. Bussel & David A. Skeel, Jr., Bankruptcy 19 (10th ed.

2015). The Bankruptcy Code’s most powerful tool for this purpose is the discharge. At

the end of bankruptcy proceedings, a debtor can usually expect that most pre-petition debts

against him will be eliminated. See id. at 25. But the Bankruptcy Code offers to do even

more than wipe the slate clean. It also tries to ensure that the debtor will not embark on his

fresh start with nothing. To this end, debtors may claim various types of property as being

“exempt” from the bankruptcy estate. Such property will not be used to pay any creditor

claims subject to discharge. In this case, the Woods took advantage of an exemption for

personal property in the hopes of retaining their 2017 tax overpayment of $6,086.

B.

Here, however, the government has asserted a claim superior to the Woods’

exemption right. This claim is based upon the “venerable” right of creditors, “dating back

to Roman and English Law,” to set off debts they owe the debtor against the debts owed to

them. In re De Laurentiis Entm’t Grp., Inc.,

(9th Cir. 1992). For

example, if creditor A is owed $10,000 by debtor B, and creditor A owes debtor B $5,000,

then the common-law right of setoff allows creditor A to eliminate its debt to debtor B,

reducing B’s debt to A to $5,000. This right “is based on the common sense notion that ‘a

man should not be compelled to pay one moment what he will be entitled to recover back

7 the next.’” In re Davis,

, 661 n.5 (5th Cir. 1989) (quoting William H. Lloyd,

The Development of Set-Off,

, 541 (1916)). It is, furthermore,

“inherent in the federal government . . . and ‘exists independent of any statutory grant of

authority to the executive branch.’” Marre v. United States,

(5th Cir.

1997) (quoting United States v. Tafoya,

(5th Cir. 1986)).

Nevertheless, there is unambiguous statutory recognition of this setoff right in

(d), the provision in which the government’s right to conduct the setoff at

issue here is explicitly located. This provision states that, “[u]pon receiving notice from

any Federal agency that a named person owes a past-due legally enforceable debt . . . to

such agency,” the Secretary of the Treasury “shall reduce the amount of

any overpayment payable to such person by the amount of such debt.”

(d). The Secretary must then “pay the amount by which such overpayment is

reduced” to the creditor agency.

This is as plain a description of a setoff right as can be found in the law. The Copley

court found, for example, that § 6402(d)’s sister provision, § 6402(a), vested a setoff right

in the Treasury, even as the exercise of said right remained at the Treasury’s discretion:

“In the case of any overpayment, the Secretary . . . may credit the amount of such

overpayment . . . against any liability in respect of an internal revenue tax . . . .”

(a) (emphasis added). The language of § 6402(d), however—“the Secretary

shall”—is not permissive, but imperative, not merely granting the Secretary the right to

setoff, but positively directing him to exercise it.

(d) (emphasis added).

8 The case for a statutory setoff right is even stronger here for § 6402(d) than it was in Copley

for § 6402(a).

If the common law and Title 26 ground the government’s setoff right, then

(a) preserves it in bankruptcy. See Citizens Bank of Md. v. Strumpf,

(1995). Section 553(a) provides that, with certain exceptions, Title 11 “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.”

(a).

Thus, § 553 “is not an independent source of law governing setoff; it is generally

understood as a legislative attempt to preserve the common-law right of setoff arising out

of non-bankruptcy law.” United States v. Norton,

(3d Cir. 1983); see

also Strumpf,

. Thus, setoffs in bankruptcy “have been generally favored,

and a presumption in favor of their enforcement exists.” De Laurentiis,

(internal quotation marks omitted).

The courts below, however, declined to hold the government’s setoff right superior

to the exemption right. But those courts lacked the guidance of Copley. And the language

in Copley is as general as it is clear: “The very broad scope of Section 553(a) necessarily

includes the property exemption provisions contained in

(c). Although

Section 522(c) generally provides that exempt property cannot be used to satisfy pre-

petition debt, that provision, as part of Title 11, must be read in conjunction with the

unambiguous language of Section 553(a).” Copley, 959 F.3d at 124. The Woods’ reliance

9 on the § 522 exemption protection as a bar against the government’s assertion of setoff

was, in the light of this holding, misplaced.

In sum, then, the Treasury’s authority to exercise its right to offset the Woods’ tax

overpayment against their debt to HUD is anchored firmly in § 6402(d) and § 553(a). This

offset right supersedes the general exemption protections of § 522(c). As against the

government’s right to setoff, the Woods’ income tax overpayment is not exemptible. The

Woods have no right to demand turnover of the overpayment.

The courts below expressed concern that such a holding may compromise the

solicitude that the Bankruptcy Code’s forward-looking face was intended to show

individuals confronting dire financial straits. But there need be no desire for pro-debtor or

pro-creditor perspectives on the bench. If there are excessive exemptions, lending

institutions may be more reluctant to lend. If exemptions are too few, prospective

borrowers may be more hesitant to borrow. The way to approach it all is straight down the

middle, which means here and elsewhere that Congress is the one to strike the

debtor/creditor balance, and courts are the ones to use their own sound judgment and

discretion in the service of the Code and its text.

III.

Determining that the government had the right to offset its debt to the Woods is not

the end of the matter. The Bankruptcy Code imposes strict procedural requirements on

how creditors may interact with debtors once a bankruptcy petition has been filed. If these

rules are not followed, disorder will result and the mission of bankruptcy law to provide a

uniform and orderly process to resolve the bankrupt’s debts will be frustrated. It is from

10 this vantage point that we now turn to the next question before us: whether the government

contravened the automatic stay by offsetting the Woods’ overpayment against its debt to

HUD.

Under the Code’s automatic stay provisions, the bankruptcy petition itself operates

as an automatic stay “applicable to all entities” of a broad range of actions aimed at the

reappropriation of property in the bankruptcy estate.

(a). Specifically

articulated at § 362(a)(7) is an automatic stay on “the setoff of any debt owing to the debtor

that arose before the commencement of the case under this title against any claim against

the debtor.” Such a setoff has been formally effected upon completion of the following

three steps: “(i) a decision to effectuate a setoff, (ii) some action accomplishing the setoff,

and (iii) a recording of the setoff.” Strumpf,

. Given that the Woods’

overpayment is concededly part of their bankruptcy estate, it is evident that by unilaterally

remitting the overpayment to HUD, so that HUD could record it against the Woods’ debt,

the government did exactly what the Code forbids.

An analysis that considers the one exception relevant to offset, § 362(b)(26), further

reinforces this conclusion. This provision explicitly carves out from the general stay “the

setoff under applicable nonbankruptcy law of an income tax refund, by a governmental

unit, with respect to a taxable period that ended before the date of the order for relief against

an income tax liability . . . .”

(b)(26) (emphasis added). In the context of

a narrow, specifically articulated exception to a general stay of all setoff actions against

property in the bankruptcy estate, a straightforward application of the expressio unius

canon makes plain that only setoffs against income tax liability—and not, for example,

11 against housing loan liability—may licitly proceed under the general stay. See In re Sexton,

. To find otherwise would not be to interpret Congress’ words but to add

terms on Congress’ behalf, an exercise exceeding the authority of this court.

Nor does § 553(a) implicitly expand the scope of the exception. One reading of §

553(a), plausible on its face, is that its admonition against interpretations “affect[ing] any

right of a creditor to offset a mutual debt” loosens the constraints of the automatic stay.

But such a reading is already foreclosed by the law of this circuit. In United States v.

Reynolds,

, 1006–07 (4th Cir. 1985), this court harmonized § 553(a), §

362(a), and § 362(a)(7), explaining that “together these sections preserve a creditor's right

to any setoff he possesses but automatically stay the exercise of that right unless the creditor

obtains from the bankruptcy court relief from the automatic stay.” Section 362(a)(7) does

not abrogate the government’s setoff rights; it only specifies the proper time and manner

of their exercise. The Supreme Court has also looked with favor on this rendering of the

Code. Strumpf,

(stating that these sections are “most naturally read as

merely recognizing [a] restriction upon when an actual setoff may be effected—which is

to say, not during the automatic stay” (emphasis in original)). The government does not

purport to characterize what it did with the Woods’ overpayment as anything other than a

genuine setoff, nor did it move to lift the stay before exercising its right. The clear import

12 of our precedent, then, is that the government’s actions violated the automatic stay, as the

district court correctly found.

IV.

In short, the government has a right to offset its debt to the Woods but failed to

exercise it according to the letter of the law. So what now? To be clear: the government

is not obligated to turn over the money it owes the Woods to the bankruptcy estate. See

Strumpf, 516 U.S. at 19–20. But neither is it yet permitted to perfect its setoff by formally

recording the Woods’ tax overpayment against their debt to HUD. See

. This is

because actions taken in violation of the automatic stay are presumptively invalid. See In

re Soares,

. However, the automatic stay can be retroactively annulled,

thus legitimizing the creditor action. See, e.g.,

at 976–77; In re Sexton,

.

To do so, the government must seek relief from the automatic stay under

(d). The district court denied relief from the automatic stay, but that decision lacked

the benefit of our holdings here and in Copley that the government’s statutory setoff rights

under § 6402 trump the Woods’ right to exempt their overpayment. Barring exceptional

circumstances, the government’s motion for relief from the automatic stay in cases of this

kind should ordinarily be granted. See Cumberland Glass Mfg. Co. v. De Witt,

(1915). As the Supreme Court has made clear, “[w]hile the operation of the

privilege of set-off has the effect to pay one creditor more than another, it is a provision

based upon the generally recognized right of mutual debtors, which [was] enacted as part

of the bankruptcy act, and when relied upon should be enforced by the court.”

13 Because no motion for relief from the stay has yet been filed, however, we need not

further opine. We hold that the lower court must, in considering this motion, give proper

weight to the government’s rights under § 6402(d), consistent with the carefully wrought

requirements of the Bankruptcy Code.

V.

For the foregoing reasons, the judgment of the district court is reversed, and the case

is remanded for further proceedings consistent with this opinion. The government’s

pending motion for summary disposition is accordingly denied as moot.

REVERSED AND REMANDED

14