In re Rochester Drug Coop., Inc.

620 B.R. 699

IN RE: ROCHESTER DRUG COOPERATIVE, INC., Debtor.

Bankruptcy Case No. 20-20230-PRW

United States Bankruptcy Court, W.D. New York.

Signed October 28, 2020

Stephen A. Donato, Camille W. Hill, Bond, Schoeneck & King, PLLC, Syracuse, NY, Nicholas Gatto, Harter Secrest & Emery, Buffalo, NY, for Debtor.

Shannon Anne Scott, DOJ-Ust, New York, NY, for U.S. Trustee.

DECISION AND ORDER GRANTING IN PART AND DENYING IN PART MOTION OF ECHO DRUGS SEEKING RELIEF FROM THE AUTOMATIC STAY

PAUL R. WARREN, U.S.B.J.

Echo Drugs, Inc. has moved for an order lifting the automatic stay, so that it may seek permission to amend its answer in a state court civil action to assert counterclaims against the Debtor. Echo describes the proposed counterclaims as sounding in setoff and recoupment. The motion is opposed by the Debtor and the Committee. For the reasons that follow, the motion is GRANTED in part, solely to permit Echo to assert its proposed counterclaim concerning "credits" allegedly due from the Debtor for near-date or post-dated drugs that Echo claims to have returned to the Debtor. The balance of the motion, seeking to assert a counterclaim against the Debtor for "shareholder patronage dividends" allegedly due for 2017, 2018 and 2019, is DENIED .

I.JURISDICTION

The Court has jurisdiction under 28 U.S.C. §§ 157 and 1334. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A). Venue is proper under 28 U.S.C. §§ 1408 and 1409.

II.FACTS

The Debtor, a once proud Rochester business that was founded over 100 years ago, filed this Chapter 11 case in March 2020, to wind-down its business operations and liquidate its assets. (ECF Nos. 1; 8 ¶¶ 43-44). Prior to filing for bankruptcy protection, the Debtor became the first pharmaceutical distributor in the United States criminally charged with drug trafficking.¹ The narcotics at the heart of the criminal charges were opioids.

Several months after filing its Chapter 11 petition, the Debtor commenced an action in state court against Echo to collect an outstanding accounts receivable of approximately $1.2 million. (ECF No. 865, Ex. A). Lev Rivkin, the principal of Echo, was named as a co-defendant as guarantor of Echo's obligation to the Debtor. (ECF No. 865 ¶¶ 7-8). Echo filed its answer, asserting a number of affirmative defenses, including that "the Defendants are entitled to offset and recoupment based upon amounts paid, which [the Debtor] has failed to account for." (Id. ¶ 9 (internal quotation marks omitted)).

Echo has moved to lift the automatic stay for the purpose of seeking permission from the state court to amend its answer to assert counterclaims against the Debtor. (ECF No. 772). Echo points to two distinct potential counterclaims it wishes to assert, although Echo blurs the distinction between its proposed counterclaims. The first proposed counterclaim is for the amount of unpaid "shareholder patronage dividends" for 2017, 2018 and 2019. (Id. ¶¶ 4-11). The second proposed counterclaim is for unpaid "credits" amounting to approximately $354,000, for the value of returned near-date and post-dated drugs, credit for which the Debtor is alleged to have failed to provide. (Id. ¶¶ 12-13). Echo asserts that its proposed counterclaims should be permitted as setoff and recoupment defenses to the Debtor's action seeking to collect an outstanding receivable against Echo. (Id. ¶ 15).

The Committee and Debtor have both objected to stay relief. (ECF Nos. 862 & 865). The objections focus on (and separate) the two proposed setoff counterclaims for analysis. First, as to the claim for unpaid "shareholder patronage dividends," the objections assert that mutuality is absent, because Echo's claim concerning patronage dividends and the trade debt owed to the Debtor by Echo are not debts owing between the same parties and in the same capacity. (ECF Nos. 862 ¶¶ 29-32; 865 ¶¶ 17-23). The Debtor argues that Echo's claim concerning unpaid patronage dividends are derivative tort claims for misconduct by the Debtor and its management, which claims belong to the Debtor's estate for the benefit of all creditors. (ECF No. 865 ¶ 22). Second, as for Echo's proposed claim for unpaid credits for returned stale pharmaceuticals, the Committee argues that Echo has not provided sufficient proof to support that claim. (ECF No. 862 ¶ 33). The Debtor goes even farther, challenging the merits of Echo's claim and offering facts to demonstrate that the proof offered by Echo, to substantiate the existence of a sizeable credit owed by the Debtor for returned "stale" products, cannot sustain scrutiny. (ECF No. 865 ¶¶ 24-28). However, neither the Committee nor the Debtor assert that mutuality is lacking as to Echo's proposed counterclaim for returned product credits.

III.DISCUSSION

Echo has acknowledged that it is aware of the Court's recent decision in this case involving Mead Square Pharmacy, in which stay relief was denied—and Echo has done its level best to distinguish its situation from that of Mead Square. See In re Rochester Drug Coop., Inc. , No. 20-20230-PRW, 2020 WL 4248726, 2020 Bankr. LEXIS 1935 (Bankr. W.D.N.Y. July 22, 2020). Echo's situation is different from Mead Square in one respect and substantially similar in another. The difference here is that Echo is seeking to assert a counterclaim in state court for an unpaid "credit" of approximately $354,000 for the value of stale products allegedly returned to the Debtor. The similarity here is that Echo, like Mead Square, also seeks to assert a counterclaim for unpaid "shareholder patronage dividends" that Echo (and Mead Square) would have received, but for alleged misconduct and misrepresentations by the Debtor's management. Echo has been careful to avoid being too forthcoming about its legal theory in pursuing recovery of the unpaid "shareholder patronage dividends," but there is little doubt that it is based on alleged misrepresentations made by the Debtor's management to Echo and other shareholder-purchasers of products from the Debtor. (See ECF No. 772 ¶¶ 3-11). The two proposed counterclaims are very different and must be considered separately.

A. Legal Standard Applicable

Echo, in it is motion, and the Debtor and Committee, in their opposition, point to the " Sonnax factors" in support of their respective and competing positions. (ECF Nos. 772 ¶¶ 22-37; 862 ¶¶ 37-52; 865 ¶¶ 29-38); see In re Sonnax Indus., Inc ., 907 F.2d 1280 (2d Cir. 1990). As this Court recently discussed:

As an initial matter, it is unnecessary for a Court to consider the Sonnax factors unless and until [Echo] has carried its initial burden of proof of demonstrating cause to lift the stay. In re Project Orange Assocs., LLC , 432 B.R. 89, 103 (Bankr. S.D.N.Y. 2010) ). It is well-settled that "[i]f the movant fails to make an initial showing of cause ... the court should deny relief without requiring any showing from the debtor that it is entitled to continued protection." In re Sonnax , 907 F.2d at 1285. Here, [Echo seems to] acknowledge[ ] that, in order to demonstrate that cause exists to lift the stay, it must prove that it has mutual claims to setoff in the state court action. [ECF No. 772 ¶¶ 15-21]. ... For mutuality to exist, the claims or debts must be owed "between the same parties in the same right or capacity." In re Ionosphere Clubs, Inc. , 164 B.R. 839, 843 (Bankr. S.D.N.Y. 1994). See alsoIn re Bennett Funding Grp. , 146 F.3d 136, 139 (2d Cir. 1998) ; In re Cairns [& Associates ], 372 B.R. [637] at 660 [Bankr. S.D.N.Y. 2007] ("mutual debts are due to and from the same person in the same capacity") quotingIn re Sentinel Prods. Corp., P.I., Inc. , 192 B.R. 41, 45 (N.D.N.Y. 1996) (internal quotation marks omitted)).

"[The] allowance of a setoff is a decision that lies within the sound discretion of the bankruptcy court." In re Bennett Funding , 146 F.3d at 140 (citing In re Ionosphere , 164 B.R. at 841 ). And, setoff must be scrutinized in light of the goals and objectives of the Bankruptcy Code. ( Id. ). "In general, the Bankruptcy Code is oriented toward the prevention of preferential treatment of creditors."

In re Ionosphere , 164 B.R. at 843 (citing Sampsell v. Imperial Paper & Color Corp. , 313 U.S. 215, 219[, 61 S.Ct. 904, 85 L.Ed. 1293] (1941) ). To ensure equality of treatment of the holders of unsecured claims, the requirement of mutuality has been narrowly interpreted by the courts, to "ensure[ ] that setoff is allowed only in situations in which the equitable considerations are strongest: namely where the claims or debts are owed between the same parties in the same right or capacity ." In re Ionosphere , 164 B.R. at 843 (emphasis added).

In re Rochester Drug Coop., Inc. , 2020 WL 4248726, at *2, 2020 Bankr. LEXIS 1935, at *5-7.

With those principles in mind, the Court turns to the two proposed setoff counterclaims for which Echo seeks stay relief.

B. The Proposed Setoff Counterclaim for Near-Date and Post-Dated Returned Product "Credits" Satisfies the Mutuality Requirement

The Debtor has sued Echo in state court to recover $1.2 million for pharmaceutical goods allegedly sold and delivered to Echo. (ECF No. 865, Ex. A.) Echo seeks stay relief so that it may assert a counterclaim to setoff for approximately $354,000 in "credits" allegedly due from the Debtor, for the value of goods Echo claims to have returned because they were too old to sell. (ECF No. 772 ¶¶ 12-13). The Committee acknowledges that, subject to proof that certain goods were actually returned, "Echo Drugs may ultimately be entitled to a setoff for [the value of] certain goods returned." (ECF No. 862 ¶ 25). The Committee's concern, however, is that Echo has raised the "credit claim" as a mere pretext to assert a counterclaim for unpaid shareholder "patronage dividends." (Id. ). The Debtor, on the other hand, engages in a factual analysis in an attempt to prove that Echo is not and could not be due credit for returned goods. (ECF No. 865 ¶¶ 24-28).

The issue here is not whether Echo will ultimately...