United States v. Fleet Bank of Massachusetts

United States Court of Appeals
For the First Circuit
____________________
No. 01-1464
IN RE: CALORE EXPRESS COMPANY, INC.,
Debtor.

____________________

UNITED STATES,

Appellant,

v.
FLEET BANK OF MASSACHUSETTS,
Appellee.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Nancy Gertner, U.S. District Judge]

____________________
Before
Lynch, Circuit Judge,
Campbell, Senior Circuit Judge,
and Lipez, Circuit Judge.

____________________

Peter Sklarew, Attorney, Tax Division, Department of
Justice, with whom Claire Fallon, Acting Assistant Attorney
General, and D. Patrick Mullarkey, Acting Deputy Assistant Attorney
General, were on brief for appellant.
Debra K. Mayfield with whom Deborah J. Hart-Klein and
Ruberto, Israel & Weiner, P.C. were on brief for appellee.

____________________

May 2, 2002
____________________
 LYNCH, Circuit Judge. This is a bankruptcy case in which

the federal government asserts a right to set off the claims of two

agencies, the Internal Revenue Service and the General Services

Administration, against contract claims of the debtor as to the

General Services Administration. If the government is correct,

Fleet Bank of Massachusetts owes it several hundred thousand

dollars, almost all from unpaid tax claims against the now-defunct

debtor. Proceedings before the bankruptcy court did not go

smoothly, primarily because the government did not keep the court

or the other parties informed of its intent to assert its setoff
rights or of the steps it took to do so. As a result we face, some
seven years into the life of the case, the government's appeal of
the bankruptcy court's ruling in a summary hearing that the

government either waived its setoff rights or had no rights to
assert. The debtor by now is long gone, and the government wishes
to seek restitution from Fleet, the debtor's primary creditor,

which the bankruptcy court permitted to sell the debtor's assets.
We reverse the entry of judgment against the government,
because the bankruptcy court could not draw the legal conclusions
it did without developing facts to support them and because we

disagree with its conclusions about the priority of the

government's setoff rights under the Uniform Commercial Code as

interpreted by the Massachusetts courts. Our decision today does

not guarantee the government success on its restitution claim if

and when a court better develops the facts involved in this case.

We then remand the case to the district court for appropriate

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disposition.

The decision does resolve some important questions. The

following aspects of this opinion either decide new issues or
clarify areas of the law:

1. We hold that this court has jurisdiction to review an order of
the bankruptcy court refusing to lift the automatic stay when
the order resolves all issues between the parties.
2. We further define the scope of a hearing on a motion for
relief from the automatic stay before the bankruptcy court
under the Federal Rules of Bankruptcy Procedure and Grella v.
Salem Five Cent Savings Bank, 42 F.3d 26 (1st Cir. 1994). We
conclude that the question of waiver by a party of its rights
is not outside the permissible scope of such a hearing.

3. We set forth principles for determining whether a creditor has
waived the right of setoff in a bankruptcy proceeding. We
hold that a creditor in bankruptcy proceedings may expressly
waive a right of setoff; that a court may imply a waiver of a
right of setoff from the creditor's conduct if that conduct
fairly demonstrates the creditor's intent; and that a waiver
of setoff rights, whether express or implied, is not
necessarily irrevocable unless the case is a proper one for a
court to apply estoppel.
4. We hold that although priority of the federal government's
rights to set off claims against debts is a matter of federal
common law, federal common law for present purposes
incorporates state law, in this case section 318 of pre-
revision Article Nine of the Uniform Commercial Code.

We also reject the argument of the IRS that it should be excused

from an error it made in filling out a government form.

I.

The legal questions presented by this case turn largely

on its history. That history is complex, and we recount it in some

detail. Calore Express Company filed a bankruptcy petition under

Chapter 11 of the Bankruptcy Code on May 5, 1995, in the District

of Massachusetts. Calore had done business as a freight

transportation company since its founding in the late 1940s, its

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operations diversifying over time. In the mid-1990s, however,

Calore's business suffered from increased competition and a series

of mishaps, until a threat by one of Calore's lenders to foreclose
liens on some of its equipment led to the 1995 Chapter 11 filing.

Among Calore's largest creditors at the time was Shawmut

National Bank.1 Before the petition, Calore owed Shawmut
approximately $2.8 million, and Shawmut had a security interest in

many of Calore's assets, including its accounts receivable. After

the petition, Calore remained debtor-in-possession and asked the

bankruptcy court to permit it to reach an emergency financing

agreement with Shawmut. Shawmut agreed to continue lending, with

the amount of the loans determined partly by Calore's postpetition

accounts receivable, and partly by the amount of those accounts
collected. To secure this new credit, Calore asked the court to

give Shawmut a superpriority claim and a security interest in all

its assets under 11 U.S.C. § 364(c), including assets acquired
postpetition and both pre- and postpetition accounts receivable.

The bankruptcy court approved this arrangement in an interim order

on May 17 and in numerous subsequent periodic orders beginning on

June 28, 1995. The June 28 order read in relevant part:

Lender shall have a super-priority claim . . . with
respect to obligations incurred pursuant to the [loan]
over any and all administrative expenses [with exceptions
not relevant here].

The Debtor is hereby authorized to grant and by entry of
this Order does grant a security interest in all post-
petition assets to the Lender and valid, binding,
enforceable and perfected Liens in and to all collateral

1
Shawmut Bank is no more, and Fleet stands in its shoes.

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 security . . . including, without limitation,

All . . . accounts . . . now owned or in which
the Debtor has any interest including all pre-
petition collateral . . . or hereafter
acquired or in which the Debtor obtains an
interest . . . .

Eventually the court permitted Calore and the Bank to renew the

arrangement by simple stipulation. The court held hearings during
this time to monitor Calore's borrowing.

Calore had done business with the General Services

Administration, and forthcoming payments from the GSA made up part

of the accounts receivable on which Calore was borrowing. Calore

also owed money to the Small Business Administration and the

Internal Revenue Service. At the beginning of the case, therefore,

there existed at least the possibility that the government might
attempt to set off the GSA's debts to Calore against Calore's debts

to the government. Nothing in the record reveals the scope of the

GSA's contractual obligations at that time, or whether it was
predictable that the GSA would continue to make postpetition

payments to Calore.

Calore's debts to the IRS arose from its failures to pay

various payroll taxes withheld from its employees' wages. Some of

these failures were prepetition, some postpetition. On December 7,

1995, and January 25, 1996, the IRS through its own counsel filed

proofs of claims for prepetition taxes. The second proof claimed

dramatically more than had the first because the IRS then took the

position that Calore was liable for certain taxes incurred by

another corporation, CFS Air Cargo, a corporation nominally

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separate from Calore but which the IRS considered Calore's alter

ego. As of January 25, 1996, the IRS amended its proof to claim a

total of $3,105,612.90 in prepetition taxes, including penalties
and interest.

As to postpetition debts, on November 20 and December 5,

1995, on February 28 and June 6, 1996, and on September 23, 1997,
the IRS filed requests for payment of the postpetition payroll

taxes as administrative expenses under 11 U.S.C. § 503(b). As of

September 23, 1997, the IRS claimed a total of $479,134.77 in

postpetition taxes, including penalties and interest. Calore

disputed the exact amounts of the pre- and postpetition tax debts,

and these amounts have not yet been established by any court. The

GSA through its own counsel also filed a proof of claim on February
1, 1996, claiming that Calore owed it $6,734.24 in overcharges.

None of these filings informed the court or the other

parties of any specific intention by the government to set off the
GSA's debts to Calore against Calore's tax debts, or of whether the

GSA would continue to incur debts to Calore. Some contained

language disclaiming setoffs. For example, the IRS filed its

prepetition proofs of claim on then-current copies of Official

Bankruptcy Form 10. Form 10 then stated that "[i]n filing this

claim, claimant has deducted all amounts that claimant owes to

debtor";2 an attachment, entitled "Proof of Claim for Internal

2
A new version of Form 10, issued since the events in this
case, omits this language and clearly states that a creditor should
list any claim subject to setoff as a secured claim and identify
the setoff.

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Revenue Taxes," stated that "[t]his claim is not subject to any

setoff or counterclaim." Moreover, although a setoff claim

qualifies as a secured claim under 11 U.S.C. § 506(a), in its
December 7 filing, the IRS identified its entire prepetition claim,

then amounting to $146,609.36, as unsecured, although it specified

that $133,281.24 of the claim should receive priority status under
11 U.S.C. § 507(a)(8). In its later January 25 filing, the IRS

identified $2,448,520.69 of its $3,105,612.90 claim as secured,

$572,683.35 as priority unsecured, and $84,408.86 as general

unsecured. The security interest it identified was a tax lien

against CFS. It left unchanged the language of Form 10 concerning

the deduction of amounts owed and the language in the attachment

concerning the absence of setoffs and counterclaims. There is no
determinative evidence as to whether IRS employees actually knew

that the GSA owed Calore money at the time of any of these filings.

The GSA's proof of claim was also filed on Form 10, but
included next to the language concerning the deduction of amounts

owed a notation referring to an attached affidavit. That affidavit

stated that the government intended to assert its right of setoff

and that the government was holding receivables to do so.

At no time before or after any of these various proofs of

claim did the bankruptcy court fix a bar date, after which new
proofs of claim or amendments would be untimely. See Fed. R.

Bankr. P. 3003(c)(3).
Calore proposed its final plan of reorganization, after

two earlier attempts, on March 8, 1996. The March 8 plan provided

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for the payment of $131,810.00 in prepetition taxes over time and

$129,243.79 in postpetition taxes immediately. The government

objected to the plan on April 1, arguing that Calore had vastly
understated the amount it owed in both pre- and postpetition unpaid

payroll taxes, and that a valid plan would need to account for the

higher amounts reflected in the IRS's proofs of claim and requests
for payment. The dispute between the government and Calore at that

time revolved primarily around whether Calore was liable for the

tax debts of CFS Air Cargo. The IRS's April 1 objection included

an assertion of the government's general right to set prepetition

debts off against prepetition claims, stating that "[t]he

Bankruptcy Code specifically preserves the United States' right to

offset any pre-petition claims of the United States against any
pre-petition claims of the Debtor." It did not specifically

mention the setoff of the GSA's debts. On April 24, the IRS and

Calore stipulated that Calore owed approximately $1,685,886.74 in
prepetition taxes. This admission doomed the reorganization plan,

as the amount admitted was too great for Calore to repay. The IRS

and Calore moved on the same day to continue the trial, with Calore

stating that it intended to propose a sale of assets under 11

U.S.C. § 363.

Calore moved for that sale on May 31. The proposed buyer

was JSC Investments, a corporation owned by the wife of Calore's

president. Calore's plan for the sale involved paying $137,000 to

the IRS. The court set a hearing for June 10, and also ordered

Calore to show cause at that time why the court should not dismiss

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the case, or convert it to Chapter 7, or appoint a Chapter 11

trustee. The court held the hearing and denied the motion for

sale, reasoning that the sale of assets as described would amount
to a plan of reorganization and therefore needed to satisfy the

Code's various requirements for such a plan -- including full

disclosure to creditors, a vote of creditors, and adherence to the
absolute priority rule and the best interests of the creditors

test. The court placed particular emphasis on the motion's failure

to address the claims of the IRS. It continued the show cause

hearing until June 17. Three days later, on June 13, Fleet, which

had by then acquired Shawmut, moved to lift the automatic stay on

collection of debts against Calore that the bankruptcy court had

imposed under 11 U.S.C. § 362(a)(4) at the beginning of the case,
so that Fleet could seize Calore's assets. The court set a hearing

for June 17, at which several of the other creditors who had moved

for relief from the stay much earlier in the case were also to be
heard.

That same day, June 13, the Assistant Attorney General

for the Tax Division of the Department of Justice sent a letter to

the Chief of the Collections Branch of the GSA. The letter

described and confirmed a phone conversation earlier that day

involving counsel for the IRS in this case,3 an attorney from the

U.S. Attorney's Office for the District of Massachusetts, and the

recipient. The letter instructed the GSA to freeze all further

3
The IRS attorney who made the phone call did not appear
for the government before this court.

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payments to Calore on postpetition accounts, and to contact IRS

counsel before making any payments to Calore or CFS on prepetition

accounts. The letter also instructed the GSA not actually to set
off any of the disputed funds until the government had received

permission to do so from the bankruptcy court. The government did

not then notify the bankruptcy court or any other party of the June
13 letter. The government says that at the time of the letter,

counsel for the GSA had erroneously informed counsel for the IRS

that the GSA had no current receivables due to Calore, and that

this explains IRS counsel's failure to notify the court or other

parties. The government also says that the letter was intended as

a mere precaution in case counsel for the GSA was wrong or in case

new receivables did accrue. In any event, the parties do not
dispute that the GSA in fact owed Calore substantial funds and that

after June 13 the GSA ceased to pay.

The court held a hearing on June 17 in which it granted
Fleet's motion but postponed deciding those of the other creditors

so that Fleet could attempt to sell the assets all at once, on the

basis that such a sale would yield the best value for the assets.

Calore and Fleet intended to make much the same sale, to the same

buyer, as they had earlier proposed through § 363. Counsel for the

IRS -- the same who had made the June 13 phone call -- was present

at that hearing, but did not speak. According to Calore, it

discovered the IRS's freeze on payments from the GSA on June 27

when one of Calore's drivers attempted to pick up a payment from

the GSA but received instead a copy of the June 13 letter. One day

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later, Fleet (notified in the interim by Calore) sent a letter to

the bankruptcy court enclosing a copy of the June 13 IRS letter and

requesting an emergency hearing. Calore joined in the motion,
taking the position that the IRS's action violated the automatic

stay.

Judge Feeney, who handled all other parts of this case,
was then unavailable. On July 2, Judge Hillman convened the

emergency hearing requested by Calore and Fleet. Calore and Fleet

argued vehemently that the government should at the very least have

mentioned the June 13 letter at the June 17 hearing, and that its

undisclosed actions violated the automatic stay. Tempers ran high;

counsel for Calore called the government's actions "fraud,"

"perhaps larceny," and "twisted." The government argued that its
actions were permitted by the rule of Citizens Bank of Maryland v.

Strumpf, 516 U.S. 16 (1995). The court agreed with Calore and

Fleet, said that the government had attempted to "sandbag" Calore,
stated that the government's actions had exceeded what Strumpf

permitted, and ordered the government to lift the freeze.

The government then moved to lift the stay so that it

could replace the freeze and impose an actual setoff, or, in the

alternative, for adequate protection of its interest in the

accounts receivable. This motion, filed on July 15, asserted the

government's right to set off all of its prepetition claims,

including the tax debts and the GSA overcharges, against its

prepetition debts, which comprised part of the GSA receivables. It

also asserted the government's right to set off its postpetition

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claims, which were entirely tax debts, against its postpetition

debts, the remainder of the GSA receivables. Fleet objected,

claiming that its security interest and superpriority status, both
created by the bankruptcy court's borrowing order, took priority

over the government's setoff rights. Fleet also urged the court to

deny the government's motion on the grounds of estoppel, laches,
and inequitable conduct on the government's part. Calore objected

on similar grounds, adding that to grant the government's motion

would destroy the going concern value of Calore's business.

On July 30, Judge Feeney held a hearing on the

government's motion to lift the stay. At that hearing, the

government asked to impose the freeze once again at least until the

court ruled on the motion. In response, counsel for Fleet stated
that if the court ruled for the government after the receivables

were paid, Fleet would "disgorge" the money owed to the government;

the court and the government agreed that this suggestion was
reasonable. On August 8, before the court issued its decision,

Fleet filed a supplemental submission informing the court and the

parties of its private sale of Calore's assets. At that sale,

Fleet received the total amount of $2,343,812.84, primarily in new

promises to pay. Some of that amount -- we cannot say exactly how

much from the record -- presumably went to pay other secured

creditors. Fleet claimed that as of August 1, Calore owed it

$2,925,986.05, plus additional unpaid interest and legal fees.

Under an agreement with the buyer, the same JSC Investments to whom

Calore and Fleet had proposed a § 363 sale, Fleet took an

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assignment of the accounts receivable, the collection of which

would go to satisfy the new promissory notes. JSC received a

portion of the accounts as costs of collection.
On August 21, the court denied the government's motion to

lift the stay and its alternative request for adequate protection

in a published opinion. In re Calore Express Co., 199 B.R. 424

(Bankr. D. Mass. 1996). The court concluded that the government

had no right of setoff in this case because, first, the government

had waived any such right on several distinct grounds, including

its failure to object to the original borrowing order, its failure

to object to Fleet's June 13 motion,4 its statements in its proofs

of prepetition claims, and its silence in its requests for payment

of postpetition expenses, id. at 432; second, allowing the exercise

of such a right would be inequitable, id. at 433; and third,

Fleet's security interest created by the borrowing orders took

priority over any right of setoff even had the government not

4
In the course of describing the government's conduct,
Judge Feeney's opinion stated that "Judge Hillman ruled that, at
the June 17, 1996 hearing on the Bank's Lift Stay Motion before
this Court, [counsel for the IRS] had violated his ethical
obligations to the parties . . . and to the Court." Calore
Express, 199 B.R. at 430. The government and the counsel concerned
petitioned the district court for a writ of mandamus on the grounds
that the bankruptcy court had reprimanded counsel for professional
misconduct without notice or a hearing. The district court issued
the writ, directing the bankruptcy court to clarify what finding it
had intended to make regarding counsel. In re Calore Express Co.,
226 B.R. 727, 733 (D. Mass. 1998). Judges Feeney and Hillman then
issued separate memoranda, each of which stated that the author had
not intended to impose sanctions on the attorney concerned or to
find him guilty of professional misconduct. In re Calore Express
Co., 228 B.R. 338 (Bankr. D. Mass. 1998) (Feeney, J.); In re Calore
Express Co., 228 B.R. 338 (Bankr. D. Mass. 1998) (Hillman, J.).
Both judges also stated that nothing in the memoranda was to affect
the August 21 order.

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waived it, id. at 433-34. The court declined, however, to reach

Fleet's arguments based on equitable subordination, noting that the

Federal Rules of Bankruptcy Procedure require an adversary
proceeding for such claims. Id. at 434. The government appealed

to the district court. On October 31, 2000, the district court

affirmed in an unpublished opinion relying solely on the
government's waiver of its right of setoff, without reaching the

question of that right's relative priority. After the district

court denied rehearing, the government took this appeal.

II.

The parties' arguments cover a broad range of procedural

and substantive questions. The government's primary request is

that we reverse the order of the bankruptcy court denying the
government's motion to lift the automatic stay. The stay itself is

now irrelevant. Fleet has long since sold Calore's assets and

collected Calore's receivables from the government. Indeed,
according to the government at oral argument, a subsequent

arbitration award has added substantial additional funds to the

amount the government owed Calore, and the government has paid that

money in compliance with the bankruptcy court's order. The

government wishes to bring an action against Fleet for restitution

of the amount that the government would have retained had it been

able to exercise its setoff right in June 1996. It takes the

position that the August 1996 order of the bankruptcy court would

presently preclude its suit, but that it can sue Fleet if the

bankruptcy court's order is reversed. The district court's ruling

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would arguably (although not certainly) otherwise bar the

government's restitution action under the doctrines of claim and

issue preclusion.
The government argues: first, that a hearing on a motion

to lift the automatic stay is a summary proceeding in which no

final adjudication of parties' claims should be made, and so the
bankruptcy court erred in ruling finally that the government had no

right of setoff; second, that the automatic stay does not apply to

postpetition setoffs, and so the bankruptcy court erred in making

any ruling whatsoever regarding postpetition setoffs following a

hearing related to the automatic stay; third, that its conduct in

this litigation did not amount to waiver of its setoff rights; and

fourth, that Fleet's security interest was not prior to the
government's setoff rights.

Fleet, defending the bankruptcy court's order, suggests

that this court lacks appellate jurisdiction. It cites the recent
case of Caterpillar Financial Services Corp. v. Braunstein (In re

Henriquez), 261 B.R. 67 (B.A.P. 1st Cir. 2001), in which the

Bankruptcy Appellate Panel for this circuit held that an order

denying a motion to lift the stay is not subject to appeal unless

it finally resolves the issues between the parties. Id. at 70-71.

Assuming, though, that this court exercises jurisdiction, Fleet

also argues: first, that the bankruptcy court correctly concluded

that the government waived its right of setoff; second, that the

bankruptcy court was within its authority to deny the government

setoff, whether or not that denial took place in the context of a

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hearing on a motion to lift the stay, and whether the setoff

related to pre- or postpetition claims and debts; third, and

finally, that regardless of waiver or inequitable conduct, its
security interest does indeed take priority over the government's

setoff rights.

III.
A. Appellate jurisdiction

We begin by considering whether we have jurisdiction to

hear this appeal. Fleet has suggested that we lack appellate

jurisdiction, citing Henriquez. That case held that a bankruptcy

court's denial of a motion for relief from an automatic stay is not

final unless it determines all the rights of a party, and so is not

subject to an appeal as of right under 28 U.S.C. § 158(a)(1) unless
it completely resolves all issues between the parties with respect

to the discrete dispute at stake in the ruling. 261 B.R. at 70.

Henriquez acknowledged that this circuit has held that grants of a

motion for relief from an automatic stay are final within the

meaning of § 158(a)(1), id. at 70 n.5 (citing Tringali v. Hathaway

Machinery Co., 796 F.2d 553, 558 (1st Cir. 1986)), but

distinguished denials of such motions, stating that the latter, in

at least some cases, leave unresolved issues between the parties to

be resolved by the bankruptcy court, id. at 70-71. For that

proposition it cited Grella v. Salem Five Cent Savings Bank, 42

F.3d 26 (1st Cir. 1994), in which this circuit described the scope

of a hearing on a motion to lift the stay as circumscribed and

summary. See Henriquez, 261 B.R. at 70-71.

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 We do not reach the question whether a bankruptcy court's

refusal to lift the automatic stay may ever lack finality under

§ 158(a)(1), as Henriquez held. Numerous circuits have held that
a district court's affirmance or reversal of the bankruptcy court's

decision whether to lift the automatic stay is final, often without

qualifying that holding. See Barclays-Am./Bus. Credit, Inc. v.

Radio WBHP, Inc. (In re Dixie Broad., Inc.), 871 F.2d 1023, 1026

(11th Cir. 1989) (collecting cases). In the present case, the

bankruptcy court's order clearly did decide the relevant dispute

between the parties. Acting under the June 17 order, Fleet has

seized the relevant assets and sold them. The government may now

recover its money only from Fleet and only on the theory that it

should have been able to exercise its setoff rights as of June 13,
and that it is now entitled to be made whole for its losses because

it was foreclosed from exercising those rights. Calore has no

money left to pay either pre- or postpetition claims, and Fleet has
no obligation to pay the government unless the government can make

out a restitution claim, which depends on its right of setoff. The

question presented by this appeal is therefore whether the

bankruptcy court correctly ruled on August 21 that the government

had no remaining setoff rights, or that Fleet's rights were senior.

We have jurisdiction to hear this appeal and decide that question.

B. Scope of the hearing

The government's first argument is that the bankruptcy

court exceeded the scope of a hearing on a motion to lift the

automatic stay by permanently foreclosing the government's right of

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setoff. Section 362(d)(1) provides that the bankruptcy court shall

grant relief from the stay "for cause, including the lack of

adequate protection of an interest in property of such party in
interest." 11 U.S.C. § 362(d)(1) (2000). The government cites

Grella, in which this court held that the grant of a motion to lift

the stay did not preclude the trustee in that case from later
contesting the validity of the claim or asserting a counterclaim.

42 F.3d at 32-33. The government also argues that at least some of

the issues decided by the bankruptcy court required it to make

findings of fact, and that the court erred by deciding those issues

after a nonevidentiary hearing. The government maintains that,

given an opportunity, it could present evidence that would

undermine the bankruptcy court's reasoning -- for example, the
court's conclusion that Fleet in fact relied to its detriment on

the government's failure to assert its setoff right.5

The government is generally correct that a hearing on a
motion to lift the stay is not the proper time or place for the

determination of many substantive rights. As this court said in

Grella, the question for the bankruptcy court at such a hearing is

generally whether the creditor's claim to the estate's property is

5
The government also argues that the bankruptcy court
exceeded the scope of the hearing by addressing postpetition setoff
rights at all, because in the government's view postpetition
setoffs are never covered by the automatic stay. The government
bases this argument on a reading of 11 U.S.C. § 362(a)(7), which
extends the automatic stay to cover the exercise of prepetition
setoffs but by its terms does not cover postpetition setoffs.
Because we hold that the bankruptcy court erred in concluding that
the government had no postpetition setoff rights, we do not decide
whether it lacked authority to consider those rights at all.

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colorable, not whether the creditor can ultimately recover in light

of all relevant legal issues. 42 F.3d at 32-34.

That does not mean, however, that such a hearing is
necessarily an inappropriate time to consider issues of waiver. A

claim that has clearly been waived is no longer colorable. See id.

at 35 ("[T]he court may consider any defenses or counterclaims that
bear on whether [a colorable claim] exists."). Further, in some

cases the question of waiver will be clear from the record as a

matter of law or from undisputed facts. In other cases, that

question will require the bankruptcy court to take evidence, which

it did not do in this case. We consider the bankruptcy court's

ruling here from that perspective: if the government has clearly,

on the record or on undisputed facts, waived its setoff rights as
a matter of law so as to deprive it of even a colorable claim to

setoff, then the bankruptcy court was correct to conclude that

those rights no longer entitled the government to move for a lift
of the stay. But if waiver was unclear from the record, or if a

disputed fact could possibly make a difference, then the bankruptcy

court erred.

We apply a similar analysis to the question of priority.

In order to obtain relief from the stay, the government was

required to show cause for relief, in addition to its colorable

claim on property of the estate. The cause the government invoked

was "the lack of adequate protection of an interest in property"

under § 362(d)(1). If as of the time of the hearing Fleet

indisputably had rights senior to the government's in the contested

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receivables, and if Calore's debt to Fleet equaled or exceeded the

value of those receivables, then the bankruptcy court correctly

denied the motion to lift the stay. This would be so not because
the government lacked a colorable claim but because the

government's security interest would have no value and the

government would be entitled to no protection of that interest.
See Superior Paint Mfg. Co. v. Lopez-Soto (In re Lopez-Soto), 764

F.2d 23, 26 (1st Cir. 1985) ("[V]alueless junior secured positions

or unsecured deficiency claims will not be entitled to adequate

protection." (quoting 2 Collier on Bankruptcy ¶ 362.07, at 362-53

(L. King et al. eds., 15th ed. 1985)) (internal quotation marks

omitted)). If we reject the bankruptcy court's grounds for finding

waiver, then we must consider whether the bankruptcy court was
correct when it concluded that, as a matter of law, Fleet's

interest took priority over the government's. This question is

distinct from the question whether a court might rearrange the
priorities of the interests under, for example, the doctrine of

equitable subordination, which the bankruptcy court acknowledged

required a full adversary proceeding. Calore Express, 199 B.R.

at 434.

There is, however, another ground on which the bankruptcy

court rested its judgment, and which Fleet has argued to us. That

ground is the discretion of the bankruptcy court to grant or deny

setoff. See Cumberland Glass Mfg. Co. v. De Witt, 237 U.S. 447,

455 (1915) ("The matter [of setoff] is placed within the control of

the bankruptcy court, which exercises its discretion in these cases

-20-
on the general principles of equity."). In exercising that

discretion, the bankruptcy court wrote:

Allowing the United States to benefit from a setoff
in the instant case would constitute an abuse of this
Court's discretion and a perversion of its equitable
powers. The United States's attempt at ambush by silence
is unconscionable and will not be permitted. The
venerable maxim, "he who seeks equity must do equity,"
precludes the relief the United States requests.
Calore Express, 199 B.R. at 433 (footnote omitted).

It is not clear that the bankruptcy court had the

equitable discretion it purported to exercise. The government has

argued to us that setoff is in fact a legal rather than equitable

doctrine and that the bankruptcy court exceeded whatever narrow

discretion it might have possessed. See N.J. Nat'l Bank v.

Gutterman (In re Applied Logic Corp.), 576 F.2d 952, 957-58 (2d
Cir. 1978) (Friendly, J.) ("The rule allowing setoff, both before

and after bankruptcy, is not one that courts are free to ignore

when they think application would be 'unjust.'"); see also

Cumberland Glass, 237 U.S. at 455 ("While the operation of this

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 has been enacted as part of the

bankruptcy act, and when relied upon should be enforced by the

court.").

The Supreme Court has recently reminded the federal

courts that the discretion of a bankruptcy judge is circumscribed

by the Bankruptcy Code and by the underlying substantive law. See

Raleigh v. Ill. Dep't of Revenue, 530 U.S. 15, 24-25 (2000)

-21-
("Bankruptcy courts are not authorized in the name of equity to

make wholesale substitution of underlying law controlling the

validity of creditors' entitlements, but are limited to what the
Bankruptcy Code itself provides."); id. at 25 (citing United States

v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 228-

229 (1996), and United States v. Noland, 517 U.S. 535, 543 (1996)).
Of course, to the extent that Fleet argues that the underlying law

of setoff is discretionary, these recent cases do not control the

outcome here. These cases may, however, represent a relevant shift

from the easy appellate acceptance of broad discretion exercised by

bankruptcy judges reflected in the language from Cumberland Glass

on which Fleet relies.

Assuming in Fleet's favor that a bankruptcy court may
properly exercise some discretion over whether to permit setoff, it

must make that decision on all the facts of the case. The

bankruptcy court's irritation with the government's attorney is
understandable; nonetheless, its approach is difficult to reconcile

with a summary hearing and impossible to reconcile with a

nonevidentiary one. In this case, the government plausibly argues

that its attorney did not act in bad faith by remaining silent on

June 17 and that Fleet did not actually rely on the government's

silence at any time in the proceedings, whether on June 17 or

earlier.6 Both questions are relevant to the equities of this

6
The bankruptcy court also did not take into account
whether any actual reliance of Fleet on the continuing availability
of funds that Calore should have used to pay postpetition taxes was
unreasonable as a matter of law. Such taxes are to be paid in the
ordinary course of business. See United States v. Yellin (In re

-22-
case, and both depend on disputed factual questions such as the

actual knowledge and motives of individuals, rather than on

undisputed facts or on the record. The bankruptcy court took
evidence on neither. Its decision to deny setoff as a matter of

equity is not sustainable on the current record.

Thus, the remainder of our analysis focuses on two narrow
questions: whether, on the record and on the undisputed facts, the

government waived its right of setoff in this case as a matter of

law; and whether, within the same framework, Fleet's lien takes

priority over the government's setoff rights.

C. Waiver

The bankruptcy court and the district court agreed that

the government had waived any claim to setoff. The bankruptcy
court wrote:

The Court finds that the United States unequivocally
waived its right to assert a setoff by 1) failing to
object to the numerous requests for orders authorizing
the Debtor to borrow from the Bank against its accounts
receivable, including those due from the United States,
on a secured and superpriority basis; 2) failing to
object to the Bank's Lift Stay Motion in which the Bank
expressly stated its intention to liquidate its
collateral, including the accounts receivable;
3) expressly stating in its Second Proof of Claim dated
January 25, 1996 and the attachment that its claim for
prepetition taxes was not subject to setoff; and
4) failing to assert a right to setoff in any of its
Requests for Payment of Postpetition Taxes,
notwithstanding the existence of a right to setoff that
would have been available to the United States because of
the Debtor's failure to pay postpetition taxes and the
Debtor's sizeable business relationship with GSA.

Calore Express, 199 B.R. at 432. The court also found significant

Weinstein), 272 F.3d 39, 47 (1st Cir. 2001).

-23-
the silence of counsel for the government at the June 17 hearing:

At the June 17, 1996 hearing, the United States, through
its attorney, remained silent, despite its knowledge that
1) the Bank, which had just been granted relief from stay
to foreclose on its collateral, had agreed to make
additional loans to the Debtor to be secured by accounts
receivable; 2) the Tax Division had directed GSA to
freeze its payments to the Debtor; and 3) it would be
claiming that it had a right to setoff its claim for pre-
and postpetition taxes against the Debtor's account
receivable from GSA. Indeed, the United States waited
approximately one month after the June 17, 1996 hearing
before it even filed its own Motion for Relief from Stay
seeking permission to setoff. The Bank and the other
parties attempting to maximize the amount realized from
the sale of the Debtor's collateral by preserving the
going concern value of the Debtor's business relied upon
the government's silence to their detriment.

Id. at 433.

Courts use the word "waiver" to mean different things in

different contexts. See generally Irons v. FBI, 880 F.2d 1446,
1452-53 (1st Cir. 1989) (en banc) (discussing the different

meanings of "waiver"). In the context of bankruptcy proceedings,

some courts have said that a waiver of setoff must be the
intentional relinquishment of a known right. McCarty v. Nat'l Bank

of Alaska, N.A. (In re United Marine Shipbuilding, Inc.), 158 F.3d

997, 1001 (9th Cir. 1998) (requiring "a voluntary or intentional

relinquishment" of setoff for waiver); see also Chassen v. United

States, 207 F.2d 83, 84 n.3 (2d Cir. 1953). Other courts have said

that a party may waive setoff rights by failing to assert them in

a timely fashion. United States v. Cont'l Airlines (In re Cont'l

Airlines), 134 F.3d 536, 541 (3d Cir. 1998) ("We recognize that a

right of setoff is preserved under § 553 in a bankruptcy proceeding

but we believe that the right must be exercised by the creditor in

-24-
timely fashion and appropriately asserted in accordance with other

provisions of the Bankruptcy Code."). These cases are in tension,

as a party's delay in asserting its right of setoff will in some
cases be unintentional.

The present case requires no general theory of setoff

waiver. We do, however, recognize the following principles.
First, a creditor in bankruptcy proceedings may expressly waive a

right of setoff -- as, for example, by a written statement that the

creditor will not assert that right. 5 Collier, supra, ¶ 553.07,

at 553-78 & n.2 (15th ed. 2001) (citing Blanton v. Prudential-Bache

Securities, Inc. (In re Blanton), 105 B.R. 321, 335 (Bankr. E.D.

Va. 1989)); see also In re Metro. Int'l, Inc., 616 F.2d 83, 86 (3d

Cir. 1980) (holding that a creditor had expressly waived its right
as a matter of law by oral statements on the record). Second, a

court may imply a waiver of a right of setoff from the creditor's

conduct. Hoffman v. Gleason (In re Capital Nat'l Bank of Lansing),

107 F.2d 101, 104 (6th Cir. 1940) (citing Cumberland Glass, 237

U.S. at 459). That conduct, however, must fairly demonstrate the

creditor's intent. For example, the voluntary payment by the

creditor of its debt to the debtor, without any reservation of a

right of setoff, waives that right. In re Mauch Chunk Brewing Co.,

131 F.2d 48 (3d Cir. 1942) (so holding with regard to a bank's

payment of an account to a trustee in bankruptcy). This circuit

has held that payment in obedience to a court's judgment, which is

not voluntary, is therefore not waiver, even though the creditor

had the opportunity to seek a stay of the judgment and chose not to

-25-
do so. Pub. Serv. Co. of N.H. v. N.H. Elec. Coop., Inc., 884 F.2d

11, 13 (1st Cir. 1989). Other courts have held that inadvertent

payment due to an administrative error also does not waive the
right. McCarty, 158 F.3d at 1001 (so holding and collecting

cases). Third, a waiver of setoff rights, whether express or

implied, is not necessarily irrevocable; instead, the creditor may
generally rescind the waiver. When, however, another party to the

proceedings has relied on the waiver to its detriment, the court

may invoke estoppel and rule that the waiver has become

irrevocable. See Metro. Int'l, 616 F.2d at 86; Chassen, 207 F.2d

at 83.7 It is not clear whether the waiver could apply even in

such a case to a creditor's claims that accrued after the attempted

recission.
Our holding that a waiver of setoff implied from the

conduct of the creditor must rest on conduct that demonstrates

intent will seldom, if ever, permit the courts of this circuit to
imply waiver from mere silence. This result is consistent with the

Bankruptcy Code, which provides that with limited exceptions the

7
Here the rule may differ for the government. The Supreme
Court has held that courts may rarely, if ever, apply the doctrine
of equitable estoppel against the government -- and never to
require the government to pay public funds contrary to a statutory
appropriation. Office of Pers. Mgmt. v. Richmond, 496 U.S. 414,
419-24 (1990). This circuit has held that, in the context of
procedural requirements in a bankruptcy proceeding, Richmond does
not permit estoppel against the government except possibly after
government agents commit affirmative misconduct. Noonan v. Sec'y
of Health & Human Servs. (In re Ludlow Hosp. Soc'y, Inc.), 124 F.3d
22, 25-26 (1st Cir. 1997). The government has not argued to us any
theory based on Richmond, Noonan, or similar cases, and so we do
not base our holding on them. If and when a court finally resolves
the government's claim against Fleet, however, it should consider
the question.

-26-
Code "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) (2000). Those exceptions include

the automatic stay, so that a creditor may not exercise a
prepetition right of setoff during bankruptcy proceedings without

first obtaining the permission of the court. See id. § 362(a)(7).

Nevertheless, there is authority that § 553 may allow a creditor

even to wait out the bankruptcy proceedings and then, afterwards,

exercise a prepetition right of setoff unimpaired by the actions of

the bankruptcy court, although the court has meanwhile granted a

discharge or confirmed a plan of reorganization. Davidovich v.
Welton (In re Davidovich), 901 F.2d 1533, 1539 (10th Cir. 1990)

("[T]he right to assert a setoff against a mutual, prepetition debt

owed the bankrupt estate survives even the Bankruptcy Court's
discharge of the bankrupt's debts."); see also Citizens Bank of Md.

v. Strumpf, 516 U.S. 16, 21 n.* (1995) (declining to answer the

question whether that right survives the confirmation of a plan of

reorganization in a Chapter 13 case).

Whether that is so we need not decide today, nor whether

to treat waiver of postpetition rights of setoff any differently.

That the question is even in issue indicates that the Code grants

considerable protection to setoff rights even though the creditors

holding those rights remain inactive in the bankruptcy proceeding.

Thus, as a general matter, a creditor's silence in the early stages

-27-
of bankruptcy proceedings, such as the filing of a proof of claim,

does not waive the right of setoff. On the facts of a specific

case, however, silence at a specific time may be unequivocally
inconsistent with the assertion of the setoff right. We address

the conclusion of the bankruptcy and district courts that this is

such a case below.
We consider the bankruptcy court's four grounds of waiver

in this light.

1. Failure to object to the borrowing order

The bankruptcy court held that the government had waived

its right of setoff by "failing to object to the numerous requests

for orders authorizing the Debtor to borrow from the Bank against

its accounts receivable, including those due from the United
States, on a secured and superpriority basis." Calore Express, 199

B.R. at 432. We disagree. If the orders authorizing the borrowing

had set a date by which to assert setoff, the government's failure
to object to the June 28, 1995, order, or to the orders and

stipulations that followed, could conceivably have been
inconsistent with an intent to assert any existing right of setoff.

The orders did not do so; instead, they granted certain security

interests and priority rights to Fleet. Even if those new rights

were senior to the government's right of setoff, the orders would

not have eliminated the right of setoff itself. They would merely

have rendered that right junior to Fleet's new rights. We discuss

below the bankruptcy court's conclusion as to seniority of

interests. Regardless, the government's acquiescence in the order

-28-
without objection did not waive its right of setoff.

2. Failure to object to Fleet's June 13 motion

The bankruptcy court held that the government had waived
its right of setoff by "failing to object to the Bank's Lift Stay

Motion in which the Bank expressly stated its intention to

liquidate its collateral, including the accounts receivable." Id.

This ground apparently encompasses the silence of counsel for the

IRS at the June 17 hearing as well as the absence of written

filings. As a matter of logic, waiver does not follow from this

silence for the same reason that it does not follow from the

government's acquiescence in the borrowing orders: lifting the

order as to Fleet affected Fleet's rights against Calore, but had

no effect on Fleet's or Calore's rights against the government, and
therefore acquiescence in the lifting was not inconsistent with the

government's intention to assert its setoff rights.

To treat the bankruptcy court's opinion fairly, however,
we take a broader view of the significance of the court's actions

at the June 17 hearing. By granting Fleet permission to sell

Calore's assets, while at the same time postponing the requests of

all other creditors, the court intended to allow Fleet to sell the

assets as a group and therefore to preserve Calore's value as a

going concern. In effect, the court was allowing Fleet to pursue

a course of action quite similar to the earlier motion for a sale

of assets under 11 U.S.C. § 363, which the court had denied on June

10 primarily because of its effect on the government's rights.

From the court's perspective, it had scrupulously protected the

-29-
government's rights on June 10, despite the accusations of Fleet

and other creditors at the time that the government's position was

unreasonable. A mere week later, the government felt once more
that its rights were threatened; but counsel, rather than raising

a setoff argument to the court, sat by in silence and allowed

events he had already set in motion to frustrate the purpose, if
not the literal language, of the court's order. It may be, as

counsel said in a later affidavit to the court, that he did not

know for sure that the GSA still owed Calore money and so that a

substantial setoff remained possible. Even so, he had an inkling

that this might be so, and should have shown greater candor.

The subsequent history of this case has shown that

counsel's silence, whether or not it was waiver or inequitable
conduct, was certainly unwise. We discourage similar conduct by

bankruptcy litigants, including the government, in the future.

Nevertheless, the question whether silence constitutes waiver
requires an inquiry, as we have discussed above, on all the facts

of the case. See 5 Collier, supra, ¶ 553.07[2]. It is unsuitable

for resolution in a nonevidentiary hearing. The concerns raised by

the bankruptcy court, although significant, did not give it

sufficient grounds to conclude as a matter of law that the

government had so clearly waived its right of setoff as to lack

even a colorable claim. Therefore, counsel's silence at the June

17 hearing does not support the bankruptcy court's finding of

waiver. If and when a court more fully develops the facts of this

case, our holding today will not preclude Fleet from arguing that

-30-
on those facts the government's silence amounted to waiver.

3. Statements made in proofs of claim

The bankruptcy court held that the government had waived
its right of setoff by "expressly stating in its Second Proof of

Claim dated January 25, 1996 and the attachment that its claim for

prepetition taxes was not subject to setoff." Calore Express, 199

B.R. at 432. This reasoning can apply, of course, only to the

IRS's prepetition claims, which are the only ones described in the

January 25 proof of claim. We agree that as to these claims the

government's filing contained a waiver (which may later have been

rescinded, as discussed below). The proof of claim itself stated

that "[i]n filing this claim, claimant has deducted all amounts

that claimant owes to debtor"; the attachment to the proof stated
that "[t]his claim is not subject to any setoff or counterclaim."

The government argues that this should be discounted as preprinted

form language, an argument we consider irrelevant. The IRS, of all
litigants, can hardly complain to the courts when it errs in

filling out a form.

The government also points out that the language of the

form contemplates that a creditor will exercise setoff rights

before even filing a proof of claim. That language seems

inconsistent with 11 U.S.C. § 362(a)(7), which subjects prepetition

rights of setoff to the automatic stay. It also seems inconsistent

with the broader policy of the Bankruptcy Code regarding setoff,

which is -- particularly in Chapter 11 reorganization cases -- to

encourage creditors to forbear at least temporarily from exercising

-31-
setoff rights that, if exercised, would put debtors immediately out

of business. See Pub. Serv. Co., 884 F.2d at 13 ("To implement the

congressional purpose, courts should attempt to minimize the
dislocations attendant to setoffs."). Nonetheless, the IRS could

have easily fixed any inconsistency by striking the offending

language or attaching an explanation, as the GSA did to its
February 1 proof of claim.

Stronger, and possibly correct, is the government's

argument that it sufficiently preserved its rights as to the setoff

of the GSA's debt against Calore's overcharges by asserting them in

the GSA's February 1 proof of claim, and as to the setoff of the

GSA's debt against Calore's tax debt by asserting them in the

government's April 1 objection to Calore's third amended
reorganization plan. As to the February 1 proof of claim, this is

unquestionably correct, as no prior statement of waiver applies to

the GSA's claim for overcharges. That claim, however, amounts to
only $6,734.24. As to the April 1 objection to Calore's plan, it

stated: "The Bankruptcy Code specifically preserves the United

States' right to offset any pre-petition claims of the United

States against any pre-petition claims of the Debtor." That

statement expresses the Government's intent, as of April 1, to

assert its setoff rights on its prepetition claims -- that is, it

rescinds any prior waiver of setoff. See Chassen, 207 F.2d at 83

(holding that a clarification by the government was "the equivalent

-32-
of an amendment of [the government's] proof of claim").8
That recission came too late, however, if Fleet had in

fact previously relied to its detriment on the IRS's waiver of
January 25. The bankruptcy court stated that Fleet's continued

lending to Calore demonstrated both reliance and detriment, a

statement that suggests the application of estoppel, although the
court did not use that term. Fleet reasserts this theory on

appeal. The government responds that: first, it is not clear when

Fleet learned of the statement on the government's proof of claim,

as shown by a statement by Fleet's counsel that he did not "review

proofs of claim . . . at that stage in the case"; second, Fleet's

actual lending exposure was approximately the same in August 1996

as it had been in May 1995, so that it is unclear that Fleet took
any knowledge about the government's intent as to setoff into

consideration; third, no deadline for the filing and amendment of

claims had passed before April 1, which appears to amount to an
argument that Fleet could not have reasonably relied on the

original waiver. Whether Fleet actually relied on the government's

waiver is a question of fact that the parties dispute, and cannot

be determined purely from the record. See Metro. Int'l, 616 F.2d

at 86-87 (holding that the undisputed facts of that case

established waiver but remanding for a hearing to establish the

question of detrimental reliance). On the facts of this case, the

8
The bankruptcy court commented in its opinion that the
language in the April 1 objection was too general. Calore Express,
199 B.R. at 433. We see no difficulty in the use of a general
statement to rescind a general waiver such as the one contained in
the January 25 proof of claim.

-33-
government's possibly-rescinded waiver therefore did not deprive

the government of a colorable claim based on its right of setoff,

and does not support the bankruptcy court's finding of waiver as a
matter of law.

4. Silence in requests for payment

The bankruptcy court held that the government had waived
its right of setoff by "failing to assert a right to setoff in any

of its Requests for Payment of Postpetition Taxes." Calore

Express, 199 B.R. at 432. We disagree. Unlike the third finding

of waiver, which was based on definite statements in the IRS's

proofs of claim, this finding relies simply on the government's

failure to mention setoff in its various requests for payment, when

there was no rule or court order requiring it to do so. As our
discussion above makes clear, that silence is insufficient to

support a conclusion of waiver as a matter of law.

5. Summary
For the reasons we have discussed, only two possible

grounds of waiver survive our decision in this appeal. One is the

statement in the IRS's January 25 proof of claim, which is a clear

waiver but which applies only to prepetition claims and which in

any event the government may have properly rescinded on April 1.

Whether that recission took effect depends on an inquiry into

estoppel, which should take into account all the facts of the case.

The other is the government's silence at the June 13 hearing, which

may constitute waiver and may potentially apply to either pre- or

postpetition claims. That inquiry, too, requires consideration of

-34-
all the facts of the case.9
D. Priority of Fleet's lien

The bankruptcy court reasoned that the government's right
of setoff was junior to Fleet's lien as a matter of law because

that court had authorized on June 28, 1995, and periodically

renewed a borrowing order under the three subsections of 11 U.S.C.
§ 364(c). The order granted a secured lien on all of Calore's pre-

and postpetition assets, including accounts receivable, to Fleet's

predecessor Shawmut. It also granted priority over all other

administrative claims. The district court did not reach this

ground of the bankruptcy court's judgment.

Only one of the bankruptcy court's three sources of

statutory authority, 11 U.S.C. § 364(c)(2), provides Fleet with a
colorable claim to priority. The borrowing order gave Shawmut a

senior lien on Calore's previously unencumbered assets under

§ 364(c)(2). It also gave Shawmut a junior lien on Calore's
previously encumbered assets, certain vehicles and equipment, under

§ 364(c)(3). Because accounts receivable were not in this

category, the § 364(c)(3) lien is not relevant here. In case

Shawmut's claim turned out to be undersecured by the assets subject

to lien, the court gave Shawmut a superpriority administrative

claim under § 364(c)(1). That superpriority is also irrelevant

here because any unsecured claim, even an administrative one, is

9
As discussed earlier, both inquiries should also take
into account the relevance, if any, of the principles set forth in
Office of Personnel Management v. Richmond, 496 U.S. 414 (1990),
and Noonan v. Secretary of Health and Human Services (In re Ludlow
Hospital Society, Inc.), 124 F.3d 22 (1st Cir. 1997).

-35-
junior to a secured claim; and the government's setoff claim

qualifies as a secured claim under 11 U.S.C. § 506(a). Therefore,

Fleet's sole possible argument for priority rests on the
§ 364(c)(2) lien.

1. Choice of law

The bankruptcy court applied Article Nine of the Uniform
Commercial Code to determine the relative priority of Fleet's lien

and the government's setoff rights. We initially determine the

proper source of law for the priority dispute in this case. As a

general matter, 11 U.S.C. § 553 does not create a scheme of

priority for the setoff rights it preserves, any more than it

creates those rights themselves, see Sisk v. Saugus Bank & Trust

Co. (In re Saugus Gen. Hosp., Inc.), 698 F.2d 42, 44 (1st Cir.
1983). Setoff is a creature of the common law, and therefore in

most cases a question of state law under Erie Railroad Co. v.

Tompkins, 304 U.S. 64 (1938). Federal law, however, determines the
rights and liabilities of the United States, as the Supreme Court

held in Clearfield Trust Co. v. United States, 318 U.S. 363 (1943).

If Congress enacts a statute, that statute governs. If Congress

does not, the federal courts apply federal common law. The United

States's general right of setoff, like its other rights in

commercial disputes, is a matter of federal common law, as is the

priority of that right as against the rights of other creditors.

We address first, if briefly, the government's contention

that this case falls within a federal statute. The government

invokes the Assignment of Claims Act, 31 U.S.C. § 3727 (1994),

-36-
which provides certain requirements for the assignment of claims

against the federal government, none of which Fleet has met. Fleet

responds correctly that the Act applies only to the voluntary
assignment of claims, and not to assignments by operation of law,

including those in the context of bankruptcy. United States v.

Aetna Cas. & Sur. Co., 338 U.S. 366, 373-74 (1949). The government
also makes some passing references to the Judgment Setoff Act, 31

U.S.C. § 3728 (1994 & Supp. II 1996), but does not press the point;

there is no judgment at stake in this case and so the Act by its

terms does not apply. Therefore, the question of the priority of

the government's setoff rights is a question of federal common law.

That said, a federal court applying federal common law

will often simply incorporate the law of the appropriate state if
there is no relevant federal interest to justify a distinct federal

rule. In United States v. Kimbell Foods, Inc., 440 U.S. 715

(1979), the Supreme Court considered whether to rely on any federal
interest in generating federal common law to determine the priority

of a lien that the government acquired as a party to a contract.
The Court held that state law should apply, and reasoned that there

was no sufficiently compelling federal interest at stake. Id. at

740. It noted that the expectations of parties to commercial

transactions tend to be based on state law, and that the federal

courts should not disrupt those expectations without good reason.

Id. at 739-40. The Court distinguished the problem of commercial

liens held by the federal government from that of federal tax

liens. Tax collection is uniquely important to the proper

-37-
functioning of the government, and in tax cases the government is

an involuntary creditor. Id. at 734-36.

The present case involves both of the situations the
Court discussed in Kimbell Foods. As to Calore's unpaid taxes, the

government is an involuntary creditor facing the problem of

enforcement: if the government's allegations are true, Calore was
engaged in a continuing process of misappropriating funds

supposedly held in trust for employee taxes both before and after

filing its Chapter 11 petition. As to the GSA's contract debts, by

contrast, the government was purchasing services on the market and

should not necessarily expect treatment different from that of any

other participant in commerce.

When the federal courts make new federal common law, it
is to protect strong federal interests -- for example, the interest

of the government as tax creditor. Happily for federalism

purposes, state law adequately protects that interest here. We
read the Uniform Commercial Code, at least as interpreted by

Massachusetts,10 differently than did the bankruptcy court, and for

present purposes we incorporate state law into federal.11 Our

analysis of the Code follows.

10
The bankruptcy court applied the law of Massachusetts to
this case, and the parties do not dispute that Massachusetts's law
applies, although they do dispute its content.
11
On July 1, 2001, Revised Article Nine of the Uniform
Commercial Code took effect in Massachusetts, as in all fifty
states. See 2001 Mass. Acts 26. Our discussion of the law, of
course, applies the law as it was in effect at the time the events
took place.

-38-
2. Article Nine and setoff priority

Initially, we note that the bankruptcy court correctly

concluded that Article Nine of the Uniform Commercial Code applied
to the relative priority of setoffs and security interests despite

the language of section 9-104(i), which states that the Article

does not apply to "any right of set-off." Mass. Gen. Laws ch. 106,
§ 9-104(i) (2000) (repealed 2001); see 5 Collier, supra, ¶

533.12[1] ("The majority of jurisdictions construe section 9-104(i)

to mean that, although a creditor may claim and enforce a right of

setoff without complying with the requirements of Article Nine,

nevertheless Article Nine governs the priority of any setoff right

in conflict with an Article Nine security interest."). The

Supreme Judicial Court of Massachusetts has applied Article Nine to
determine the validity of a setoff right after an assignment of

accounts receivable as security. See Graves Equip., Inc. v. M.

DeMatteo Constr. Co., 397 Mass. 110, 489 N.E.2d 1010, 1011 (1986);
Fall River Trust Co. v. B.G. Browdy, Inc., 346 Mass. 614, 195

N.E.2d 63, 64 (1964).

The bankruptcy court then proceeded to apply section

9-312(5) of that Article. Section 9-312(5) accords priority

"between conflicting security interests in the same collateral" to

that secured party who first files or perfects according to the

requirements of Article Nine; or, if neither of the contesting

parties has filed or perfected, to that party whose interest first

attached.12 Fleet defends the bankruptcy court's choice of that

12
The relevant part of section 9-312 reads:

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provision. The government argues that, instead, the court should

have applied section 9-318, which applies to the assignment of

accounts receivable. Under section 9-318, an account debtor may
assert against an assignee any "defense or claim" that either

arises from the terms of the assigned contract or accrued before

the account debtor had notice of the assignment.13
For three reasons, we hold that section 9-318 applies to

this case and section 9-312(5) does not. First, the government's

right of setoff fits within subsection 9-318(1)(b)'s description of

"a defense or claim of the account debtor against the assignor."

In two cases we cited earlier, Graves Equipment and Fall River

Trust, Massachusetts's highest court applied section 9-318 to a

right of setoff asserted by an account debtor against an assignee
of accounts receivable. Graves Equip., 489 N.E.2d at 1011-12; Fall

(5) In all cases not governed by other rules stated in this
section . . . priority between conflicting security interests
in the same collateral shall be determined according to the
following rules:
(a) Conflicting security interests rank according to
priority in time of filing or perfection. . . .
(b) So long as conflicting security interests are
unperfected, the first to attach has priority.

Mass. Gen. Laws ch. 106, § 9-312 (2000) (repealed 2001).
13
The relevant part of section 9-318 reads:

(1) . . . [T]he rights of an assignee are subject to
(a) all the terms of the contract between the account
debtor and assignor and any defense or claim arising
therefrom; and
(b) any other defense or claim of the account debtor
against the assignor which accrues before the account
debtor receives notification of the assignment.

Mass. Gen. Laws ch. 106, § 9-318 (2000) (repealed 2001).

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River, 195 N.E.2d at 64. The only possible way to distinguish this

case from Graves Equipment and Fall River Trust would rely on the
fact that in this case, Fleet's predecessor Shawmut first took a
lien on Calore's accounts, by a prepetition security agreement and

then by the June 1995 borrowing order; only later, with the July
1996 sale of assets, did Fleet obtain permission to lift the
automatic stay and to exercise its right to take an assignment of
the accounts. The application of section 9-312(5) must therefore
rest on the premise that in this context the rights of a creditor
who holds a perfected lien on accounts receivable and subsequently

becomes an assignee exceed those of one who becomes an assignee

directly.

Neither Fleet nor the bankruptcy court, however, offer
any reason grounded in policy to reach a different result in this

case, which features an assignment through a lien, from that we

would reach in a case of a direct assignment. It would be an odd
result if parties whose agreement to assign accounts would remain

subject to an account debtor's existing defenses and claims could

bypass those defenses and claims with the device of a lien.
Moreover, there is authority in other jurisdictions to the

contrary. See Me. Farmers Exch. v. Farm Credit of Me., 2002 ME 18,

¶ 13 (stating that section 9-318 "provides a limited right to a

setoff for [an account debtor], a right that can be superior to the
security interest of a secured party," and then applying section

9-318(1)(a) because the account debtor had notice); Commerce Bank,

N.A. v. Chrysler Realty Corp., 244 F.3d 777, 783 (10th Cir. 2001)

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(applying Kansas law) ("The fact that [the secured party] had a

perfected security interest, and [the account debtor] did not,
makes no difference because [the secured party]'s secured status
comes into play only after it is shown that [the assignor] was

entitled to payment of the funds."); see also Chase Manhattan Bank

(N.A.) v. State, 357 N.E.2d 366, 369 (N.Y. 1976) ("[T]he 'first to
file' rule [referring to section 9-312(5)], designed to resolve
situations where secured parties are competing in asserting
superior rights, should not be controlling when the dispute is
between a secured party and an account debtor."). In addition, in

United California Bank v. Eastern Mountain Sports, Inc., 546 F.

Supp. 945 (D. Mass. 1982), cited in Graves Equipment, 489 N.E.2d at

1012, a case decided under Massachusetts law, the District of
Massachusetts applied section 9-318 to an assignment following the

conveyance of a security interest. Id. at 950, 963-64.

Fleet relies for its contrary argument on MNC Commercial

Corp. v. Joseph T. Ryerson & Son, Inc., 882 F.2d 615 (2d Cir.

1989), in which the Second Circuit applied section 9-312 to a

dispute between an account debtor and the assignee of accounts
receivable. Id. at 620. In that case, however, the account debtor

did not actually own the claim against the assignor that it sought

to assert against the assignee, and the court stated that New York

law left open the question what would occur if the account debtor
did own the asserted claim. Id. In this case, Fleet cannot argue

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that the government does not own the IRS's claim against Calore.14

Second, the government's right of setoff is not clearly
a "security interest" within the meaning of section 9-312(5).
Although a claim accompanied by a right of setoff is a "secured

claim" within the meaning of the Bankruptcy Code, 11 U.S.C.
§ 506(a), a secured claim within the meaning of federal bankruptcy
law is not necessarily the same thing as a security interest within
the meaning of Article Nine. If a right of setoff were an Article
Nine security interest, it is difficult to see how it would escape
the procedural requirements for priority, such as filing or

perfection, imposed by that Article. That result would produce

tension with the reading of section 9-104(i) discussed above, under

which setoffs are not subject to Article Nine's procedural
requirements. Some courts have found persuasive in this context a

comment of Article Nine's reporter, Professor Grant Gilmore, that

"[o]f course a right of set-off is not a security interest and has
never been confused with one: the statute [referring to section 9-

104(i)] might as appropriately exclude fan dancing." I G. Gilmore,

Security Interests in Personal Property § 10.7, at 315-16 (1965),

quoted in Nat'l City Bank, N.W. v. Columbian Mut. Life Ins. Co.,

282 F.3d 407, 410 (6th Cir. 2002).

14
Fleet might have made, but did not make, the somewhat
analogous argument that a claim of the IRS and a debt of the GSA
are not mutual for the purpose of setoff. The bankruptcy court
raised but did not answer that question. Calore Express, 199 B.R.
at 432 & n.7. As we lack the benefit of decisions by either the
bankruptcy court or the district court, and as the parties have not
briefed the issue, we also decline to answer that question today.
It will remain for any further proceedings brought by the
government.

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 Third, section 9-312(5) by its terms applies "[i]n all

cases not governed by other rules stated in this section," that is,
section 9-312. The first subsection of that section, 9-312(1), in
turn states that "[t]he rules of priority stated in other sections

of this Part and in the following sections shall govern when
applicable." The Part cited is Part Three of Article Nine, which
includes section 9-318. This language indicates that section
9-312(5) states a default rule that courts should apply only in the
absence of other governing provisions. Thus, to the extent we
could properly view the dispute between Fleet and the government as

either a contest "of priority between conflicting security

interests" or a question of the validity of a "defense or claim of

the account debtor against the assignor," we should adopt the
latter perspective.

Accordingly, we next apply section 9-318 to the facts of

this case.
3. Timing of notice and accrual

In this case, because Calore's debt to the IRS was

unrelated to the terms of the contract between Calore and the GSA,
subsection (1)(b) of section 9-318 governs the outcome. Under that

provision, the crucial times are when the government received

notice of the assignment of Calore's debts to Fleet, and when the

IRS's claim against Calore accrued.
The parties contest exactly when the government received

notice. The government argues that it received notice only when

Fleet informed the court and the other parties of the sale of

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Calore's assets in August 1996. Because that date is also when

Calore ceased doing business as Calore, the government's tax claims
necessarily accrued before notice, and those claims take priority.
Fleet argues that the government received notice at the time of the

first borrowing order, in June 1995, which gave Fleet's predecessor
Shawmut its security interest in all of Calore's assets.
The government's claims based on Calore's prepetition tax
debts accrued, by definition, before Calore's Chapter 11 petition
and so before the borrowing order. The government's rights based
on those claims therefore take priority over Fleet's security

interest even on Fleet's view of timing. The government's setoff

rights based on postpetition tax claims presumably accrued, at

least in part, after June 1995 but before August 1996. We must
therefore decide whether the borrowing order provided the

government with reasonable notice under section 9-318, so that the

government cannot now assert claims accruing after the borrowing
order against Fleet.

It did not. The borrowing order at most informed the

government not of an assignment of Calore's accounts, but only of
a lien placed on those accounts that could later lead to an

assignment. Following the borrowing order, the government and

other acccount debtors continued to do business with and make

payments to Calore, and not to Shawmut, the lienholder. At least
one court has reasoned in applying section 9-318 that notice of an

assignment that precedes the assignment itself is ineffective. See

Citizens State Bank of Corrigan v. J.M. Jackson Corp., 537 S.W.2d

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120, 121 (Tex. Civ. App. 1976) ("[An account debtor can]not be put

on notice of an assignment prior to the time that that assignment
existed."). This is not a case in which Calore assigned accounts
receivable to serve as security, with the assignment effective at

the time the debt was incurred, although such assignments do occur
and are sometimes called "security interests." In this case, Fleet
acquired its right to collect Calore's receivables only later,
after the July 1996 sale of assets.
We need not rule out the possibility that some
particularly comprehensive and express form of notice could

potentially affect an account debtor's rights before an actual

assignment, however. On the facts of this case, the borrowing

order lacked sufficient detail to satisfy the requirements of
section 9-318(3), which states that notice must "reasonably

identify the rights assigned." Mass. Gen. Laws ch. 106, § 9-318(3)

(2000) (repealed 2001). As quoted earlier, the borrowing order
refers generally to all of Calore's accounts. It does not identify

any debtors, contracts, or amounts. Although there are no relevant

cases under Massachusetts law, courts applying section 9-318(3) as
part of the law of other states have required more detail in

notices of assignment. See Progressive Design, Inc. v. Olson Bros.

Mfg. Co., 263 N.W.2d 465, 468-69 (Neb. 1978) (rejecting as

reasonable notice a letter that "did not identify the contract by
date, or by the type or kind of contract, nor did it refer to the

product or services contracted for, nor even the amount of money

involved"); Bank of Salt Lake v. Corp. of the President of the

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Church of Jesus Christ of Latter-Day Saints, 534 P.2d 887, 891
(Utah 1975) (dictum) (stating that a letter with incorrect invoice
numbers and amounts did not provide reasonable notice). Certainly,
in order to prevent an account debtor from raising against an

assignee defenses and claims accruing after the notice but before
the assignment itself, the notice given would have to meet at least
the standards set forth in these cases.
The reason that the order did not include such specifics
is probably that no one involved -- Fleet, Calore, or the
bankruptcy court -- intended the order to serve as notice to

Calore's account debtors of an assignment of Calore's accounts

receivable. Nor would the attorneys at the U.S. Attorney's Office

for the District of Massachusetts, to whom the order was served,
have had any reason to think that the order had such a purpose.

Nothing in the order even mentioned the IRS or the GSA, whose

agents might perhaps have understood the potential significance of
a potential assignment. Cf. Chase Manhattan Bank, 357 N.E.2d at

369 (holding that a UCC filing statement filed with New York's

Secretary of State did not give reasonable notice to the state of
its contents under section 9-318). Accordingly, the government

received its notice of assignment no earlier than the following

August; because the government's tax claims accrued prior to that

date, it can exercise its right of setoff against Fleet, and the
bankruptcy court's conclusion was mistaken.

The purpose of the rule requiring notice to foreclose an

account debtor's setoff rights for claims independent of the

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contract out of which the account arises is presumably to permit

the account debtor to protect its rights. Knowing that it will no
longer be able to rely on the assigned accounts in disputes with
the assignor, the account debtor may act differently in dealings

with the assignor, or even cease doing business with the assignor
entirely. The government in this context is, of course, unable to
make such choices. Calore's tax debts would continue to accrue
regardless of the government's actions. That distinction between
the government and an ordinary commercial actor is one of the
reasons that the federal courts have been particularly careful to

guard the government's interest in tax collection. See Kimbell

Foods, 440 U.S. at 735-36 ("The United States is an involuntary

creditor of delinquent taxpayers, unable to control the factors
that make tax collection likely."). Nevertheless, proper notice in

this case might have been helpful to the United States:

specifically, it might have alerted government attorneys to the
need to act quickly to protect the government's rights. Thus,

while we have treated the waiver and priority questions separately

in this opinion, the underlying theme remains that it is not clear

on the present record that the government's inaction was

unreasonable or inappropriate.

IV.

On the present record, the bankruptcy court's decision
can stand on none of the grounds it gave: waiver, equitable

discretion over setoff, and priority are all insufficient. As the

government points out, the remaining dispute no longer concerns an

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existing bankruptcy estate; neither party has briefed where any

future proceedings, if any, should take place. We therefore
reverse the decision of the district court and remand with
instructions to reverse the decision of the bankruptcy court, and

to determine, with the assistance of the parties, the appropriate
disposition of the case. Should the government bring future
proceedings against Fleet for restitution, this opinion will
provide guidance for that action. No costs are awarded.

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