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BANK OF KANSAS v. HUTCHINSON HEALTH SERVICES

January 19, 1990.

BANK OF KANSAS, Appellee,
v.
HUTCHINSON HEALTH SERVICES, INC., a Kansas corporation, and THE STATE OF KANSAS, DEPARTMENT OF SOCIAL AND REHABILITATION SERVICES, Defendants, and THE CENTRAL STATE BANK, Trustee, Intervenor, and THE STATE DEPARTMENT OF HUMAN RESOURCES OF KANSAS, Intervenor/Appellant.



The opinion of the court was delivered by

This case is a priority battle between the Bank of Kansas (Bank), which has a perfected security interest in Hutchinson Health Services, Inc.'s

[246 Kan. 84]

      (HHS) accounts receivable, and the Kansas Department of Human Resources (DHR), which claims a right to set off HHS' delinquent unemployment contributions against funds owed to the debtor by the Kansas Department of Social and Rehabilitation Services (SRS) for Medicaid cost reimbursements.

The Bank made three separate loans to HHS totaling $281,384.58. The loans were secured by a perfected security interest in HHS' accounts receivable, including Medicaid reimbursement funds owed to HHS by SRS. HHS defaulted on the loans. On November 19, 1984, the Bank filed its amended petition against HHS and SRS, seeking judgment against HHS on the promissory notes for $186,141.51 and seeking an order requiring SRS to pay the Bank all previously withheld Medicaid payments.

Central State Bank intervened in the action. On November 6, 1984, HHS had deposited a check in the amount of $100,864 for Medicaid cost reimbursements from the State of Kansas into its checking account at Central State Bank. On November 19, Central State Bank declared itself insecure and set off the $26,229 that was remaining in HHS' account against debts owed to Central State by HHS. The trial court held that Central State's right of setoff was superior to the Bank's security interest and certified that judgment pursuant to K.S.A. 1988 Supp. 60-254(b). On appeal, the Court of Appeals reversed, holding that Article 9 of the UCC governed the priority as between a perfected security interest and a right of setoff and that the Bank had priority over Central State Bank. Bank of Kansas v. Hutchinson Health Services, Inc., 12 Kan. App. 2d 87, 735 P.2d 256, rev. denied 241 Kan. 838 (1987).

  DHR also intervened, alleging that HHS owed $14,916.42 in delinquent unemployment contributions and that DHR was entitled to set off this amount against any funds owed to HHS by SRS. On March 15, 1985, the Bank and DHR entered into an agreement regarding these funds, which provided:
"1. Both parties recognize that Intervenor State of Kansas Department of Human Resources has acquired by setoff $14,916.42 from the funds held by State of Kansas Department of Social and Rehabilitation Services on behalf of Defendant Hutchinson Health Services, Inc.
  "2. The proper priority to these funds shall be determined by the court at a later date.

[246 Kan. 85]

     

 
"3. The Plaintiff and State of Kansas Department of Human Resources reserve the right to challenge the priority of these funds."
  SRS subsequently paid $105,607.79, representing the remaining accounts receivable of HHS being held by SRS, to the Clerk of the District Court for Reno County. Those funds were subsequently distributed to the Bank in partial satisfaction of its claim against HHS. On May 16, 1985, the trial court granted judgment for the Bank against HHS in the amount of $197,812.42 plus interest.
  Both the Bank and DHR moved for summary judgment as to the remaining $14,916.42. The district court originally granted summary judgment in favor of DHR on December 2, 1986, finding that 42 U.S.C. § 1396a(a) (1982) prohibits assignment of payments under a state plan for medical assistance and, therefore, the Bank could have no perfected security interest in the accounts receivable from SRS. No journal entry was ever filed. On January 13, 1988, the Bank filed a motion to reconsider the judgment, citing the Court of Appeals' holding in Bank of Kansas, 12 Kan. App. 2d 87, Syl. ¶ 1:
"42 U.S.C. § 1396a(a)(32) (1982), which requires a state medicaid plan to provide that no medicaid reimbursement payment shall be made under an assignment to anyone other than the individual providing medical care, does not prohibit a medical care provider from using medical reimbursement payments as collateral for bank loans."
  The district court then found in favor of the Bank on February 4, 1988, and a journal entry to that effect was filed on March 1, 1988. The district court subsequently denied DHR's motion to alter or amend and DHR filed a timely notice of appeal.

  On appeal, DHR argued that, pursuant to K.S.A. 84-9-104(i), Article 9 of the UCC does not apply to rights of setoff and, therefore, the Bank of Kansas decision should be reversed or should be limited on its facts. DHR also asserted that its right of setoff was superior to the rights of the Bank and that it had a "super priority" pursuant to either K.S.A. 75-6201 et seq. or K.S.A. 44-717. The Bank argued that Article 9 should be applied to determine priority between DHR and the Bank; that DHR does not have a common-law right of setoff; that DHR does not have a right of setoff under K.S.A. 75-6201 et seq.; and that

[246 Kan. 86]

      K.S.A. 44-717 does not give DHR lien rights superior to the perfected security interest of the Bank.

  The Court of Appeals first reiterated its holding in the earlier Bank of Kansas case that, while a creditor who is seeking to exercise the right of setoff need not comply with the requirements of Article 9, the priority as between the right of setoff and a perfected security interest is governed by Article 9. Bank of Kansas v. Hutchinson Health Services, Inc., 13 Kan. App. 2d 421, 423, 773 P.2d 660 (1989) (citing Bank of Kansas, 12 Kan. App. 2d at 87.). The court further found that DHR was not provided with a super-priority under K.S.A. 44-717(c). 13 Kan. App. 2d at 425.

  The resolution of two issues will determine the outcome of this appeal. Those issues are: (1) whether DHR had a right to set off the funds owed to HHS by SRS, and (2) which party has priority in its claim to the funds in question.

  DHR argues that K.S.A. 75-6201 et seq. gives it a right of setoff. K.S.A. 75-6201 states: "The purpose of this act is to establish as policy that state agencies shall cooperate in identifying debtors who owe money to the state and that procedures be established for setting off against debtors the sum of any debt owed to the state." The article goes on to establish the circumstances under which the right to set off is granted and the procedures to be followed by the state agencies to exercise that right. Pursuant to K.S.A. 75-6204, where a debt is owed to the State of Kansas or any state agency, the Director of the Division of Accounts and Reports of the Department of Administration may set off the debt against money owed to the debtor by the state or any state agency. According to DHR, HHS owed it $14,916.42 in unemployment taxes for the third and fourth quarters of 1984. DHR made two separate requests for setoff to the Division of Accounts and Reports, the first on December 7, 1984, for the third quarter taxes due, and ...


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