KB Toys: Delaware Bankruptcy Court Weighs In On Claims Trading

On May 4, 2012 Judge Kevin J. Carey of the U.S. Bankruptcy Court for the District of Delaware held that a claim against a debtor's estate, transferred to a third party, is subject to the same infirmities as in the hands of the original holder of the claim. In re KB Toys, Inc., — B.R. —-, 2012 WL 1570755, at *11 (Bankr. D. Del. 2012). Judge Carey's opinion diverged from, and criticized, the decision of the U.S. District Court for the Southern District of New York in Enron Corp. v. Springfield Assocs., L.L.C., 379 B.R. 425 (S.D.N.Y. 2007). In that case, the court held that whether the disabilities of the original holder are inherited by a subsequent transferee turns on whether the transfer is by way of sale or assignment.

Background

In KB Toys, the liquidating trustee under a confirmed chapter 11 plan sought to disallow various trade claims transferred from certain of KB Toys' creditors to ASM Capital, L.P. and ASM Capital II, LLP. Prior to bringing the claims objections, between February 2006 and June 2009, the trustee commenced preference actions against all of the original claimants, and obtained either default judgments or summary judgments against each of them. All but one of the trade claims transferred to ASM were transferred prior to the commencement of the preference actions; the other claim was transferred after the liquidating trustee had obtained a default judgment against the original claimant. After the claims were transferred to ASM, the trustee sought to disallow the claims purchased by ASM pursuant to section 502(d) of the Bankruptcy Code.

Section 502(d) of the Bankruptcy Code provides, in relevant part: "the court shall disallow any claim of any entity . . . that is the transferee of a transfer avoidable under section . . . 547 . . . of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable under section 522(i), 542, 543, 550 or 553 of this title." In effect, section 502(d) provides that any claim against the estate asserted by the recipient of an avoidable transfer may be disallowed unless and until the recipient relinquishes the debtor's property back to the estate.

When a claim held by a defendant in an avoidance action is transferred to a third party (in this case, ASM), courts have reached different conclusions as to whether the 502(d) "disability" is a "personal disability" of the defendant, or if the "disability" travels with...