KEVIN J. CAREY, Bankruptcy Judge.
KB Toys, Inc. and related entities (the "Debtors") filed voluntary petitions under chapter 11 of the United States Bankruptcy Code on January 14, 2004 (the "Petition Date"). Before the Court is the Residual Trustee's (the "Trustee") Tenth Omnibus Substantive Objection to Claims Pursuant to Sections 365(d), 502(b) and 502(d) of the Bankruptcy Code (D.I.6012) (the "Claim Objection"), in which, among other objections, the Trustee seeks disallowance of certain trade claims. Prior to the Claim Objection, the Trustee brought preference actions pursuant to Bankruptcy Code § 547 (the "Preference Actions") and obtained default judgments or summary judgments against certain original holders of some trade claims (the "Original Holders").
On the Petition Date, the Debtors filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code, then liquidated substantially all of their assets. On August 18, 2005, this Court entered an order (the "Confirmation Order") (D.I. 2981) confirming the Debtors' First Amended Joint Plan of Reorganization Proposed by the Debtors and the Official Committee of Unsecured Creditors Under Chapter 11 of the Bankruptcy Code (the "Plan") (D.I. 2554).
On March 15, 2004, the debtors each filed a Statement of Financial Affairs ("SOFA") (See D.I. 473-501) pursuant to Code § 521(a)(1)(B)(iii). Question 3 of the SOFA asks the debtor to identify all payments made within 90 days immediately proceeding the commencement of the case (the "Preference Section"). The Preference Section in the SOFA for most of the related debtor entities states:
(See, e.g., D.I. 473). Exhibit 3A attached to the SOFA for KB Toy of Massachusetts, Inc., also filed on March 15, 2004, contains a list of creditors who received potentially avoidable transfers during the preference period. (See D.I. 481). All nine Original Holders of the Sold Claims are listed on Exhibit 3A.
ASM purchased the Sold Claims from the Original Holders between April 7, 2004 and May 18, 2007.
Between February 23, 2006 and May 16, 2008, the Trustee commenced adversary proceedings against the Original Holders. Between June 2, 2006 and June 1, 2009, the Trustee obtained default judgments or summary judgments against the Original Holders based on their failure to answer or, having answered, failure to otherwise defend against the proceedings. ASM acquired eight of the Sold Claims before the Trustee commenced adversary proceedings. ASM acquired one of the Sold Claims (Liquidxs.com) after the Trustee had obtained a default judgment against Liquidxs.com. The transactions are illustrated in the chart that follows:
Claim BR 3001 Summons Judgment Indemnification
Original Holder Amount Date Bought Notices Date Date Clause
SPL $ 73,030.00 4/7/2004 4/7/2004 2/23/2006 6/16/2006 No
Merchandising
Shaw Creations $ 14,005.68 4/9/2004 5/16/2008 6/23/2008 No
Haschel-Caribe $128,817.85 4/26/2004 4/26/2004 6/22/2007 6/1/2009 No
Marketing &
Distribution
HAS Sales & $118,813.48 4/29/2004 4/29/2004 2/23/2006 6/9/2006 No
Marketing
Hubbard $ 2,340.50 5/3/2004 5/3/2004 6/14/2006 9/22/2006 No
Security
Natural Science $ 77,676.38 11/17/2004 11/17/2004 2/23/2006 6/6/2006 Yes
Industries
Accessory Time $ 64,440.00 8/4/2005 8/4/2005 3/8/2006 6/2/2006 Yes
Inc
Liquidxs.com $163,092.60 1/16/2007 1/16/2007 2/23/2006 6/6/2006 Yes Lee Middleton $ 30,151.85 5/18/2007 5/22/2007 2/20/2008 6/30/2008 Yes Dolls
On July 31, 2009, the Trustee filed the Claim Objection seeking disallowance of, among other claims, the Sold Claims pursuant to Bankruptcy Code § 502(d). The face amount of the Sold Claims exceeds $650,000. ASM filed a response on August 28, 2009, arguing that the Sold Claims are not subject to disallowance under Section 502(d) (D.I.6023). The Trustee replied to ASM's Response on November 16, 2009, and ASM filed a Supplemental Response on November 24, 2009. On December 10, 2009, this Court held a hearing on the Claim Objection. On February 8, 2010, ASM filed an additional Memorandum of Law in support of its position.
The issue before the Court is whether the purchaser of a trade claim holds the purchased claim subject to the same rights and disabilities, and is subject to Bankruptcy Code § 502(d) challenge, as is the original holder of the claim.
When interpreting a section of the Bankruptcy Code, the rules of statutory construction require that "we begin by analyzing the statutory language, `assuming that the ordinary meaning of that language accurately expresses the legislative purpose.' We must enforce plain and unambiguous statutory language according to its terms." Hardt v. Reliance Standard Life Ins. Co., ___ U.S. ___, 130 S.Ct. 2149, 2156, 176 L.Ed.2d 998 (2010) (quoting Gross v. FBL Fin. Serv., Inc., 557 U.S. 167, 129 S.Ct. 2343, 2350, 174 L.Ed.2d 119 (2009)); Patel v. Attorney General of U.S., 599 F.3d 295, 298 (3d Cir.2010).
Bankruptcy Code § 502(d) provides in relevant part:
11 U.S.C. § 502(d) (emphasis added). At issue is the meaning of the phrase "any claim of any entity." The Trustee argues that the statute says "claim," not "claimant;" and, therefore, § 502(d) should be interpreted to mean a disability accompanies the claim through its journey into the hands of others. ASM argues that "any claim of any entity" means only the "claimant," and, consequently, the disability rests with the original claimant.
Differences of opinion exist about the "plain meaning" of § 502(d). Compare Enron Corp. v. Avenue Special Situations
In the case before me, the Trustee makes three arguments in support of his Objection. First, in accordance with Enron II, the Trustee argues that the claims transferred to ASM were assignments and, therefore, the claims should be disallowed. Second, the Trustee argues that KB Toys' Statement of Financial Affairs gave ASM constructive knowledge, if not actual knowledge, of the preferential transfers. Such knowledge is evidence that ASM did not purchase the claims in good faith and, therefore, the claims should be disallowed. Third, the Trustee questions Enron II's analysis and its policy concerns.
ASM makes two primary arguments in defense of its claims. First, in accordance with Enron II, ASM asserts that the claims at issue were transferred by "sales" and not "assignments." ASM argues that the parties' intent to "sell" the claims outweighs the fact that the documents used in the claim transfer were titled "Assignment Agreement" and referred to the parties as "assignor" and "assignee." ASM also argues that "assignment" and "sale" are often used interchangeably in such claim transfer agreements, although claim transfer agreements are always "sales."
Second, again relying on the reasoning of the court in Enron II, ASM also argues that the plain language of § 502(d) dictates focus on the claimant, not the claim. ASM contends that disallowance is a personal disability of the claimant and, to the extent the Trustee has valid judgments against the Original Holders, the Trustee may preclude the Original Holders from participating in a distribution on account of any additional claims they may assert. However, any personal disabilities are not transferred to, and cannot be asserted against, ASM.
I agree with the analysis and conclusions of the courts in Metiom and Enron I, discussed in more depth below: the plain language, legislative history, and decisional law support the view that a claim in the hands of a transferee has the same rights and disabilities as the claim had in the hands of the original claimant. Disabilities attach to and travel with the claim.
In light of the debate over the clarity of the statutory language of § 502(d), it is helpful to explore the origins of § 502(d). The legislative history reveals that "subsection [502](d) is derived from present law." Id. The "present law" from which § 502(d) is derived is § 57g of the Bankruptcy Act of 1898 (repealed 1978) (the "Bankruptcy Act"). See In re America West Airlines, Inc., 217 F.3d 1161, 1168 (9th Cir.2000) (stating "the predecessor to § 502(d) [is] § 57(g) of the Bankruptcy
Section 57g of the Bankruptcy Act provided:
Vol A COLLIER ON BANKRUPTCY App. Pt. 3(a), Bankruptcy Act of 1898, Section 57g (11 U.S.C. § 93) (Alan N. Resnick & Henry J. Sommer eds., 16th ed.). In other words, the claims of creditors who received avoidable transfers (preferential or otherwise) were not allowed until the transfers were surrendered to the estate. Section 57g established the basis for allowance or disallowance of particular claims. This supports the interpretation of § 57g's statutory successor similarly: disabilities travel with claims. Section 502(d) "requires disallowance of a claim of a transferee of a voidable transfer in toto if the transferee has not paid the amount or turned over the property received as required under the sections under which the transferee's liability arises." H.R. Report No. 595, 95th Cong., 1st Sess. 354 (1977), 1978 U.S.C.C.A.N. 5963, 6310; S. Rep. No. 989, 95th Cong., 2d Sess. 65 (1978), 1978 U.S.C.C.A.N. 5787, 5851.
In 1902, the Eighth Circuit Court of Appeals considered application of section 57g of the Bankruptcy Act to a claim objection, and decided that:
Swarts v. Siegel, 117 F. 13, 15 (8th Cir. 1902). In that case, a bank held the debtor's promissory note of $25,000, upon which a third party, F. Siegel & Bro. ("Siegel"), "had indorsed their names before the notes were discounted for the purpose of giving [the debtors] credit, so that they became accommodation makers thereon." Id. at 14. Within four months prior to the debtor's bankruptcy filing, the debtor paid $14,600 to the bank on account of its obligation under the note. Id. Siegel's indorsement allowed the bank to collect the balance due, including interest, ($10,535.46), from Siegel. Id. Thus, Siegel stepped into the shoes of the bank and became a creditor of the debtor's bankruptcy estate for $10,535.46 via subrogation. Id. at 15 (citing section 57i of the Bankruptcy Act). The Court wrote: "one who holds the rights or claims of another by subrogation takes them subject to the limitations and disqualifications attached to them in the hands of his predecessor." Id.
Therefore, stepping into the shoes of the bank posed a problem for Siegel because the bank had an unpaid preference judgment against it. Id. at 14 (stating "[t]he preference, amounting to $14,600, which the court required the claimants to repay, is the same preference, and results from the same payments, which the [bank] has been required to surrender as a condition of the allowance of its claim against the estate of this bankruptcy in Swarts v. Fourth Nat. Bank, 117 Fed. 1 [(8th Cir.
The Eighth Circuit held that it did, stating "[t]he result is that the claim of F. Siegel & Bro. against the estate of the bankrupt cannot be lawfully allowed unless. . . the sum of $14,600 is paid back to the trustee either by the Fourth National Bank of St. Louis or by Siegel." Id. at 20. The Court noted that, as a surety, Siegel did not pay the bank voluntarily to relieve the bankrupt from liability, "but to buy the claim of the bank against [the debtor]." Id. at 16. The Swarts Court then wrote that "[Siegel's] only claim is for the amount the bankrupt owes upon the notes, and they take this claim subject to its disqualification in the hands of its former holder, the bank. It cannot be allowed until the preference . . . has been restored to the trustee." Id.
Other circuit court decisions after Swarts applied the same reasoning. In Goldie v. Cox, the Eighth Circuit held "[a]n assignee stands in the shoes of the assignor and subject to all equities against the assignor [and] [u]nless these claims. . . can be allowed to the claimant, the assignee would fare likewise." Goldie v. Cox, 130 F.2d 695, 720 (8th Cir.1942) (citing Fidelity Mut. Ins. Co. v. Clark, 203 U.S. 64, 74, 27 S.Ct. 19, 51 L.Ed. 91 (1906)). In Dorr Pump & Mfg. Co., the Seventh Circuit held that stockholders, who made payments to wage earners in exchange for assignments of their rights against the estate, stood "in the shoes of the wage earners." Dorr Pump & Mfg. Co. v. Heath et al. (In re Dorr Pump & Mfg. Co.), 125 F.2d 610, 611 (7th Cir.1942).
Decisional law following the enactment of the Bankruptcy Code continued to interpret the rights of transferees as subject to the equities and burdens of the transferor. Incorporation by Congress of the former disallowance provision into the Code is significant and, unless it can be inferred that Congress intended clearly to change a provision of the existing law (such as through an explicit change in the language of the statute or a statement in legislative history), prior case law interpreting the provision is still valid law. See Dewsnup v. Timm, 502 U.S. 410, 419 112 S.Ct. 773, 116 L.Ed.2d 903 (1992) ("When Congress amends the bankruptcy laws, it does not write `on a clean slate.' See Emil v. Hanley [(In re John M. Russell, Inc.)], 318 U.S. 515, 521, 63 S.Ct. 687, 690-691, 87 L.Ed. 954 (1943). Furthermore, this Court has been reluctant to accept arguments that would interpret the Code, however vague the particular language under consideration might be, to effect a major change in pre-Code practice that is not the subject of at least some discussion in the legislative history.").
Recent bankruptcy court decisions in the Southern District of New York have espoused a view consistent with pre-Code case law. In Metiom, one of the issues before the Court was whether a claim may be disallowed in the hands of a transferee if the transferor received an avoidable transfer at the time it held the claim. In re Metiom, Inc., 301 B.R. 634, 642-43 (Bankr.S.D.N.Y.2003). The Court held that:
Id. at 643. The Court further noted that "[t]he case most directly on point stated the rule over a century ago" and cited to Swarts. Id. The Metiom Court also decided:
Id.
In Enron I, the Bankruptcy Court held that "bank-loan claims, which were transferred by the original holder of the claims, who is alleged to have received avoidable transfers, [are subject] to disallowance under § 502(d) of the Bankruptcy Code in the hands of a transferee." Enron I, 340 B.R. at 210. In that case, the debtor brought preference and fraudulent conveyance actions against Fleet National Bank ("Fleet") and other lenders. Id. at 184-85. After the bankruptcy filing, but prior to commencement of the avoidance actions, Fleet transferred the claims to other entities. Id. The debtor filed an adversary complaint against the claim purchasers under Bankruptcy Code § 502(d) to disallow the transferred claims. Id. The claim purchasers moved to dismiss the complaint, arguing that the language of § 502(d) did not apply to them because (among other things) "the purpose of § 502(d) is not to punish, but to coerce the holder of the claim, which itself holds a voidable transfer, to comply with judicial orders requiring it to return the avoidable transfer." Id. at 189. Therefore, they argued, § 502(d) applies only to the party who received the avoidable transfer because that party can decide whether "to return the smaller amount of the avoidable transfer to the debtor in exchange for allowance of their larger claims."
The Enron I Court reviewed carefully the language and legislative history of § 502(d), as well as existing case law, and concluded:
Id. at 183-84. Agreeing with the Metiom Court, the Enron I Court decided that § 502(d) is, in essence, an affirmative defense to a claim and an affirmative defense is not destroyed by a transfer of the claim. Id. at 198. The Court further noted that the Federal Rules of Bankruptcy Procedure supported this result:
Id. at 198-99. The Enron I Court noted additionally that case law "affirmed the principle that a claim transfer does not change the nature of the claim in bankruptcy; rather it creates a substitution of parties." Id. (citing Carnegia v. Georgia Higher Educ. Assistance Corp., 691 F.2d 482, 483 (11th Cir.1982)).
Moreover, the Enron I Court considered the policy arguments advanced by both parties before it. The debtor argued that one of the consequences of shielding transferred claims from disallowance under § 502(d) would be to encourage creditors to "wash" the claims free of any possibility of disallowance simply by transferring them. The claim purchasers argued that the debtor retained the ability to pursue the previous claim holder for recovery of the avoidable transfer. The Court wrote:
Id. at 201. The Enron I Court also considered the claim purchasers' contention that "a judicial determination that the claims should be disallowed would seriously and needlessly undermine confidence in the system of post-petition transfers of claims and impact the liquidity of the market for post-petition transfers of claims." Id. at 202. The Court noted:
Id.
In Enron II, the district court vacated and remanded the bankruptcy court's decision in Enron I. Enron II, 379 B.R. at 428. The Enron II Court found that "[t]he plain language of section 502(d) focuses on the claimant as opposed to the claim and leads to the inexorable conclusion that disallowance is a personal disability of a claimant, not an attribute of the claim." Id. at 443.
The Enron II Court also determined that one of the main purposes of section 502(d), namely to coerce the return of assets obtained by preferential transfer, "would not be served if a claim in the hands of a claimant could be disallowed even where that claimant never received
Id. at 443-444 (emphasis in original). The Enron II Court decided that the Enron I Court and the Metiom Court should have distinguished between an claim purchaser and a claim assignee. Id. at 445 (emphasis added). The Enron II Court noted that sales and assignments can have very different consequences for the transferee:
Id. at 435-36 (including n. 58, other footnotes omitted). Therefore, "[a] personal disability that has attached to a creditor who transfers its claim will travel to the transferee if the claim is assigned, but will not travel to the transferee if the claim is sold." Id. at 436 (emphasis in original). The Enron II Court remanded the case to the Bankruptcy Court to determine whether the transfers were assignments or sales.
The terms "assignment" and "sale" are not easily distinguishable. The Bankruptcy Code does not define "sale" or "assignment," although the Code definition of "transfer" arguably includes both.
The Enron II Court opined that burdening the transferee of a claim with a disability imposed on a claim by the transferor would upset the distressed debt markets. Enron II, 379 B.R. at 448 (stating "[t]he unnecessary breadth of the Bankruptcy Court's decisions threatened to wreak havoc on the markets for distressed debt.").
Claims trading markets are as old as our nation. See Chaim J. Fortgang & Thomas M. Mayer, Trading Claims and Taking Control of Corporations in Chapter 11, 12 CARDOZO L. REV. 1, 25-27 (Oct. 1990) (discussing the purchase of Continentals (i.e., debt securities issued by the states during the Revolutionary War to pay the colonies' soldiers and the farmers and merchants who supplied them) by early claims traders in anticipation of the federal government backing the states' debts). Policy makers specifically contemplated and addressed the transfer of claims in the provisions in the 1898 Act, which were carried forward into the current Bankruptcy Code, and the Federal Rules of Bankruptcy Procedure.
There is no question that the distressed claims trading market has grown in size and scope. See Adam J. Levitin, Bankruptcy Markets: Making Sense of Claims Trading, 4 BROOKLYN J. CORP., FIN. & COMM. L. 67 (2009); Michelle M. Harner, Trends in Distressed Debt Investing: An Empirical Study of Investors' Objectives, 16 AM.
In the matter before me, the Debtors filed a SOFA listing potential preference defendants prior to any of the transactions between ASM and the Original Holders. Thus, the Debtor's SOFA placed ASM and all other potential buyers of trade claims on constructive notice, if not actual notice, of potential preference actions against the original claim holders and the potential for disallowance of the claims under § 502(d). ASM could have discovered the potential for disallowance with very little due diligence and factored the potential for disallowance into the price it paid for the trade claims.
Indeed, in several claim purchases, ASM did protect itself by including indemnity clauses in the transfer agreements requiring an immediate restitution payment if a transferred claim is disallowed. Historically, indemnity provisions have been important terms in claims trading agreements.
Id. at 207-08. A claim purchaser knows that it is obtaining a claim against a debtor whose unfavorable financial condition has caused it to seek the protections afforded by the bankruptcy process. A purchaser of claims in a bankruptcy is well aware (or should be aware) that it is entering an arena in which claims are allowed and disallowed in accordance with the provisions of the Bankruptcy Code and the decisional law interpreting those provisions. Under such conditions, a claims purchaser is not entitled to the protections of a good faith purchaser.
For the foregoing reasons, I conclude that a trade claim purchaser holds that claim subject to the same rights and disabilities under Bankruptcy Code § 502(d) as does the original trade claimant. The Trustee's Claim Objection will be sustained.
An appropriate order follows.
AND NOW, this 4th day of May, 2012, upon consideration of Residual Trustee's (the "Trustee") Tenth Omnibus Substantive Objection to Claims Pursuant to Sections 365(d), 502(b) and 502(d) of the Bankruptcy Code (D.I.6012) (the "Claim Objection"), after oral argument and for the reasons set forth in the foregoing Memorandum, it is hereby
(1) The Claim Objection is
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Claim
Number/
Claim Holder Claim Amount Schedule
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ASM $ 73,030.00 128036750
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ASM $ 64,440.00 1208/128006490
----------------------------------------------
ASM $ 77,676.38 1271
----------------------------------------------
ASM $163,092.60 128023890
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ASM $118,813.48 128018480
----------------------------------------------
ASM $ 2,340.50 128019350
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ASM $ 30,151.85 128023390
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ASM $128,817.85 128006960
----------------------------------------------
ASM $ 14,005.68 128035690
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(the "ASM Claims"), and
(2) Pursuant to Bankruptcy Code § 502(d), the ASM Claims are disallowed in full and expunged in their entirety.
Enron I, 340 B.R. at 204.
