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Bankruptcy Claims Still Disallowed in Hands of Transferee

By Gabriella Khorasanee, JD on November 20, 2013 2:55 PM

Last week the Third Circuit clarified an area of bankruptcy law that was unclear -- whether a disallowed trade claim in bankruptcy proceedings is also disallowable "in the hands of a subsequent transferee." The Third Circuit held that it was.

KB Toys Bankruptcy

KB Toys filed for Chapter 11 bankruptcy in 2004, and pursuant to the bankruptcy code, filed its Statement of Financial Affairs ("SOFA"), showing payments made in the prior 90 days that may be subject to attack as avoidable preferences.

During the years that followed in the bankruptcy proceedings, ASM Capital ("ASM") purchased claims from existing claimants that did not want to carry the risk of not getting paid, a practice permitted under the Bankruptcy rules. The problem was, that ASM purchased the claims before the bankruptcy Trustee initiated preference actions against the claims. The Trustee won judgments in each of the actions, but was unable to collect because all of the original claimants were no longer in business.

As a result, the Trustee sought disallowance of the claims under 11 U.S.C. § 502(d) arguing that the original claims were disallowable. The Bankruptcy Court held that the claims, even in the transferee's hands, were disallowable, and the district court affirmed.

Legal Analysis

The Third Circuit first began its analysis of § 502(d) by looking at the text of the statute. The court found the language of the statute clear, stating: "Because the statute focuses on claims --and not claimants -- claims that are disallowable under § 502(d) must be disallowed no matter who holds them."

The court also refused to protect ASM as "good faith" purchaser because (1) it did not purchase property from the estate, but claims; and (2) ASM took on the risks particular to purchasing bankruptcy claims.


This case is significant for companies like ASM that are in the business of purchasing bankruptcy claims. That ASM, and companies like it, has decided to take on the risks associated with bankruptcy claims, is on them. It's part of their business model, and courts know that the bankruptcy code was not designed to protect them. They should proceed at their own risk.

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