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A Circuit Court Definitively Addresses Claims Trading
The United States Court of Appeals for the Third Circuit recently held that “a trade claim that is subject to disallowance under ' 502(d) in the hands of the original claimant is similarly disallowable in the hands of a subsequent transferee.” In re KB Toys Inc., 736 F.3d 247 (3d Cir. 2013). Previously, the district court in Enron came to the opposite conclusion. In re Enron Corp., 379 B.R. 425 (S.D.N.Y. 2007) (Enron II). Despite being the highest court to address his issue ' one that implicates the trillion-dollar trade claims market ' the Third Circuit did not generate the controversy and outpouring of commentary that the previous Enron decisions did in addressing the same issue. See In re Enron Corp., 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (disallowance of bankruptcy claims under ' 502(d) travels with the claim) (122 citing references); In re Enron Corp., 333 B.R. 205 (Bankr. S.D.N.Y. 2005) (concluding equitable subordination of bankruptcy claims under ' 510 travels with the claim) (142 citing references) (collectively, Enron I); Enron II (reversing and remanding Enron I) (185 citing references); and KB Toys (23 citing references).
This disparity can be understood, as Enron and KB Toys addressed very different types of claims. Enron addressed bank loans, which together with bonds (collectively, Financial Claims) generally comprise the largest portion of pre-petition debt. In contrast, KB Toys addressed trade claims (Trade Claims), which generally comprise a much smaller portion of that debt. “Some purchasers [of Trade Claims] are simply arbitraging. ' [O]ther purchasers [of Financial Claims] have more sophisticated motives. ' [seeking ] 'fulcrum securities.'” Tally M. Wiener & Nicholas B. Malito, On the Nature of the Transferred Bankruptcy Claim, 12 U. Penn. J. Bus. Law 35 (2009). The Third Circuit noted that the transferee belonged to the former category and its holding “only concerns trade claims.” KB Toys , 736 at 247. This distinction provides a basis to limit KB Toys to Trade Claims and reconcile these cases.
In addition to being the highest court decision to address this issue, KB Toys provides bankruptcy courts in the Southern District of New York (SDNY) a basis for re-embracing Enron I. While bankruptcy courts in the SDNY may treat Enron II, a district court decision, as persuasive, “only decisions of the Second Circuit Court of Appeals are controlling.” See In re 400 Madison Avenue Ltd. Partnership, 213 B.R. 888, 890 n.2 (Bankr. S.D.N.Y. 1997)). A decision by the Third Circuit may provide a basis for bankruptcy courts in the SDNY to re-embrace Enron I.
This article analyzes the Enron and KB Toys courts' treatment of the public policy issues associated with claims trading, and the implications of the KB Toys holding with respect to Financial Claims trading in the Third and other circuits. Based on the distinction between Trade Claims and Financial Claims, the article argues that KB Toys is limited to Trade Claims.
Enron
Fleet National Bank (Fleet) loaned Enron money (the Bank Loans) before the latter's infamous collapse. After the bankruptcy filing and prior to the commencement of any action against Fleet, it transferred portions of the Bank Loans to third parties. Enron thereafter brought a complaint to clawback pre-petition transfers to Fleet ' alleging that these transfers were preferential or fraudulent ' and sought to disallow the claims of the third parties pursuant to ' 502(d). Significantly, the debtors did not allege that the holders of the transferred claims themselves had acted inequitably in any manner or that the claims arose out of transactions challenged by Enron in its complaint. Enron I, 333 B.R. 211. Enron I found that the acquisition of claims in a bankruptcy proceeding “should not grant greater rights to their new holders than those claims ' enjoyed by the transferring holders” and, as such, the transferees were subject to disallowance pursuant to ' 502(d). 340 B.R, at 199. Previously, the bankruptcy court found that transferred claims were subject to subordination pursuant to ' 510. Enron I, 333 B.R. 205.
Enron II reversed and remanded Enron I. Enron II concluded that, as a matter of law, “section 510(c) and disallowance under section 502(d) are personal disabilities ' and do not inhere in the claim.” 379 B.R. at 435-36. Enron II distinguished between a sale and an assignment. “[A] purchaser does not stand in the shoes of the seller and, as a result, can obtain more than the transferor had in certain circumstances.” By contrast, “[a]n assignee of a claim takes with it whatever limitations it had in the hands of the assignor.” Enron II was broadly criticized for its distinction between sale and assignment. See KB Toys, 470 B.R. 331, 340 (Bankr. D. Del. 2012).
KB Toys
In KB Toys, ASM Capital, LP and ASM Capital II, LLP (collectively, ASM) acquired nine trade claims (Claims) from trade claimants (Original Claimants). The trustee brought preference actions against, and obtained judgment against, the Original Claimants. These actions were uncollectable because the Original Claimants were no longer in business. One of the Claims was even purchased after the Trustee obtained a judgment against that claimant. The Trustee sought to disallow the Claims pursuant to ' 502(d).
The KB Toys bankruptcy court disallowed the Claims, concluding under ' 502(d) that
“[d]isabilities attach to and travel with the claim.” KB Toys, 736 F.3d at 251. Furthermore, the KB Toys bankruptcy court concluded that the statement of financial affairs (the SOFA) filed in the bankruptcy proceedings put ASM on “constructive notice” of the potential preference actions and, accordingly, that ASM was “not entitled to protection as a 'good faith' purchaser.” Id. at 250-51. “The KB Toys District Court noted that it believed the plain language of ' 502(d) was ambiguous but it otherwise adopted the reasoning of the Bankruptcy Court.” Id. at 251.
The Third Circuit explained that the “issue here is whether a trade claim that is subject to disallowance under ' 502(d) in the hands of the original claimant is similarly disallowable in the hands of a subsequent transferee,” and answered affirmatively based on the language, the objectives, and the legislative history of ' 502(d). Id' at 249. The Third Circuit reasoned that “[b]ecause the statute focuses on claims ' and not claimants ' claims that are disallowable under ' 502(d) must be disallowed no matter who holds them.” Id. at 252 (citation omitted).
Crucially, the Third Circuit held that to allow a transferee/purchaser greater rights would provide an incentive to “wash the claim of any disability ' to receive some value for an otherwise valueless claim.” Id. This result would contravene the aims of ' 502(d): 1) ensuring equality of distribution ' “the estate has less money and the other creditors would receive smaller amounts”; and 2) coercing compliance with judicial orders ' “the original claimant no longer has a claim that the trustee can leverage.” Id. The Third Circuit noted that ASM could have easily protected itself “by reviewing the Debtors' publicly available SOFAs.” Id.
KB Toys' Broad Rationale Appears to Envelope Financial Claims
Section 502(d) does not distinguish between different types of claims, and should be equally applicable to all types of transferred claims. Furthermore, the Third Circuit's broad policy arguments ' 1) “claims washing”; and 2) “sophisticated traders bearing the risk” ' appear to be applicable to all traded claims. Moreover, the Third Circuit criticism of Enron II ' “reliance on this supposed state law distinction may also be problematic for several reasons” ' is likewise applicable to all traded claims. KB Toys, 736 F.3d at 254.
The Application of KB Toys to Equitable Subordination
KB Toys did not address whether claims can be equitably subordinated in the hands of transferees pursuant to ' 510. However, the Third Circuit's rationale of claims washing and criticism of Enron II would support an adoption of Enron I's rationale regarding ' 510.
The subordination of traded claims in the hands of transferees may well have a more significant impact than disallowance pursuant to ' 502(b). The amici curiae (Enron amici) argued that subordination of transferred claims would have a disastrous effect on the claims trading market. For example, in the Refco bankruptcy, the debtor borrowed from one bank, Bawag P.S.K. Group. If the transferred claims would be tainted by Bawag's alleged bad acts, all claims trading would essentially be halted. Moreover, allegations of ' 510 can be far more difficult for a claims purchaser to uncover or indentify than clawback actions (the basis for such actions will certainly not appear on bankruptcy schedules or even publicly available books and records). (See, e.g. Enron I, 333 B.R. at 229: “Banks are involved in hundreds of transactions with a debtor, therefore, as a practical matter, it would be impossible for them to conduct due diligence on all transactions in which they purchase claims.”)
Many of the key rationales of KB Toys are applicable to the equitable subordination of transferred claims. However, importantly, the rationale of the SOFA providing notice is not applicable to equitable subordination. The Third Circuit's “claims washing rationale” is as applicable to ' 510 as it is to ' 502(b). Furthermore, the Third Circuit found Enron II problematic for several reasons, including that “the state law on which it relies does not provide a distinction between assignments and sales.” KB Toys, 736 F.3d at 254. Thus, KB Toys places claims traders on notice that transferred claims may well be subject to subordination pursuant to ' 510.
Taking the Third Circuit at Face Value
The Third Circuit appears to have dealt a significant blow to the claims trading market. However, in Enron, the amici, including the Securities Industry and Financial Markets Association, the International Swaps and Derivatives Association, the Loan Syndications and Trading Association and the Commercial Law League of America, argued that the stability of the trade claims market was at stake. In contrast, there was a noticeable absence of any amici curiae in KB Toys. This supports the notion that KB Toys can be limited to Trade Claims. Thus, courts, even a court in the Third Circuit, may follow Enron II when addressing Financial Claims.
The Distinction Between Financial Claims and Trade Claims
The distinction between Financial Claims and Trade Claims is readily apparent in these cases. Enron addressed billions of dollars of bank claims, and KB Toys addressed hundreds of thousands of dollars of trade claims. As discussed, Enron amici appeared unconcerned with the outcome of KB Toys.
The crucial distinctions between Financial and Trade Claims provide a basis for understanding the Third Circuit's profession that the “issue in this case ' only concerns trade claims.” KB Toys, 736 at 247. These distinctions include: 1) Public Policy: Trade Claims are of limited significance to the claims trading market; 2) “Claims washing”: This rationale has limited relevance to Financial Claims; and 3) Diligence: Examination of the SOFA has limited value in regard to Financial Claims.
Public Policy
Enron I and Enron II both contained a detailed analysis of the effect of their decisions on the claims trading market and the associated public policy. In contrast, KB Toys lacked this analysis. In Enron I, after the court's extensive public policy analysis, the court concluded that its decision would not impair the claims trading market because the efficient marketplace would properly take into account and price all of the risks. In fact, Enron I posited that “immunizing a transferred claim from disallowance under section 502(d) would alter the risk factors associated with a claim and would interfere with the efficient market by artificially enhancing the claim's value in the claims-transfer market.” Enron I, 340 B.R. at 209.
Enron II began its decision noting “the outcry from commentators and amici curiae, who have expressed great concern that the effect of these opinions will wreak havoc in the markets for distressed debt.” Enron II, 379 B.R. at 428. Enron II concluded that
“[a]ccordingly, the concerns raised by Industry Amici with respect to the effects of the Bankruptcy Court's rulings on the markets for distressed debt are no longer present.” Id. at 448, fn. 114.
Importantly, Enron II noted that a court may depart from the plain language of a statute to avoid a result “demonstrably at odds with the intentions of [the statute's] drafters” and, as such, it is “proper to consider the effect that the court's interpretation would have on the markets.” Id. at 432. Thus, a court's position regarding the importance of claims trading may well be an integral element to its treatment of transferred claims.
Opponents argue that claims trading is destructive. (See, e.g., Harvey R. Miller, Chapter 11, Reorganization Cases and the Delaware Myth, 55 Vand. L. Rev. 1987, 2014-2015 (2002): “Distressed debt trading ' [has] destroyed the symbiotic relationship of debtor and creditor. … Chapter 11 is premised upon a symbiotic relationship between debtor and creditor. '”) In contrast, many commentators find that the claims trading market is beneficial to the reorganization process. These benefits include: 1) “increased market liquidity/enhancement of sellers' recovery[,] resulting in lower cost of borrowing”; and 2) “consolidation of diverse interests in the hands of a few sophisticated investors, leading to more vigorous negotiations, rapid reorganizations and maximization of value for remaining creditors.” Robert D. Drain & Elizabeth J. Schwartz, Are Bankruptcy Claims Subject to the Federal Securities Laws?, 10 A.M. Bankr. Inst. L. Rev. 569, 575-576 (2002). (See also Enron I, 340 B.R. at 200 “the existence of a market to transfer claims is commonly viewed to provide a source of liquidity to the original or subsequent holders of the claims, including financial institutions that provide pre-petition loans to debtors.”) In fact, bankruptcy courts in the SDNY routinely enter orders to help facilitate the efficient negotiations amongst claims traders protecting claims traders from allegations of insider trading.
'Claims Washing'
In KB Toys, “claims washing” was not an abstract issue. The preferences were not collectable from the original claimants. If the claims were not sold subject to their ' 502(d) infirmity, the original claimants would have successfully washed their claims at the expense of the estate.
However Enron I and Enron II expressed little concern over “claims washing.” Enron I did “not speculate” whether the absence of disallowance would provide an “incentive to engage in “claim washing.” “[T]here is no evidence in the body of jurisprudence dealing with claims-transfers, in any study, nor in any law review that suggests that “claim washing” [for Financial Claims] is an actual 'real world' problem.” Enron I' 340 B.R. 180.
Likewise, Enron II found that claims washing “cut both ways” and “would not be “washed” because the transferor remains subject to direct actions.” 379 B.R. 425, 447. Claims washing was not viewed as a motivation for large financial institutions by the Enron courts because they would still be subject to the avoidance actions/subordination. In contrast, with respect to Trade Claims, there can no longer be any doubt that claims washing is an actual real-world problem. Thus, claims washing, a key rationale of the KB Toys holding, is not applicable to Financial Claims.
SOFA and Diligence
In KB Toys, ASM could have easily protected itself by reviewing the publicly available SOFAs. Indeed, perhaps ASM did review the SOFAs and took a calculated risk. KB Toys, 736 F.3d at 255. In contrast, in Enron, diligence would have not necessarily uncovered a potential suit. “[B]anks are involved in hundreds of transactions with a debtor, therefore, as a practical matter, it would be impossible for them to conduct due diligence on all transactions in which they purchase claims.” Enron I, 340 B.R. at 202. Thus, another key rationale of the KB Toys holding is not applicable to Financial Claims.
The Uncertainty
This KB Toys decision ' finding that ' 502(d) disabilities attach to and travel with the traded claim ' appears to definitively address all traded claims, and appears to support the application of equitable subordination pursuant to ' 510 to traded claims. The effect of this decision should have negatively impacted the claims trading market in not only the Third Circuit, but also other circuits and even the Southern District of New York. However, this article has demonstrated why the KB Toys holding may be limited to Trade Claims and, as such, Enron II remains the highest court to address Financial Claims. Further, this discussion highlights the critical role the stability of the claims trading market may play in further court decisions.
The United States Court of Appeals for the Third Circuit recently held that “a trade claim that is subject to disallowance under ' 502(d) in the hands of the original claimant is similarly disallowable in the hands of a subsequent transferee.” In re KB Toys Inc., 736 F.3d 247 (3d Cir. 2013). Previously, the district court in Enron came to the opposite conclusion. In re Enron Corp., 379 B.R. 425 (S.D.N.Y. 2007) (Enron II). Despite being the highest court to address his issue ' one that implicates the trillion-dollar trade claims market ' the Third Circuit did not generate the controversy and outpouring of commentary that the previous Enron decisions did in addressing the same issue. See In re Enron Corp., 340 B.R. 180 (Bankr. S.D.N.Y. 2006) (disallowance of bankruptcy claims under ' 502(d) travels with the claim) (122 citing references); In re Enron Corp., 333 B.R. 205 (Bankr. S.D.N.Y. 2005) (concluding equitable subordination of bankruptcy claims under ' 510 travels with the claim) (142 citing references) (collectively, Enron I); Enron II (reversing and remanding Enron I) (185 citing references); and KB Toys (23 citing references).
This disparity can be understood, as Enron and KB Toys addressed very different types of claims. Enron addressed bank loans, which together with bonds (collectively, Financial Claims) generally comprise the largest portion of pre-petition debt. In contrast, KB Toys addressed trade claims (Trade Claims), which generally comprise a much smaller portion of that debt. “Some purchasers [of Trade Claims] are simply arbitraging. ' [O]ther purchasers [of Financial Claims] have more sophisticated motives. ' [seeking ] 'fulcrum securities.'” Tally M. Wiener & Nicholas B. Malito, On the Nature of the Transferred Bankruptcy Claim, 12 U. Penn. J. Bus. Law 35 (2009). The Third Circuit noted that the transferee belonged to the former category and its holding “only concerns trade claims.” KB Toys , 736 at 247. This distinction provides a basis to limit KB Toys to Trade Claims and reconcile these cases.
In addition to being the highest court decision to address this issue, KB Toys provides bankruptcy courts in the Southern District of
This article analyzes the Enron and KB Toys courts' treatment of the public policy issues associated with claims trading, and the implications of the KB Toys holding with respect to Financial Claims trading in the Third and other circuits. Based on the distinction between Trade Claims and Financial Claims, the article argues that KB Toys is limited to Trade Claims.
Enron
Fleet National Bank (Fleet) loaned Enron money (the Bank Loans) before the latter's infamous collapse. After the bankruptcy filing and prior to the commencement of any action against Fleet, it transferred portions of the Bank Loans to third parties. Enron thereafter brought a complaint to clawback pre-petition transfers to Fleet ' alleging that these transfers were preferential or fraudulent ' and sought to disallow the claims of the third parties pursuant to ' 502(d). Significantly, the debtors did not allege that the holders of the transferred claims themselves had acted inequitably in any manner or that the claims arose out of transactions challenged by Enron in its complaint. Enron I, 333 B.R. 211. Enron I found that the acquisition of claims in a bankruptcy proceeding “should not grant greater rights to their new holders than those claims ' enjoyed by the transferring holders” and, as such, the transferees were subject to disallowance pursuant to ' 502(d). 340 B.R, at 199. Previously, the bankruptcy court found that transferred claims were subject to subordination pursuant to ' 510. Enron I, 333 B.R. 205.
Enron II reversed and remanded Enron I. Enron II concluded that, as a matter of law, “section 510(c) and disallowance under section 502(d) are personal disabilities ' and do not inhere in the claim.” 379 B.R. at 435-36. Enron II distinguished between a sale and an assignment. “[A] purchaser does not stand in the shoes of the seller and, as a result, can obtain more than the transferor had in certain circumstances.” By contrast, “[a]n assignee of a claim takes with it whatever limitations it had in the hands of the assignor.” Enron II was broadly criticized for its distinction between sale and assignment. See KB Toys, 470 B.R. 331, 340 (Bankr. D. Del. 2012).
KB Toys
In KB Toys, ASM Capital, LP and ASM Capital II, LLP (collectively, ASM) acquired nine trade claims (Claims) from trade claimants (Original Claimants). The trustee brought preference actions against, and obtained judgment against, the Original Claimants. These actions were uncollectable because the Original Claimants were no longer in business. One of the Claims was even purchased after the Trustee obtained a judgment against that claimant. The Trustee sought to disallow the Claims pursuant to ' 502(d).
The KB Toys bankruptcy court disallowed the Claims, concluding under ' 502(d) that
“[d]isabilities attach to and travel with the claim.” KB Toys, 736 F.3d at 251. Furthermore, the KB Toys bankruptcy court concluded that the statement of financial affairs (the SOFA) filed in the bankruptcy proceedings put ASM on “constructive notice” of the potential preference actions and, accordingly, that ASM was “not entitled to protection as a 'good faith' purchaser.” Id. at 250-51. “The KB Toys District Court noted that it believed the plain language of ' 502(d) was ambiguous but it otherwise adopted the reasoning of the Bankruptcy Court.” Id. at 251.
The Third Circuit explained that the “issue here is whether a trade claim that is subject to disallowance under ' 502(d) in the hands of the original claimant is similarly disallowable in the hands of a subsequent transferee,” and answered affirmatively based on the language, the objectives, and the legislative history of ' 502(d). Id' at 249. The Third Circuit reasoned that “[b]ecause the statute focuses on claims ' and not claimants ' claims that are disallowable under ' 502(d) must be disallowed no matter who holds them.” Id. at 252 (citation omitted).
Crucially, the Third Circuit held that to allow a transferee/purchaser greater rights would provide an incentive to “wash the claim of any disability ' to receive some value for an otherwise valueless claim.” Id. This result would contravene the aims of ' 502(d): 1) ensuring equality of distribution ' “the estate has less money and the other creditors would receive smaller amounts”; and 2) coercing compliance with judicial orders ' “the original claimant no longer has a claim that the trustee can leverage.” Id. The Third Circuit noted that ASM could have easily protected itself “by reviewing the Debtors' publicly available SOFAs.” Id.
KB Toys' Broad Rationale Appears to Envelope Financial Claims
Section 502(d) does not distinguish between different types of claims, and should be equally applicable to all types of transferred claims. Furthermore, the Third Circuit's broad policy arguments ' 1) “claims washing”; and 2) “sophisticated traders bearing the risk” ' appear to be applicable to all traded claims. Moreover, the Third Circuit criticism of Enron II ' “reliance on this supposed state law distinction may also be problematic for several reasons” ' is likewise applicable to all traded claims. KB Toys, 736 F.3d at 254.
The Application of KB Toys to Equitable Subordination
KB Toys did not address whether claims can be equitably subordinated in the hands of transferees pursuant to ' 510. However, the Third Circuit's rationale of claims washing and criticism of Enron II would support an adoption of Enron I's rationale regarding ' 510.
The subordination of traded claims in the hands of transferees may well have a more significant impact than disallowance pursuant to ' 502(b). The amici curiae (Enron amici) argued that subordination of transferred claims would have a disastrous effect on the claims trading market. For example, in the Refco bankruptcy, the debtor borrowed from one bank, Bawag P.S.K. Group. If the transferred claims would be tainted by Bawag's alleged bad acts, all claims trading would essentially be halted. Moreover, allegations of ' 510 can be far more difficult for a claims purchaser to uncover or indentify than clawback actions (the basis for such actions will certainly not appear on bankruptcy schedules or even publicly available books and records). (See, e.g. Enron I, 333 B.R. at 229: “Banks are involved in hundreds of transactions with a debtor, therefore, as a practical matter, it would be impossible for them to conduct due diligence on all transactions in which they purchase claims.”)
Many of the key rationales of KB Toys are applicable to the equitable subordination of transferred claims. However, importantly, the rationale of the SOFA providing notice is not applicable to equitable subordination. The Third Circuit's “claims washing rationale” is as applicable to ' 510 as it is to ' 502(b). Furthermore, the Third Circuit found Enron II problematic for several reasons, including that “the state law on which it relies does not provide a distinction between assignments and sales.” KB Toys, 736 F.3d at 254. Thus, KB Toys places claims traders on notice that transferred claims may well be subject to subordination pursuant to ' 510.
Taking the Third Circuit at Face Value
The Third Circuit appears to have dealt a significant blow to the claims trading market. However, in Enron, the amici, including the Securities Industry and Financial Markets Association, the International Swaps and Derivatives Association, the Loan Syndications and Trading Association and the Commercial Law League of America, argued that the stability of the trade claims market was at stake. In contrast, there was a noticeable absence of any amici curiae in KB Toys. This supports the notion that KB Toys can be limited to Trade Claims. Thus, courts, even a court in the Third Circuit, may follow Enron II when addressing Financial Claims.
The Distinction Between Financial Claims and Trade Claims
The distinction between Financial Claims and Trade Claims is readily apparent in these cases. Enron addressed billions of dollars of bank claims, and KB Toys addressed hundreds of thousands of dollars of trade claims. As discussed, Enron amici appeared unconcerned with the outcome of KB Toys.
The crucial distinctions between Financial and Trade Claims provide a basis for understanding the Third Circuit's profession that the “issue in this case ' only concerns trade claims.” KB Toys, 736 at 247. These distinctions include: 1) Public Policy: Trade Claims are of limited significance to the claims trading market; 2) “Claims washing”: This rationale has limited relevance to Financial Claims; and 3) Diligence: Examination of the SOFA has limited value in regard to Financial Claims.
Public Policy
Enron I and Enron II both contained a detailed analysis of the effect of their decisions on the claims trading market and the associated public policy. In contrast, KB Toys lacked this analysis. In Enron I, after the court's extensive public policy analysis, the court concluded that its decision would not impair the claims trading market because the efficient marketplace would properly take into account and price all of the risks. In fact, Enron I posited that “immunizing a transferred claim from disallowance under section 502(d) would alter the risk factors associated with a claim and would interfere with the efficient market by artificially enhancing the claim's value in the claims-transfer market.” Enron I, 340 B.R. at 209.
Enron II began its decision noting “the outcry from commentators and amici curiae, who have expressed great concern that the effect of these opinions will wreak havoc in the markets for distressed debt.” Enron II, 379 B.R. at 428. Enron II concluded that
“[a]ccordingly, the concerns raised by Industry Amici with respect to the effects of the Bankruptcy Court's rulings on the markets for distressed debt are no longer present.” Id. at 448, fn. 114.
Importantly, Enron II noted that a court may depart from the plain language of a statute to avoid a result “demonstrably at odds with the intentions of [the statute's] drafters” and, as such, it is “proper to consider the effect that the court's interpretation would have on the markets.” Id. at 432. Thus, a court's position regarding the importance of claims trading may well be an integral element to its treatment of transferred claims.
Opponents argue that claims trading is destructive. (See, e.g., Harvey R. Miller, Chapter 11, Reorganization Cases and the Delaware Myth, 55 Vand. L. Rev. 1987, 2014-2015 (2002): “Distressed debt trading ' [has] destroyed the symbiotic relationship of debtor and creditor. … Chapter 11 is premised upon a symbiotic relationship between debtor and creditor. '”) In contrast, many commentators find that the claims trading market is beneficial to the reorganization process. These benefits include: 1) “increased market liquidity/enhancement of sellers' recovery[,] resulting in lower cost of borrowing”; and 2) “consolidation of diverse interests in the hands of a few sophisticated investors, leading to more vigorous negotiations, rapid reorganizations and maximization of value for remaining creditors.” Robert D. Drain & Elizabeth J. Schwartz, Are Bankruptcy Claims Subject to the Federal Securities Laws?, 10 A.M. Bankr. Inst. L. Rev. 569, 575-576 (2002). (See also Enron I, 340 B.R. at 200 “the existence of a market to transfer claims is commonly viewed to provide a source of liquidity to the original or subsequent holders of the claims, including financial institutions that provide pre-petition loans to debtors.”) In fact, bankruptcy courts in the SDNY routinely enter orders to help facilitate the efficient negotiations amongst claims traders protecting claims traders from allegations of insider trading.
'Claims Washing'
In KB Toys, “claims washing” was not an abstract issue. The preferences were not collectable from the original claimants. If the claims were not sold subject to their ' 502(d) infirmity, the original claimants would have successfully washed their claims at the expense of the estate.
However Enron I and Enron II expressed little concern over “claims washing.” Enron I did “not speculate” whether the absence of disallowance would provide an “incentive to engage in “claim washing.” “[T]here is no evidence in the body of jurisprudence dealing with claims-transfers, in any study, nor in any law review that suggests that “claim washing” [for Financial Claims] is an actual 'real world' problem.” Enron I' 340 B.R. 180.
Likewise, Enron II found that claims washing “cut both ways” and “would not be “washed” because the transferor remains subject to direct actions.” 379 B.R. 425, 447. Claims washing was not viewed as a motivation for large financial institutions by the Enron courts because they would still be subject to the avoidance actions/subordination. In contrast, with respect to Trade Claims, there can no longer be any doubt that claims washing is an actual real-world problem. Thus, claims washing, a key rationale of the KB Toys holding, is not applicable to Financial Claims.
SOFA and Diligence
In KB Toys, ASM could have easily protected itself by reviewing the publicly available SOFAs. Indeed, perhaps ASM did review the SOFAs and took a calculated risk. KB Toys, 736 F.3d at 255. In contrast, in Enron, diligence would have not necessarily uncovered a potential suit. “[B]anks are involved in hundreds of transactions with a debtor, therefore, as a practical matter, it would be impossible for them to conduct due diligence on all transactions in which they purchase claims.” Enron I, 340 B.R. at 202. Thus, another key rationale of the KB Toys holding is not applicable to Financial Claims.
The Uncertainty
This KB Toys decision ' finding that ' 502(d) disabilities attach to and travel with the traded claim ' appears to definitively address all traded claims, and appears to support the application of equitable subordination pursuant to ' 510 to traded claims. The effect of this decision should have negatively impacted the claims trading market in not only the Third Circuit, but also other circuits and even the Southern District of
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