Open Questions Regarding Disallowance Under Section 502(d)

Under Section 502(d) of the Bankruptcy Code, any claim of an entity that received an avoidable transfer and that has not repaid the amount of the avoidable transfer shall be disallowed. 11 U.S.C. §502(d). If, however, the claim was transferred by the original creditor so that the entity holding the claim is not the entity that received an avoidable transfer, can the claim still be disallowed under Section 502(d) of the Bankruptcy Code? The district court in Enron II held that the answer depends on whether the claim was acquired through a sale or an assignment. Enron II reasoned that, because disallowance under Section 502(d) is a disability applicable to the claimant and is not an attribute of the claim, a sale of the claim cleanses the disability. Enron II, 379 B.R. at 443-45. According to Enron II, an assignment of the claim, however, does not purge the disability because the assignee stands in the shoes of the assignor. Id. at 439.

One court in a published decision (which was reversed on other grounds) has approvingly cited to Enron II in support of this proposition. But several courts (including the Third Circuit Court of Appeals) have criticized Enron II. Firestar is the latest decision to reject the reasoning in Enron II. Firestar also presents an opportunity to consider another issue pertinent to section 502(d) that was not raised in that case: whether a judicial determination avoiding the underlying transfer is a condition to disallowance under section 502(d).

Does Section 502(d) Apply to the Claim or the Claimant

Enron II involved an appeal of an adversary proceeding commenced by Enron against third party distressed debt funds seeking to disallow claims originally held by Fleet National Bank. Before the adversary proceeding was filed against the claims purchasers, Enron had sued its bank lenders, including Fleet, for alleged fraudulent transfers and preferences, and that adversary proceeding was pending at the time without a judicial determination of the avoidability of the transfers to the banks. The claims purchasers filed a motion to dismiss the adversary complaint on the basis that, among other things, the claims they acquired from Fleet should not be disallowed under Section 502(d) because only Fleet, and not the claims purchasers and current holders of the claims, was being sued for fraudulent transfers and preferences that were unrelated to the claims Enron was seeking to disallow. Bankruptcy Judge Gonzalez denied the motion to dismiss and held that "the transfer of a claim subject to disallowance in the hands of the transferor remains subject to disallowance in the hands of a transferee." In re Enron Corp., 340 B.R. 180, 210 (Bankr. S.D.N.Y. 2006) (Enron I).