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The Bankruptcy StrategistFeaturesBankruptcyLitigation

Bankruptcy Code Section 502(d) Claim Disallowance Issues 'Travel With' the Claim

By Rudolph J. Di Massa, Jr. and Geoffrey A. Heaton 
September 01, 2020

In a recent decision, the U.S. Bankruptcy Court for the Southern District of New York held that claim disallowance issues under Section 502(d) of the Bankruptcy Code "travel with" the claim, and not with the claimant. Declining to follow a published district court decision from the same federal district, the bankruptcy court found that section 502(d) applies to disallow a transferred claim regardless of whether the transferee acquired its claim through an assignment or an outright sale. See, In re Firestar Diamond, 615 B.R. 161 (Bankr. S.D.N.Y. 2020).

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Background

Firestar Diamond, Inc., Fantasy, Inc. and A. Jaffe, Inc. (the debtors) filed for protection under Chapter 11 of the Bankruptcy Code in the Southern District of New York. The debtors were jewelry wholesalers that did business with major U.S. retailers. After the filings, an examiner appointed in the debtors' cases found "substantial evidence to support the knowledge and involvement by the debtors and their senior officers and directors" in certain alleged fraudulent conduct. Events flowing from this investigation led to the appointment of a Chapter 11 trustee to administer the debtors' bankruptcy estates.

In the course of their pre-bankruptcy dealings, the debtors incurred accounts payable indebtedness to three non-debtor entities: Firestar Diamond International, Firestar Diamond BVBA, and Firestar Diamond FZE. These nondebtor entities, in turn, had financial dealings with four separate banks. Pursuant to those dealings, the non-debtor entities either: a) pledged to the banks their debtor-related accounts receivable; or b) sold to the banks certain invoices that had been issued to the debtors. The banks had otherwise had no prior direct dealing with either of the debtors.

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