When Is It Appropriate To Dis allow An Allowed Claim? By Geraldine - PDF document

When Is It Appropriate To Dis allow An Allowed Claim? By Geraldine E. Ponto and David N. Crapo Time-honored principles concerning the allowance of claims are breached when the strictures of Section 502(d) of the Bankruptcy Code are applied prematurely. Section 502(d) of the Bankruptcy Code does not provide prophylactic relief to a trustee (or debtor in possession) and prevent a distribution on a deemed allowed claim before a determination has been made by the court that property is recoverable from the claimant or that the claimant is liable on an avoidance claim. 11 U.S.C. § 502(d). “[T]he purpose of section 502(d) is to ensure compliance with judicial orders.” In In re Odom Antennas, Inc ., 340 F.3d 705, 708 (8 th Cir. 2003), citing In re Davis , 889 F.2d 658, 661 (5 th Cir. 1989), cert denied , 495 U.S. 933 (1990). The language of Section 502(d) expressly provides for the disallowance of a claim held by an entity that retains an avoidable transfer such as a preference. Odom Antennas, id., citing 11 U.S.C. § 502(d). Consequently, a court-ordered determination that an entity has received an avoidable transfer must be made before Section 502(d) can be invoked to disallow a claim. In re Lids Corp ., 260 B.R. 680, 684 (Bankr. D. Del. 2001), citing Davis , 889 F.2d at 658. See also In re Atl. Computer Sys. , 173 B.R. 858, 862 (S.D.N.Y. 1994) (Section 502(d) “envisions some sort of determination of the claimant’s liability [under the avoidance provisions of the Bankruptcy Code] before its claims are disallowed . . .”). As with any other statute, an analysis of Section 502(d) must begin with the plain language of the statute itself. 1 The interpretation of Section 502(d) should be guided by the premise that what “Congress ‘says in a statute it means and means in a statute what it says there.’” Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A. , 530 U.S. 1, 6 (2000) 1 Section 502(d) provides: (d) Notwithstanding subsections (a) and (b) of this section, the court shall disallow any claim of any entity from which property is recoverable under section 542, 543, 550, or 553 of this title or that is a transferee if a transfer avoidable under section 522(f), 522(h), 544, 545, 547, 548, 549, or 724(a) of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable under section 522(i), 542, 543, 550, or 553 of this title. 11 U.S.C. § 502(d). #1258128 v1

( quoting Connecticut Nat. Bank v. Germain , 503 U.S. 249, 254 (1992)). “When ‘the statute’s language is plain, the sole function of the courts--at least where the disposition required by the text is not absurd--is to enforce it according to its terms.’” Hartford Underwriters, id . ( quoting U.S. v. Ron Pair Enterprises , Inc. , 489 U.S. 235, 241 (1989) (citations omitted)). The plain language of Section 502(d) affords relief after the liability of a transferee of an avoidable transfer has been determined. In re LaRoche Indus., Inc ., 284 B.R. 406, 408 (Bankr. D. Del. 2002) . The determination of liability must come first, or else, as the court determined in the Odom Antennas case, it is impossible to determine whether Section 502(d) applies. See Odom Antennas , 340 F.3d at 708. Despite the plain language of Section 502(d) and the courts that have found that it requires a court-ordered determination of liability before such relief comes into play, Section 502(d) has been invoked as authority to defer distribution on claims that have been deemed allowed under Section 502(a), before a trustee has (i) analyzed whether the claimants potentially received an avoidable transfer, (ii) initiated an avoidance action against the claimants (iii) proven the case and obtained a determination of liability. That type of wholesale, premature application of the statute is improper. It works this way: a trustee identifies all, or almost all, vendors to a debtor as potentially having received an avoidable transfer and moves to temporarily disallow those vendors’ claims until the trustee reviews and analyzes whether he has grounds to seek to avoid any avoidable transfers to those vendors. The trustee may predicate the relief sought on the fact that he has not yet had time to analyze avoidance claims but believes that once he does, he will be asserting avoidance claims against vendors whose claims have been deemed allowed. No time limit is imposed on the trustee for completing his analysis of avoidance claims under Section 502(d), and, therefore, the only time limit on that process would be the statute of limitations under Section 546(a) of the Bankruptcy Code. 2 Absent an objection by vendors 2 Section 546(a) provides: (a) An action or proceeding under section 544, 545, 547, 548, or 553 of this title may not be commenced after the earlier of – - 2 - #1258128 v1

affected by such a motion, even though no avoidance action against the vendors has been initiated by the trustee, much less any determination by a court of the vendors’ liability, the trustee may succeed in disallowing the vendors’ deemed allowed claims using Section 502(d) as the ground for relief. In effect, the trustee obtains an indefinite injunction precluding a distribution on such claims, without the necessity of satisfying the requirements under Rules 7001(7) and 7065 of the Federal Rules of Bankruptcy Procedure. That result also supplants the relief provided in Section 502(a) of the Bankruptcy Code, which deems a claim allowed when a proof of claim has been filed unless a party in interest has objected to the claim. 11 U.S.C. § 502(a). 3 Worse yet, Section 502(d) has been applied to claims previously allowed by court order following the trustee's objection to the claim on other grounds. To accomplish that, the trustee merely reserves his right to contest the claims at a later time in the case. It is commonplace for claimants to face the prospect of multiple challenges to a single claim raised at different times during a case. May A Preference Action Be Initiated After A Creditor’s Claim Has Been Allowed By Court Order? Beginning with Katchen v. Landy , 382 U.S. 323 (1966), and continuing with Langenkamp v. Culp , 498 U.S. 42 (1990), the Supreme Court has pronounced that the resolution of preference claims is an integral part of the general claims resolution process. Katchen v. (1) the later of – (A) 2 years after the entry of the order for relief; or (B) 1 year after the appointment or election of the first trustee under section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such election occurs before the expiration of the period specified in subparagraph (A); or (2) the time the case is closed or dismissed. 11 U.S.C. § 546(a). 3 Section 502(a) provides: A claim or interest, proof of which is filed under section 501 of this title, is deemed allowed, unless a party in interest. . .objects. 11 U.S.C. § 502(a). - 3 - #1258128 v1