Volume 2, Number 5
Haste
Makes Waste? Preferences
and Claims Avoidance in
the Murky World of §502(d)
Written
By
Stephen C. Hunt*
The allowance of claims and recovery of avoidable transfers are important, complementary principles in the adjustment of the debtor-creditor relationship. Like Themis personified, claims are modified or expunged to ensure that distributive justice is accomplished through the bankruptcy claim allowance and distribution process, while preferential transfers are disgorged from creditors who, by accident or design, lingered too long at the well before the commencement of a bankruptcy case. Historically, the claims adjustment and preference recovery processes have enjoyed separate lives in the ebb and flow of bankruptcy cases. For example, thought was sometimes given to the modification or expungement of claims only after the passage of a claims bar date, or in relation to the classification of claims in a chapter 11 plan. And preferences were addressed in a timely, albeit not always early, fashion in relation to the filing deadlines applicable to a given case by operation of §546(a). In this manner, claims allowance and preference avoidance were recognized as related concepts—after all, the monies recovered from the latter often paid the former. But the fragile unity of these concepts was often ignored, at least until recently, when some courts concluded that the adjudication of claims prior to the commencement of preference actions might extinguish the viability of unasserted preference cases.
Section 502 of the Bankruptcy Code provides for the allowance and disallowance of claims or interests, while §547 identifies the substantive requirements for recoveries of preferences. The interplay of the claims adjustment and preference recovery process is expressly recognized in §502(d), which states in relevant part:
Notwithstanding subsections (a) and (b) of this section, the Court shall disallow any claim of any entity … that is a transferee of a transfer avoidance under Section … 547 of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity of transferee is liable under Section 550 of this title.
Therefore,
creditors are not permitted
to receive distributions
from their bankruptcy estates
on account of their claims
to the extent that they
are, among other things,
also transferees of avoided
transfers, such as preferences.
But what if creditors have
already had their claims
allowed, or even paid, from
the bankruptcy estate prior
to the commencement of preference
actions? May §502(d)
be read conversely, as a
prohibition against the
commencement of preference
actions once creditors’
claims have already been
addressed and resolved by
the bankruptcy court? Several
courts believe so, and this
may not only forever change
case management for the
claims allowance and preference
recovery processes by debtors
and trustees, but also give
a “free pass”
to savvy preference defendants
whose claims were allowed
by court order prior to
the commencement of preference
actions against them.
In LaRoche Industries,
Inc. v. General American
Transportation Corp. (In
re LaRoche Industries, Inc.),
284 B.R. 406 (Bankr. D.
Del. 2002), the defendant
had timely filed a proof
of claim, the allowance
of which was objected to,
in part, by the debtor.
The bankruptcy court allowed
the defendant’s claim,
albeit in a lesser amount
than as filed. After the
debtor’s plan was
confirmed, the defendant
received a distribution
on account of its allowed
claim. The debtors’
preference complaint was
filed sometime later. The
defendant sought summary
judgment dismissing the
debtors’ preference
avoidance complaint with
prejudice. In granting the
motion, the bankruptcy court
focused on the interplay
between claim allowance
and distribution and preference
recovery, as set forth in
Bankruptcy Code §502(d)
to conclude that the debtors’
right to assert a preference
action against the defendant
had been extinguished upon
the allowance of its claim,
as a preference action,
the court observed, is “part
and parcel of the claims
allowance process.”
Harkening back to §57g
of the Bankruptcy Act, and
to some extent the Supreme
Court’s decision in
Katchen v. Landy,
382 U.S. 323, 86 S.Ct. 467,
15 L.Ed.2d 391 (1966), the
LaRoche court observed
that creditors were historically
forbidden from having their
claims allowed unless preferential
transfers were first surrendered.
Consequently, the LaRoche
court concluded that avoidance
actions under the Bankruptcy
Code, such as preferences,
can only be determined “as
part of the claims allowance
process and not at a later
time, especially after distribution
under the plan has been
made.” This holding
was further supported by
an issue of fairness, as
the LaRoche court
noted that “[I]t is
clearly inequitable to allow
a debtor to object to a
claim while concealing a
cause of action for a preference”
as such would constitute
a clear “attempt to
take unfair advantage of
the Bankruptcy Code and
Rules.”
The LaRoche court’s
holding is not a mere “reed
waiving in the wind.”
In addition to the Katchen
decision cited above, the
decision approvingly cites
to Asousa Partnership
v. Pinnacle Foods, Inc.
(In re Asousa Partnership),
276 B.R. 55 (Bankr. E.D.
Pa. 2002) (synthesizing
Katchen and the Bankruptcy
Code), while distinguishing
Cohen v. TIC Financial
Systems (In re Ampace Corp.),
279 B.R. 145 (Bankr. D.
Del. 2002). The LaRoche
decision has also resonated
in other cases, namely
Caliolo v. TKA FABCO Corp.
(In re Cambridge Industries
Holdings, Inc.), 2003
WL 1818177, 2003 Bankr.
LEXIS 577 (Nos. 00-1919,
00-1921, 02-3405) (Bankr.
D. Del. April 2, 2003) and
Caliolo v. Azdel, Inc.
(In re Cambridge Industries
Holdings, Inc.), 2003
WL 21697190, 2003 Bankr.
LEXIS 794 (Nos. 00-1919,
02-03293) (Bankr. D. Del.
July 18, 2003). Most recently,
in Peltz v. Gulfcoast
Workstation Group (In re
Bridge Information Systems,
Inc.), 293 B.R. 479
(Bankr. E.D. Mo. 2003),
the bankruptcy court questioned
the LaRoche application
of Bankruptcy Code §502(d),
and its interpretation of
Katchen, to extinguish preference
recoveries once a creditor’s
claim has been allowed.
However, the Bridge
court did not reach
a conclusion as to the extent
of the LaRoche
holding as the pending matter
was factually distinguishable
and noted that §502(d)
could at least serve as
an affirmative defense to
a preference action in appropriate
cases.
In sum, LaRoche
suggests that debtors and
trustees should carefully
consider the timing of claims
objections and preference
actions, and the risks of
commencing them separately.
In circumstances where creditors
have contested a claims
objection, had won an order
allowing their claim and
distribution prior to being
sued for a preference, LaRoche
provides persuasive reasoning
for the argument that the
preference claim may have
been resultantly extinguished.
Conversely, where a claim
has not been contested,
or such a contest was not
resolved until after the
preference case was already
commenced, LaRoche
and its progeny provide
little solace for the alleged
transferee.
*The author
is a shareholder with the
creditors’ rights
department of Miami-based
Adorno & Yoss, P.A.,
resident in the firm’s
Fort Lauderdale office.
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End Depends
On What Circuit You’re
In
Breakup Fees Revisited: Burlington Industries Inc. and SHC Inc.
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