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A Circuit Court Definitively Addresses Claims Trading

By Yitzhak Greenberg

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.

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