The Third Circuit in In re KB Toys, Inc. recently affirmed a decision of the Delaware District Court, holding that trade claims are subject to disallowance under section 502(d) of the Bankruptcy Code despite their subsequent sale to a third party. This case is of particular interest to investors in distressed debt.

Generally, section 502(d) of the Bankruptcy Code provides that a bankruptcy court shall disallow “any claim of an entity” that is the transferee of an avoidable transfer (such as a preference or fraudulent conveyance), unless the property subject to avoidance is returned to the estate. In KB Toys, the Third Circuit considered whether a trade claim that is subject to disallowance under section 502(d) with respect to the original claimant is also disallowable in the hands of a subsequent transferee.