Buyer Beware: Third Circuit Confirms Claims are Subject to Disallowance Despite Sale to Third Party


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.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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