KB Toys: Reintroducing Uncertainty Regarding Section 502(d) Disallowance for Transferred Claims

Key Takeaway: In a recent decision in the Chapter 11 case of In re KB Toys, Inc., the United States Bankruptcy Court for the District of Delaware disallowed trade claims purchased post-petition by a claims purchaser because the original holder of the trade claims had not yet returned the property it had received as a preferential transfer. Relying on the language in Section 502(d) of the Bankruptcy Code, the Bankruptcy Court concluded that the trade claims purchaser held those claims subject to the same rights and disabilities as the seller of such claims. As a result, the claims would be disallowed until the original holder returned the property it had received as a preferential transfer. This decision is important because the Court held that the claims purchaser was not entitled to the protections of a good faith purchaser. Accordingly, the risk of purchasing a claim subject to disallowance could fall squarely onto the shoulder of the claims buyer, and not the claims seller, unless the seller agrees to indemnify the buyer under such circumstances.

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