Court Holds that Administrative Claims Cannot Be Disallowed Under Section 502(d)


By: Michael Ryan Diaz
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
 
In ASM Capital, LP v. Ames Department Stores, Inc. (In re Ames Department Stores, Inc.),[1] the Second Circuit held that section 502(d), which disallows claims of a party that has failed to return preferential transfers to the debtor,[2] does not bar payment for administrative expenses under section 503(b).[3] The debtor, Ames Department Stores, Inc. (“Ames”), filed a voluntary petition under chapter 11 of the Bankruptcy Code.[4] While in bankruptcy, Ames received a default judgment, for the recovery of preferential transfers,[5] against one of its suppliers, G & A Sales, Inc. (“G & A Sales”).[6] Also facing insolvency, G & A Sales filed a bankruptcy petition and transferred to other entities all of its assets, including two administrative claims against Ames for providing post-petition supplies.[7] These administrative claims were sold to ASM Capital, a distressed-debt investment firm. Meanwhile, Ames’ board of directors eventually decided that liquidation, rather than reorganization, would maximize value for the debtor’s estate.[8] In the midst of liquidation, Ames made distributions for administrative expenses to certain claimants, but withheld payment to ASM Capital on the ground that section 502(d) disallows administrative expense claims that were acquired from a party who had failed to return any preferential transfer or its equivalent value. ASM Capital responded by filing a motion in the bankruptcy court to order the debtor to pay ASM Capital its administrative expense claims. ASM Capital argued that section 502(d) does not apply to administrative expense claims, but the bankruptcy court rejected this argument and denied the motion.[9] Although the district court affirmed the bankruptcy court’s ruling,[10] the Second Circuit reversed and held that section 502(d) does not apply to administrative expense claims.[11] 
 
The Second Circuit reasoned that administrative expenses did not fall within the types of claims that section 502(d) proscribes.[12] The court identified several Code provisions that distinguish between claims and administrative expenses.[13] For example, the court observed that section 507(a)(2) refers to administrative “expenses” whereas other subsections under 507(a) refer to allowed unsecured “claims.”[14] The court also argued that the opening language of section 502(d)[15] indicates that it is merely an exception carved out of the provisions of sections 502(a) and 502(b), which do not apply to administrative claims. Administrative claims, which are covered by section 503 and not sections 502(a) or 502(b), should therefore not be subject to section 502(d)’s provisions for disallowing claims. In further support of its conclusion, the court also identified a procedural anomaly that would result if administrative expenses were treated as “claims” under section 502(d);[16] the entity seeking payment for administrative expenses may risk losing its claim unless it files a proof of claim required by section 501,[17] even though “administrative expenses may not be filed under section 501.”[18]
 
ASM Capital will have a significant impact on post-petition conduct among debtors and other stakeholders in the bankruptcy proceeding. By alleviating the risk that an administrative expense claim may be disallowed, the Second Circuit has provided greater incentive for businesses to transact with post-petition debtors,[19] which would typically give debtors a better opportunity to reorganize successfully.[20] In addition, distressed-debt investors like ASM Capital may be more willing to purchase administrative expense claims, which would provide greater liquidity to businesses that enter into post-petition transactions with debtors.[21] These incentives, however, must be weighed against the purpose of section 502(d) — to ensure compliance with judicial orders requiring parties to return avoidable transfers, or their equivalent value, to the debtor’s estate.[22] The Second Circuit may have sympathized with ASM Capital’s position because it had no control over its predecessor’s failure to comply with a default judgment in the preference action; nor was ASM Capital given the opportunity to dispute the merits of the preference action.[23] Under the Second Circuit’s ruling, however, any entity is entitled to payment for administrative expenses, even if it was the same entity that did not comply with the order to return avoidable transfers.[24] 


[1] 582 F.3d 422 (2d Cir. 2009), cert. denied, 78 U.S.L.W. 3375, (U.S. 2010).
[2] Section 502(d) provides, in relevant part, that “[n]otwithstanding subsections (a) and (b) of this section, the court shall disallow any claim of any entity . . . that is a transferee of a transfer avoidable under [section 547] of this title, unless such . . . transferee has paid the amount . . . , or turned over any such property, for which such . . . transferee is liable under section 522(i), 542, 543, 550, or 553 of this title.” 11 U.S.C. § 502(d) (2006).
[3] ASM Capital, 582 F.3d at 432.
[4] Id. at 424.
[5] Under section 547, a preference includes any transfer, on account of antecedent debt, made to a creditor prior to the bankruptcy petition filing and while the debtor was insolvent, if the transfer exceeded the value of what the creditor would have received in the bankruptcy proceeding for the antecedent debt. See generally Collier on Bankruptcy, ¶ 547.01 (Alan N. Resnick et. al. eds., 16th ed. 2009), available at LEXIS, 5-547 Collier on Bankruptcy P 547.01.
[6] The Second Circuit did not detail the exact nature of the preferential transfers. However, the court stated that the debtor had received a default judgment in the preference action for $825,138. ASM Capital, 582 F.3d at 425.
[7] Id. at 426.
[8] Id. at 424.
[9] Id.at 425.
[10] In response to ASM Capital’s request for a supplemental finding that the order was final and appealable, the bankruptcy court found that the debtor was “highly unlikely” to collect its judgment from G & S Sales because it had filed its own bankruptcy petition and transferred all of its assets. Id.at 425–26.
[11] Id. at 432 (remanding case to bankruptcy court for order requiring debtor to distribute payment to ASM Capital).
[12] See ASM Capital, 582 F.3d at 427.
[13] Id. at 432 (citing cases identifying sections of Code where there is a distinction between claims and administrative expenses).
[14] Id. at 429; see also 3 Norton Bankruptcy Law and Practice § 49:16, at 49-94 to 49-96 (William L. Norton, Jr. ed., 3d ed. 2008). Compare 11 U.S.C. § 507(a)(2) (2006) (“administrative expenses allowed under section 503(b)”), with 11 U.S.C. § 507(a)(1), (3)–(10) (2006) (allowed unsecured “claims”).
[15] “Notwithstanding subsections (a) and (b) of this subsection . . . .”   11 U.S.C. § 502(d).
[16] ASM Capital, 582 F.3d at 429.
[17] See 11 U.S.C. § 502(b)(9) (2006) (permitting court to allow claim except when proof of claim is not timely); ASM Capital, 582 F.3d at 429 (identifying separate procedures for allowance of claims and allowance of administrative expenses).
[18] ASM Capital, 582 F.3d at 429 n.4 (citing Official Bankruptcy Form B 10 (Dec. 2007)).
[19] See John J. Rapisardi, Circuit Limits Grounds to Disallow Administrative Expense Claims, 242 N.Y. L.J. 3 (2009); Petition for Writ of Certiorari at 30, Ames Dep’t Stores, Inc. v. ASM Capital, L.P., No. 09-726 (U.S. Dec. 17, 2009), 2009 WL 4953064.
[20] See Collier on Bankruptcy, supra note 5, at ¶ 503.06[2], available at LEXIS, 4-503 Collier on Bankruptcy P 503.06 (citations omitted) (identifying administrative priority as incentive for businesses to provide goods and services to the debtor so that it may reorganize successfully).
[21] See Collier on Bankruptcy, supra note 5, at  ¶ 502.05[1], available at LEXIS, 4-502 Collier on Bankruptcy P 502.05 (suggesting court’s ability to disallow claims reduces liquidity in claims-trading market).
[22] See Campbell v. United States (In re Davis), 889 F.2d 658, 661 (5th Cir. 1989); Petition for Writ of Certiorari, supra note 19, at 30.
[23] See supra note 6. The Second Circuit did not address whether ASM Capital is necessarily liable for the default judgment against G & A Sales. Assuming ASM Capital purchased the administrative claims in good faith, the Second Circuit could have held that the default judgment was a “personal disability” that did not travel with the claim once it was purchased. See Collier on Bankruptcy, supra note 5, at ¶ 502.05[1] available at LEXIS, 4-502 Collier on Bankruptcy P 502.05 (quoting Enron Corp. v. Springfield Assocs., LLC (In re Enron Corp.), 379 B.R. 425, 445 (S.D.N.Y. 2007)).
[24] See Petition for Writ of Certiorari, supra note 19, at 37 (arguing that a preference recipient will no longer have any incentive to return voidable transfers).