The allowance of claims and recovery of avoidable transfers are important, complementary principles in the adjustment of the debtor-creditor relationship. Like Themis personified, claims are modified or expunged to ensure that distributive justice is accomplished through the bankruptcy claim allowance and distribution process, while preferential transfers are disgorged from creditors who, by accident or design, lingered too long at the well before the commencement of a bankruptcy case. Historically, the claims adjustment and preference recovery processes have enjoyed separate lives in the ebb and flow of bankruptcy cases. For example, thought was sometimes given to the modification or expungement of claims only after the passage of a claims bar date, or in relation to the classification of claims in a chapter 11 plan. And preferences were addressed in a timely, albeit not always early, fashion in relation to the filing deadlines applicable to a given case by operation of §546(a). In this manner, claims allowance and preference avoidance were recognized as related concepts—after all, the monies recovered from the latter often paid the former. But the fragile unity of these concepts was often ignored, at least until recently, when some courts concluded that the adjudication of claims prior to the commencement of preference actions might extinguish the viability of unasserted preference cases.
Section 502 of the Bankruptcy Code provides for the allowance and disallowance of claims or interests, while §547 identifies the substantive requirements for recoveries of preferences. The interplay of the claims adjustment and preference recovery process is expressly recognized in §502(d), which states in relevant part:
Notwithstanding subsections (a) and (b) of this section, the Court shall disallow any claim of any entity … that is a transferee of a transfer avoidance under Section … 547 of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity of transferee is liable under Section 550 of this title.
Therefore, creditors are not permitted to receive distributions from their bankruptcy estates on account of their claims to the extent that they are, among other things, also transferees of avoided transfers, such as preferences. But what if creditors have already had their claims allowed, or even paid, from the bankruptcy estate prior to the commencement of preference actions? May §502(d) be read conversely, as a prohibition against the commencement of preference actions once creditors’ claims have already been addressed and resolved by the bankruptcy court? Several courts believe so, and this may not only forever change case management for the claims allowance and preference recovery processes by debtors and trustees, but also give a “free pass” to savvy preference defendants whose claims were allowed by court order prior to the commencement of preference actions against them.
In LaRoche Industries, Inc. v. General American Transportation Corp. (In re LaRoche Industries, Inc.), 284 B.R. 406 (Bankr. D. Del. 2002), the defendant had timely filed a proof of claim, the allowance of which was objected to, in part, by the debtor. The bankruptcy court allowed the defendant’s claim, albeit in a lesser amount than as filed. After the debtor’s plan was confirmed, the defendant received a distribution on account of its allowed claim. The debtors’ preference complaint was filed sometime later. The defendant sought summary judgment dismissing the debtors’ preference avoidance complaint with prejudice. In granting the motion, the bankruptcy court focused on the interplay between claim allowance and distribution and preference recovery, as set forth in Bankruptcy Code §502(d) to conclude that the debtors’ right to assert a preference action against the defendant had been extinguished upon the allowance of its claim, as a preference action, the court observed, is “part and parcel of the claims allowance process.”
Harkening back to §57g of the Bankruptcy Act, and to some extent the Supreme Court’s decision in Katchen v. Landy, 382 U.S. 323, 86 S.Ct. 467, 15 L.Ed.2d 391 (1966), the LaRoche court observed that creditors were historically forbidden from having their claims allowed unless preferential transfers were first surrendered. Consequently, the LaRoche court concluded that avoidance actions under the Bankruptcy Code, such as preferences, can only be determined “as part of the claims allowance process and not at a later time, especially after distribution under the plan has been made.” This holding was further supported by an issue of fairness, as the LaRoche court noted that “[I]t is clearly inequitable to allow a debtor to object to a claim while concealing a cause of action for a preference” as such would constitute a clear “attempt to take unfair advantage of the Bankruptcy Code and Rules.”
The LaRoche court’s holding is not a mere “reed waiving in the wind.” In addition to the Katchen decision cited above, the decision approvingly cites to Asousa Partnership v. Pinnacle Foods, Inc. (In re Asousa Partnership), 276 B.R. 55 (Bankr. E.D. Pa. 2002) (synthesizing Katchen and the Bankruptcy Code), while distinguishing Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145 (Bankr. D. Del. 2002). The LaRoche decision has also resonated in other cases, namely Caliolo v. TKA FABCO Corp. (In re Cambridge Industries Holdings, Inc.), 2003 WL 1818177, 2003 Bankr. LEXIS 577 (Nos. 00-1919, 00-1921, 02-3405) (Bankr. D. Del. April 2, 2003) and Caliolo v. Azdel, Inc. (In re Cambridge Industries Holdings, Inc.), 2003 WL 21697190, 2003 Bankr. LEXIS 794 (Nos. 00-1919, 02-03293) (Bankr. D. Del. July 18, 2003). Most recently, in Peltz v. Gulfcoast Workstation Group (In re Bridge Information Systems, Inc.), 293 B.R. 479 (Bankr. E.D. Mo. 2003), the bankruptcy court questioned the LaRoche application of Bankruptcy Code §502(d), and its interpretation of Katchen, to extinguish preference recoveries once a creditor’s claim has been allowed. However, the Bridge court did not reach a conclusion as to the extent of the LaRoche holding as the pending matter was factually distinguishable and noted that §502(d) could at least serve as an affirmative defense to a preference action in appropriate cases.
In sum, LaRoche suggests that debtors and trustees should carefully consider the timing of claims objections and preference actions, and the risks of commencing them separately. In circumstances where creditors have contested a claims objection, had won an order allowing their claim and distribution prior to being sued for a preference, LaRoche provides persuasive reasoning for the argument that the preference claim may have been resultantly extinguished. Conversely, where a claim has not been contested, or such a contest was not resolved until after the preference case was already commenced, LaRoche and its progeny provide little solace for the alleged transferee.
*The author is a shareholder with the creditors’ rights department of Miami-based Adorno & Yoss, P.A., resident in the firm’s Fort Lauderdale office.