ASM Capital, LP v. Ames Dept. Stores, Inc. (In re Ames Dept. Stores, Inc.), 582 F.3d 422 (2d Cir. 2009)

 In re Circuit City, No. 08-35653, 2010 WL 56076 (Bankr. E.D. Va. Jan. 6, 2010)

 The ASM and Circuit City cases address the issue of whether section 502(d) of the Bankruptcy Code can be used by a debtor to temporarily disallow administrative expense claims of creditors that are defendants in pending avoidance actions. The two courts reached different conclusions on the issue. This article analyzes the reasoning of each court and the Petition for a Writ of Certiorari pending with the United States Supreme Court, which was denied on February 22, 2010.

 ASM Capital, LP v. Ames Dept. Stores, Inc.

 In ASM, the Debtor filed a preference action against one of its suppliers. The supplier held “administrative expense” claims against the Debtor, because it provided goods to the Debtor after it filed for bankruptcy. Section 503(b) of the Bankruptcy Code provides that claims arising from the provision of postpetition goods or services to a debtor, such as those of the supplier in this case, may be given “administrative expense” priority status. The supplier sold its administrative expense claims to ASM Capital LP, whom the Debtor refused to pay, arguing that the claims were barred pursuant to section 502(d) of the Bankruptcy Code until the avoidance action against the supplier was resolved.

 Section 502(d) of the Bankruptcy Code provides for the temporary disallowance of claims of creditors that hold a debtor’s property and refuse to return it. Section 502(d) provides:

the court shall disallow any claim of any entity from which property is recoverable under section 542, 543, 550, or 553 of this title or that is a transferee of a transfer avoidable under section 522 (f), 522 (h), 544, 545, 547, 548, 549, or 724 (a) of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable under section 522 (i), 542, 543, 550, or 553 of this title.

The Bankruptcy Court for the Southern District of New York ruled in favor of the Debtor, holding that section 502(d) could bar payment on all claims, including section 503 administrative expense claims. The Defendant appealed the Bankruptcy Court’s decision to the District Court for the Southern District of New York, which affirmed the Bankruptcy Court’s holding. The Defendant appealed again.

 The Second Circuit reversed the District Court’s and Bankruptcy Court’s decisions. It conceded that while the definition of “claim” in section 101(5) of the Bankruptcy Code is broad, there are crucial differences between administrative expense claims pursuant to section 503 and prepetition claims, which are referred to in section 501. For example, section 501 deems a prepetition claim allowed once a proof of claim is filed. Section 503(a), on the other hand, requires that a request for allowance of administrative expense claim be filed with a bankruptcy court and is deemed allowed only after a bankruptcy court approves the request. The Second Circuit also noted that section 502(d) does not explicitly refer to administrative expense claims filed pursuant to section 503, whereas other subsections of section 502 do explicitly refer to administrative expense claims.

 As further support for its position, the Second Circuit stated that the Bankruptcy Code makes a “clear division between an entity in its pre and post petition states.” The Court further noted that “[a]dminsitrative expenses arise post-petition” and generally cannot be setoff against prepetition claims. The Second Circuit found that this distinction militates against barring administrative claims that arose postpetition until an avoidance action that relates to a debtor’s prepetition transfers is resolved. It also reasoned that the higher priority granted to administrative expense claims is designed to encourage third parties to do business with the bankruptcy estate, an objective that would be frustrated by allowing the Debtor to use section 502(d) to bar claims that arise from these transactions. Accordingly, the Second Circuit vacated the decisions of the lower courts and remanded the case for further proceedings.

 Circuit City

 In a recent 2010 decision, the Bankruptcy Court for the Eastern District of Virginia reached a different result than ASM. In Circuit City, the Debtors sought to use section 502(d) of the Bankruptcy Code to temporarily disallow administrative expense claims that arose under section 503(b)(9). Section 503(b)(9) provides administrative expense status to claims of suppliers who ship goods to a debtor within 20 days prior to its bankruptcy filing. Citing ASM, the creditors asserted that section 502(d), which permits disallowance of claims filed by parties from which a debtor seeks to recover property, was intended to cover prepetition claims pursuant to section 501, not administrative expense claims pursuant to section 503.

 The Bankruptcy Court found as an initial matter that a “plain reading” of the definition of “claim” in section 101(5) of the Bankruptcy Code includes administrative expense claims, and, therefore, such claims should be covered by section 502(d).

 The Bankruptcy Court further stated that barring the administrative expense claims in this case was consistent with the Bankruptcy Code’s goals of “equitable distribution and efficiency.” Specifically, the Bankruptcy Court reasoned that if section 502(d) of the Bankruptcy Code did not apply to 503(b)(9) claims, the creditors could “double dip” and use their shipments to the Debtor both as new value to offset any preferential payments they received and to recover payment on the administrative expense claim that arose from the shipments. The Bankruptcy Court viewed such a result as unfairly treating some claimants more favorably than others. Therefore, the Bankruptcy Court disallowed the administrative expense claims at issue pursuant to section 502(d).

 Appeal to the Supreme Court

The debtor in ASMhas filed a Petition for a Writ of Certiorari, seeking to have the Supreme Court of the United States hear its appeal from the Second Circuit’s decision. Among the reasons the Debtor cited in favor granting Certiorari is a split among Circuit Courts, with the Second Circuit holding in ASM that the Debtor may not use section 502(d) of the Bankruptcy Code to bar administrative expense claims and the Eighth Circuit holding that section 502(d) may be used to bar administrative expense claims. The Debtor asserted that “[the] issue arises in virtually every chapter 11 case and continues to spawn confusion and diverse opinions from multiple lower courts.” Addressing the merits of the Second Circuit’s opinion, the Debtor argued that the Second Circuit’s holding creates an absurd situation where a debtor is required to make a distribution on a claim, even when the original claimant still owes the debtor money. It also argued that the “plain meaning” of the Bankruptcy Code’s definition of “claim” includes administrative expense claims and permits the Debtor to bar them using section 502(d) of the Bankruptcy Code. According to the Debtor, the legislative intent to ensure equality of distribution to creditors from the bankruptcy estate also supports its position. 

 On February 22, 2010 the Supreme Court denied Certiorari.

 Commentary

The ASM and Circuit City decisions address issues of exceptional importance to debtors as well as numerous other parties involved in bankruptcy cases. Many small to medium sized companies regularly deliver goods to debtors shortly before and after a bankruptcy filing, particularly in the case of large chain stores such as the Ames Department Stores and Circuit City. The Supreme Court’s denial of Certiorari is unfortunate; a resolution of this split among Circuit  Courts would have had a direct, practical effect upon many parties-in-interest.