Doing the Splits
522(f), 522(h), 544, 545, 547, 548, 549, or 724(a) . . . 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 . . . .” (Emphasis added.)
The application of this statute can be harsh, requiring the disallowance of the entire claim of a claimant, even if that claim far exceeds the amount for which the claimant is “liable” to the bankruptcy estate. However, this mandatory disallowance is not necessarily permanent. Section 502(d)’s requirement to disallow claims within its purview is still subject to the provisions of Section 502(j), which provides that “[a] claim that has been allowed or disallowed may be reconsidered for cause.” Certainly, no matter which side of the circuit divide one falls on, if the amount for which the claimant is “liable” is paid to the bankruptcy estate, this should constitute “cause” for reconsideration of a disallowance under Section 502(d) pursuant to the provisions of Section 502(j).
This journey into the meaning of modern statutory parlance begins with the Fifth Circuit in the case of In re Davis, 889 F.2d 658 (5th Cir. 1989). In that case, the Internal Revenue Service (IRS) sought the payment of approximately $6.5 million in unpaid taxes, penalties, and interest from the debtors. The debtors responded by commencing an adversary proceeding, wherein the bankruptcy court found only $84,000 to be owed to the IRS. The IRS appealed this determination, but while the appeal was pending, the debtor’s plan was confirmed. The newly appointed plan trustee sought turnover of $400,000 in refunds and interest from the IRS and asserted the IRS’s claim should be disallowed under Section 502(d).
The district court determined in the trustee’s turnover action that a significant portion of the IRS’s claim should be disallowed under Section 502(d) because of the IRS’s failure to promptly pay over the debtors’ refunds. In reversing, the Fifth Circuit held that Section 502(d) requires disallowance only after a creditor “has been afforded a reasonable time in which to turn over amounts adjudicated to belong to the bankruptcy estate,” and this had not occurred in this case. Id. at 662. In so concluding, the Fifth Circuit required a final adjudication of liability against the creditor at issue and a “reasonable time” for that creditor to comply with that adjudication before Section 502(d) could be used to disallow the claim of such creditor.
Eleven years later, the Ninth Circuit’s decision in El Paso v. America West Airlines, Inc.1 (In re America West Airlines, Inc.), 217 F.3d 1161 (9th Cir. 2000), created the circuit split on the issue of when and how the disallowance provisions of Section 502(d) come into play. Unlike the Davis case, America West involved a statutory tax lien which was avoidable under Section 545(2), but which had not been avoided. Rejecting the Fifth Circuit’s interpretation of Section 502(d) as requiring an adjudication of liability against a creditor prior to its use, the Ninth Circuit focused on the word “avoidable” as used in Section 502(d), which the Court found did not require a final adjudication, and distinguished it from the alternative basis for disallowance if property is “recoverable” under alternative enumerated sections of the Bankruptcy Code. The Ninth Circuit rejected the argument that the creditor must first be
1Our author Annette Jarvis personally briefed and argued the America West case in front of the 9th Circuit that created this circuit split.
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