In re Firestar Diamond, Inc.

• Citation: 627 B.R. 804
• Decision Date: 30 April 2021
• Docket Number: 20-cv-4169 (JGK), 20-cv-4698 (JGK)
• Parties: IN RE: FIRESTAR DIAMOND, INC.
• Court: U.S. District Court — Southern District of New York

627 B.R. 804

IN RE: FIRESTAR DIAMOND, INC.

20-cv-4169 (JGK), 20-cv-4698 (JGK)

United States District Court, S.D. New York.

Signed April 30, 2021

Joseph E. Czerniawski, Condon and Forsyth LLP, New York, NY, Carl Nicholas Wedoff, Marc Brian Hankin, Jenner & Block LLP, Richard Beryl Levin, Cravath, Swaine & Moore LLP, New York, NY, Angela M. Allen, Jenner & Block, Chicago, IL, for In re: Firestar Diamond, Inc.

MEMORANDUM OPINION AND ORDER

JOHN G. KOELTL, District Judge:

The appellants, Bank of India (London Branch) ("BOI-L"), Receivers of Firestar Diamond BVBA on behalf of Bank of India (Antwerp Branch) ("BOI-A"), Union Bank of India (UK) Ltd ("UBI"), and Bank of India, Bharat Diamond Bourse Branch ("BOI-BDB", collectively "Banks"), bring this appeal from a Memorandum of Decision and Order of the Southern District of New York Bankruptcy Court disallowing their claims against Firestar Diamond, Inc. (hereinafter "Debtor" or "Firestar"). For the reasons explained below, the order of the bankruptcy court is vacated and the matter is remanded to the bankruptcy court for further proceedings consistent with this opinion.

I

The following facts are drawn from the Appellant's Appendix, ECF Nos. 11-18 in 20-cv-4169, filed in conjunction with this appeal and are undisputed unless noted otherwise.

Firestar is an importer and wholesaler of jewelry products. A-11. On February 26, 2018, Firestar and two of its affiliates, Fantasy, Inc. ("FI") and A. Jaffe, Inc. ("A. Jaffe," collectively with FDI and FI, the "Debtors"), filed a petition under Chapter 11 of the Bankruptcy Code in the Southern District of New York Bankruptcy Court. A-5. Nirav Modi, directly or indirectly, is the majority shareholder of Firestar's parent company, Firestar International Limited ("FIL"). A-12. Approximately three weeks prior to the petition, Punjab National Bank filed a criminal complaint against Modi, alleging bank fraud, and India's Central Bureau of Investigation launched an investigation. A-15. This led to asset freezes and operational disruptions that affected the Debtors' businesses and led them to seek Chapter 11 protection. A-16. The bankruptcy court appointed an examiner to investigate the Debtors' involvement with the alleged fraud and, in his report, the examiner found substantial evidence to support the knowledge and involvement of the Debtors in the alleged fraud. A-248. The bankruptcy court also appointed a trustee to administer the Debtors' estates since June 2019. A-85.

The Banks' claims against Firestar originate from their dealings with three subsidiaries of Firestar, namely Firestar Diamond International Private Limited ("FDIPL"), Firestar Diamond BVBA, ("BVBA"), and Firestar Diamond FZE ("FZE," collectively, the "Affiliates"). The Affiliates traded merchandise with Firestar. See, e.g., A-433; A-491; A-662; A-745. The Banks extended credit to the Affiliates to fund their working capital. A-716, A-768, A-853. The Affiliates used their receivables, including those generated by sales of merchandise to Firestar, to secure the financing from the Banks. In some instances, the Affiliates designated the Banks as payees on the invoices issued to Firestar, directing Firestar to make payment directly to the Banks, see, e.g., A-780. In other instances, the Affiliates sold their invoices at a discount to the Banks. See, e.g., A-661. Some of these invoices remained unpaid at the time of the petition and those unpaid invoices form the basis for the Banks' claims at issue in this appeal.

Under the Bankruptcy Code, the court must disallow claims made by entities who received property that is recoverable or transfers that are avoidable, among other reasons, because such transfers are fraudulent or preferential, until such transfers are first returned to the estate. See 11 U.S.C. §§ 502(d), 544, 547, 548.

There was no allegation in this case that the Banks received payments that were fraudulent or preferential such that they need to be returned before the Banks can file claims in the bankruptcy. Instead, the trustee has alleged that Firestar made numerous transfers of money and merchandise to the Affiliates in furtherance of the fraud. A-424; A-482; A-553. On that basis, the trustee has asserted that the transfers to the Affiliates were avoidable as fraudulent and preferential under sections 544, 547, and 548 of the Bankruptcy Code and section 276 of the New York Debtor and Creditor Law. A-426; A-484; A-556.

The trustee's arguments with respect to the Affiliates are undisputed. The core of the dispute among the parties in this appeal is what significance the trustee's arguments with respect to the Affiliates have to the Bank's claims. The trustee has argued that because the Banks' claims are based solely on amounts purportedly owed by Firestar to the Affiliates, they are subject to the same defenses as if the Affiliates were asserting them. Accordingly, the trustee has argued, the Banks' claims should be disallowed pursuant to Section 502(d) of the Bankruptcy Code as if they were asserted by the Affiliates.¹

The Banks have challenged the trustee's characterization of the claims as being based solely on the amounts owed by Firestar to the Affiliates. Instead, the Banks have argued that they are owed money directly by Firestar based on Firestar's agreement to make payment to the Banks. Further, the Banks have argued that Section 502(d) does not apply because there is no allegation that the Banks have received fraudulent or preferential transfers that are voidable under the Bankruptcy Code. Additionally, the Banks have argued that disallowance under section 502(d) "is a personal disability of a claimant, not an attribute of the claim." In re Enron Corp., 379 B.R. 425, 443 (S.D.N.Y. 2007) (" Enron II").² Under this reasoning, the Banks argue that their claims do not necessarily suffer from the same defects as if they were brought by the Affiliates.

In its Memorandum of Decision, the bankruptcy court granted the trustee's objections to the Banks' claims. In re Firestar Diamond, Inc., 615 B.R. 161, 171 (Bankr. S.D.N.Y. 2020). In its analysis, the bankruptcy court rejected the Banks' reliance on Enron II, according to which the disabilities of a claimant are passed on in an assignment of a claim, but not in a sale of a claim. Instead, the bankruptcy court held that Section 502(d) "follows the claim, not the claimant," regardless of how the claim is transferred. Id. at 168. Furthermore, the bankruptcy court adopted the trustee's characterization that "the [Banks'] claims are based on amounts owed to" the Affiliates and the trustee's conclusion that the claims would be subject to disallowance if the Affiliates filed the claims. Id. at 169. Given its conclusion that Section 502(d) disallowance follows the claims regardless of how the claim is transferred, the bankruptcy court determined that it need not decide whether the transactions underlying the Banks' claims were "sales" or "assignments." Id. at 170. The court went on to observe that the transactions "might not even be ‘sales’ protected from disallowance under Enron II" but were instead part of a secured loan. Id.

II

On appeal, the Court reviews a bankruptcy court's factual findings for clear error and its legal conclusions de novo. Nat'l Union Fire Ins. Co. v. Bonnanzio, 91 F.3d 296, 300 (2d Cir. 1996). The Court may affirm on any ground that finds support in the record and need not limit its review to the bases raised or relied upon in the decisions below. See, e.g., In re Coronet Capital Co., No. 94-cv-1187, 1995 WL 429494, at *3 (S.D.N.Y. July 20, 1995).

III

The Bankruptcy Code "requires a court to disallow an entity's claim against the bankruptcy estate if the estate is entitled to recover property from that entity, such as because of a voidable preference, but that entity has failed to first transfer this property back to the bankruptcy estate." In re McLean Indus., 30 F.3d 385, 388 (2d Cir. 1994). Section 502(d) provides, in pertinent part,

[T]he 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."

11 U.S.C. § 502(d). It is undisputed in this appeal that any claims by the Affiliates against Firestar would be disallowed under Section 502(d) because the Affiliates have not transferred to Firestone any preferences they received under Section 544, 547, and 548.

There is disagreement among the courts about the applicability of Section 502(d) to transferees of claims. On one end of the spectrum is Enron II, on which the Banks relied in the bankruptcy court, and which held that Section 502(d) disabilities "are not attributes of the claim but rather are personal disabilities of individual claimants," 379 B.R. at 445, and "unless there was a pure assignment (or other basis for the transferee to step in the shoes of the transferor), as opposed to a sale of the claim, the claim in the hands of the transferee is not subject to ... disallowance based solely on the conduct of the transferor," id. at 439. On the other end of the spectrum is the decision of the Third Circuit Court of Appeals in In re KB Toys Inc., which held that "because § 502(d) permits the disallowance of a claim that was originally owned by a person or entity who received a voidable preference that remains unreturned, the cloud on the claim continues until the preference payment is returned, regardless of whether the person or entity holding the claim received the preference payment." 736 F.3d 247, 254 (3d Cir. 2013).

For the reasons articulated by the bankruptcy court and the Court of Appeals for the Third Circuit in KB Toys, a transferee of a claim is...