On August 27, 2007, United States District Judge Shira Scheindlin held that Springfield Associates, an innocent transferee of a claim from Citigroup against Enron, was not subject to certain counterclaims and defenses so long as Springfield was a “purchaser” and not an “assignee” of the claim. See In re Enron Corp. v. Springfield Assocs. L.L.C., No. 07 Civ. 1957, 2007 U.S. Dist. LEXIS 63129 (S.D.N.Y. Aug. 27, 2007). Equitable subordination under Bankruptcy Code § 510 and disallowance under Bankruptcy Code § 502(d), the Springfield opinion held, were “personal disabilities” of Citigroup and did not apply to any “purchaser” of claims from Citigroup.1 Thus, if Springfield was a “purchaser,” Enron’s action to (i) equitably subordinate the claim under Bankruptcy Code § 510 based on Citigroup’s alleged wrongdoing and (ii) disallow the claim under Bankruptcy Code § 502(d) based on Citigroup’s receipt of an allegedly voidable transfer should be dismissed. Based on this ruling, the district court remanded the case for a factual finding as to whether the transaction was a “sale” or an “assignment.”

Industry groups such as the Loan Syndication and Trading Association initially claimed the decision was a victory for “the distressed debt market.”2 But Springfield, and then the LSTA, thereafter sought permission to appeal the alleged “victory,” arguing that Springfield should have prevailed no matter whether it was deemed an “assignee” or a “purchaser.” Springfield undoubtedly appealed because it was concerned that it would qualify as an assignee rather than a purchaser. The LSTA sought to appeal on the ground that market participants could not determine whether they qualify as assignees or purchasers.

In fact, if the decision is correct that an “assignment” is a transaction in which the transferee steps into the shoes of the transferor,3 then most bank claim transfers appear to qualify as “assignments” rather than “purchases.” A bank claim transferee always steps into the shoes of its transferor because it assumes the transferor’s obligations to the bank agent. The same is true of physically-settled swaps because the swap counterparties explicitly step into each other’s shoes. Indeed, the only type of claim transfer that does not require the transferee to “step into the shoes” of the transferor appears to be the assignment of a trade claim. Thus, in the absence of clarification, no transferee can assume that it qualifies as a protected “purchaser” as opposed to a vulnerable “assignee,” and every transferee will need all the same contractual representations, warranties and indemnities that market participants have always obtained.`

The LSTA and Springfield are right when they argue that there is no legal difference between an “assignment” and a “purchase.” But under the applicable statutes, Uniform Commercial Code (the “UCC”) § 9-404(a) and New York General Obligations Law (the “GOL”) § 13-105— neither of which the opinion addresses—Springfield should lose, not win, on appeal.

UCC § 9-404(a) provides that an “assignee” of a bank claim (i.e., Springfield) takes the claim subject to both

(1) any defense or claim in recoupment arising from the transaction that gave rise to the bank claim; and

(2) any other defense or claim of the account debtor [i.e., Enron] against the assignor [i.e., Citigroup] which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.

(Emphasis added.)

GOL § 13-105 likewise provides:

Where a claim . . . can be transferred, the transfer thereof passes an interest, which the transferee may enforce by an action or special proceeding . . . in his own name, as the transferrer might have done; subject to any defense or counter-claim, against the transferrer, before notice of the transfer . . . .

(Emphasis added.)

Under these statutes, it makes no difference whether defenses or counterclaims are “personal disabilities” of Citigroup or whether Congress “intended” Bankruptcy Code §§ 502(d) and 510 to apply to Citigroup’s transferees. Suppose, for example, that Lender Lou lends Borrower Bill $100 on Monday, assaults Bill on Tuesday and sells the loan to Transferee Ted on Wednesday. Bill’s counterclaim for assault is “personal” to Lou and completely unrelated to the loan, yet Ted still buys the loan subject to Bill’s counterclaim, not because the assault statute applies to assignees (the proposition is absurd), but because the UCC and the GOL make the loan subject to the counterclaim. It follows that the UCC and the GOL make Springfield’s purchased claim subject to Enron’s actions for disallowance and equitable subordination under the Bankruptcy Code in the absence of federal common law to the contrary—and there is no such federal common law.5

The Springfield decision does not address these statutes or offer any reason why they do not apply to the claim Springfield acquired. While one can guess at possible rationales for this omission, none are persuasive.

It is possible, for example, that the decision’s distinction between “assignees” and “purchasers” was an attempt to avoid UCC § 9-404(a), which by its terms applies only to “assignees.” But the UCC defines “purchase” to include an assignment,6 and includes “sale” within the meaning of “assignment.”7 In fact, sometimes the UCC uses “assignment” to describe a transaction where the transferee does not step into the shoes of the transferor.8 UCC Articles 8 and 9, moreover, make no relevant distinction between an outright sale or the grant of a security interest.9

While the Springfield opinion cites UCC § 8-202, which immunizes a securities “purchaser” from defenses, to support the proposition that “a purchaser does not stand in the shoes of the seller and, as a result, can obtain more than the transferor had in certain circumstances,”10 the decision does not recognize that the term “purchase” includes all transfers. As such, UCC § 8-202 protects even a mere pledgee of securities—securities that never leave the shoes of the seller.11 Thus, in the context of securities, bank claims and other “choses in action,” the UCC equates “security interest,” “purchase,” “sale” and “assignment.”12 The distinction between “purchase” and “assignment” upon which the opinion relies simply does not exist, and UCC § 9-404(a) applies to a transaction whether it is called an “assignment” or a “purchase.”

Like the UCC, GOL § 13-105 also does not distinguish between a “purchaser” and an “assignee” of a claim. Rather, that section—which makes a transferred claim subject to “any defense or counterclaim existing before the transferrer receives notice of the transfer”—applies to all “transfers.” GOL § 13-107 defines “transfer,” to include both a “sale” and an “assignment.” Thus, under GOL § 13-105, both a “purchaser” of a claim and an “assignee” of a claim are “transferees.”

Similarly, the court’s characterization of equitable subordination and disallowance as “creditor remedies” may have led it to conclude that such remedies fall outside UCC § 9-404, which by its terms provides that a transferred claim remains subject to counterclaims and defenses of the debtor.13 But the decision bases this characterization only on cases holding that individual debtors “lack standing” to bring an equitable subordination claim. An individual debtor’s estate is administered by a trustee, however, and therefore the trustee, not the debtor, has standing. In a typical chapter 11 proceeding, the debtor-in-possession—Enron—is the trustee and has standing to bring the claim.

In addition to labeling equitable subordination as a “creditors’ remedy,” the opinion also purports to limit the benefit of equitable subordination to creditors who held their claims at the time of the wrong doing:

[B]ecause Mobile Steel dictates that equitable subordination is not available to creditors who suffered no injury, creditors who acquired their claims post-petition and after the alleged misconduct that forms the basis for the equitable subordination may not be entitled to that remedy. 14

While this statement is made in dicta, if followed, it would be catastrophic for Enron’s creditors, few of whom held their claims at the time of Citigroup’s alleged wrongdoing. At the same time, the principal beneficiaries of the decision would not be innocent buyers, who were generally indemnified by their sellers under standard LSTA documents, but instead the allegedly guilty sellers who would be released from those indemnities. It would also release the sellers from liability in respect of claims held by all other buyers. As such, the dictum stands as an object lesson to claims buyers who think they deserve to be shielded from the disabilities of their sellers. Sellers have disabilities and sellers have rights, and buyers who assert freedom from the former may find that they have lost their ability to assert the latter.

Significantly, the uncertainty flowing from the Springfield decision is unlikely to be judicially resolved in the near future. On September 24, 2007, Judge Scheindlin rejected the requests of Springfield and the LSTA to certify her decision for interlocutory appeal to the Second Circuit pursuant to 28 U.S.C. § 1292(b). Although the Court had accepted the appeal from the bankruptcy court under the same standard applicable under § 1292(b), it nevertheless held that immediate appeal from its decision was not appropriate, but rather, in accordance with standard practice, should come after final resolution of all issues in the bankruptcy court. It reached this conclusion because, among other things, it found that the Springfield decision did not involve “controlling question of law . . . over which there is a substantial ground for difference of opinion.” In particular, the court held that there was no substantial difference of opinion concerning the distinction between transfers by sale and by assignment or the principle that an assignee stands in the shoes of its assignor. It also dismissed concerns raised by Springfield and the LSTA that uncertainty in the marketplace required prompt appellate review, explaining that its decision had actually “scaled back the Bankruptcy Court’s rulings” and taken “care to ensure that the markets would not be disturbed.”15 Time will tell whether the Court was correct to be so sanguine about the effect of its decision on the marketplace. Its refusal to certify an immediate appeal, however, renders the chances of immediate higher court review quite small and likely insures that the market will be living with the Springfield decision for some time.