The size and complexity of the marketplace for buying bankruptcy claims has changed dramatically. Once dominated by individual trade creditors hoping to receive some value for their uncollected debt in Chapter 11 bankruptcies, buying and selling unsecured bankruptcy claims has become big business. Hedge funds and investments banks have an appetite for non-correlated risk associated with the legal process of bankruptcy as opposed to the earnings and interest-rate driven stock market. The bankruptcy claim trading process offers several benefits to creditors as well.
Now, just about any unsecured trade creditor may be approached to trade claims in bankruptcy (by sale or transfer) with a bankruptcy claim buyer. When a creditor holds a claim against a bankrupt estate, they are effectively speculating on the outcome of the case. Moreover, buying a bankruptcy claim is a conscious decision to participate in the bankruptcy process. During the pendency of a bankruptcy case, creditors may be called on to (a) file a formal claim or motion with the court, (b) vote on a plan of reorganization, (c) defend a claim objection or (d) defend an avoidance or preference action seeking to claw money back from the creditor. Failure to act in any of these circumstances could have disastrous effects for the creditor. However, acting on them can be extremely expensive because it is almost always done through the retention of a creditor’s own competent bankruptcy counsel.
Table of Contents
Who’s Selling, Who’s Buying Bankruptcy Claims
Buyers purchase bankruptcy claims:
- To speculate on the outcome of the case (a very common reason)
- To obtain control over the reorganized debtor
- To block any Chapter 11 plan they oppose
In most cases, these buyers of bankruptcies are professional claims traders, who may either hold the claim or resell it to another buyer of bankruptcy claims . Trade claims in bankruptcy can be sourced directly or through a broker. These purchases can be made with the strategic objective of controlling the direction of the Chapter 11 case by owning a substantial percentage of one or more classes of creditors. (Buying more than one-half the number of bankruptcy claims, or one-third the dollar amount, provides the purchaser substantial control of a customer’s plan of reorganization.)
The seller’s motivation is:
- To realize an immediate cash payment which can be very favorable from a tax standpoint
- To avoid at least three kinds of risk that buying your bankruptcy claim for cash eliminates
- To eliminate their risk of receiving illiquid stock or notes (potentially paid over the course of years) instead of cash
A seller can be any trade creditor with an unsecured bankruptcy claim. Members of Official Committees have special rights and obligations. In almost all cases a seller of a bankruptcy claim who is a member of an Official Committee resigns after selling their claim. The reason is plain: they are no longer a creditor in the bankruptcy case and have no economic stake in the outcome.
What is Being Bought and Sold
Obviously, not all unsecured bankruptcy claims are equal. The characteristics of the claim determine its level of attractiveness to a buyer of such bankruptcy claims. Buying a bankruptcy claim is more likely with the following characteristics, which command the highest prices in the market:
- Relatively large
- Undisputed in the customer’s schedule of liabilities filed with the bankruptcy court. (Sometimes a buyer may offer to buy the undisputed portion of a claim, with a further option to purchase the balance should it be recognized as valid at a later date)
- Recognized as valid by the Bankruptcy Court (stipulated by special order)
- 503(b)(9) claims, which enjoy priority of payment over other unsecured claims
How Buying Bankruptcy Claims Works
Generally, buying and selling bankruptcy claims is freely allowed in Chapter 11 bankruptcies and can be of benefit to both the creditor and the trade claims buyer.
The following steps outline the typical process involved in selling bankruptcy claims. However, if the trade creditor sells its bankruptcy claim before the customer files Chapter 11, the sale is governed by state contract law.
Note that the mechanics of buying bankruptcy claims are not set out in the bankruptcy law and the Bankruptcy Court is not involved in negotiating or approving the purchase price. The notice requirement of the bankruptcy Code is outlined in Section 3001.
Step 1: The Offer
The bankruptcy trade claims process usually begins with a buyer offering, in written or verbal form, to purchase a creditor’s bankruptcy claim. Sometimes sellers approach buyers with a bid request to buy their bankruptcy claim. Offers are expressed as a percentage of the claim amount. While there have been offers in certain bankruptcies for as high as 90% to 100+% of the claim, these are very rare. Typically, an offer of much less is made. The higher the likelihood of a good payout for the bankruptcy claim, the higher the offer may be.
Step 2: Confirmation
Often after a price is agreed upon, the bankruptcy trade claims process can move to either a trade confirmation or directly to an Assignment of Claim Agreement. A Trade Confirm outlines the key terms of the offer but is not an actual full contract. The Trade Confirm is similar to a letter of intent and generally states that the sale of the bankruptcy claim is subject to a mutually acceptable Assignment of Claim Agreement, which is the document that conveys title.
The Trade Confirm is generally a one-page term sheet that contains a bullet point list of the salient terms of the trade such as:
- Description of the bankruptcy claim which is being purchased (amount, priority level)
- Purchase price
- Other customary terms
Step 3: Assignment of Claim Agreement
This document is the full contract which will bind the parties. Key terms include:
- Description of the bankruptcy claim which is being purchased (amount, priority level)
- Purchase price
- Representations and Warranties
- Venue
- Notice requirements
Notably, the Assignment of Claim Agreement is not required to be filed with the Court, except under rare circumstances. The trade claim buyer and trade vendor seller can be confident about the privacy of their transaction.
Step 4: Evidence of Transfer of Claim
This is the form required by Bankruptcy Code Section 3001 as a means to notify other parties of the claim transfer. . The Evidence of Transfer only includes information important for the administration of the claim such as: buyer and seller’s name and address and description of the claim being transferred. As described above, the key terms of the sale including the purchase price are confidential and not disclosed in this document.
Conclusion
The buying and selling of bankruptcy claims is specifically provided for in the US Bankruptcy Code. The practice has been ongoing for decades because it is an efficient way for trade vendors to get immediate liquidity on their bankruptcy invoices. There can be many benefits for each party in a bankruptcy claim trade. It is important to understand that the Assignment of Claim Agreement is a legally binding contract and it should be read carefully and treated as such. Follow Part 2 of this series on selling your bankruptcy claim.
