Buying and selling bankruptcy claims as financial instruments, or bankruptcy claims trading, involves a willing buyer and seller. Buyers include banks, hedge funds and dedicated trade claim investment funds. Sellers include any type of creditor in a bankruptcy case, most commonly: goods and service vendors and landlords. In significant Chapter 11 cases, claims are frequently bought and sold by these types of entities. This activity benefits claim sellers by providing them immediate liquidity. This examination of bankruptcy claim trading expands on a previous blog “Sell Your Bankruptcy Claim for Cash in 4 Steps.”
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Why Does Someone Want to Buy My Bankruptcy Claim?
Traders buying bankruptcy claims generally do so in order to speculate on the outcome of a given bankruptcy case. Buyers of bankruptcy claims would realize a positive return to the extent distributions exceed the purchase price or suffer a loss if distributions do not exceed the purchase price. Furthermore, the length of time between buying a bankruptcy claim and repayment can be relevant. For instance, if distributions exceed purchase price by 10% but it takes 5 years for the trader buying the bankruptcy to receive a distribution after sale, it is a positive return but very low (possibly even below the risk-free rate). When you buy a bankruptcy claim, you become a participant in the case: you can vote for the debtor’s reorganization plan and take a broader involvement in the case. Additional benefits include the ability to:
- Gain ownership in the restructured debtor’s equity.
- Make strategic investments in the debtor’s capital structure.
- Provide liquidity to sellers who don’t want post-reorganization equity (e.g., smaller companies needing immediate cash flow or averse to distribution risks).
- Attain and exert influence in a bankruptcy proceeding.
Should I Sell My Bankruptcy Claim?
Sellers generally trade claims because they don’t want to speculate on the outcome of a given bankruptcy case or spend the time and money tracking the case and potentially defending their claim. Selling bankruptcy claims also offers the following advantages:
- Escape the risk of delayed recovery of your bankruptcy claim, given the prolonged nature of bankruptcy cases.
- Potentially receive a tax deduction if the claim is sold at a loss.
- Steer clear of value fluctuations, which are common during the case’s progression.
- Eliminate a non-performing receivable from their financial records.
- Minimize legal costs tied to claim assessment, filing, potential litigation, and the overall expenses associated with navigating and monitoring the time-intensive bankruptcy process.
When Can I Sell My Bankruptcy Claim?
Bankruptcy claims are traded throughout all stages of a Chapter 11 case, starting from the moment the bankruptcy petition is filed and extending even after plan confirmation. Prices for these claims can greatly fluctuate based on case developments, such as asset sales, litigation resolutions, or the formulation of reorganization or liquidation plans. Broader industry shifts, including commodity prices, foreign competition, regulatory matters, and economic trends, can also impact claim prices.
The trading process involves agreements like claims purchase agreements, assignment of claim agreements, or purchase and sale agreements. While no universal standard exists, these agreements typically incorporate negotiable provisions based on factors like claim size, the buyer-seller relationship, and the claim’s price.
What Rules Apply to Selling My Bankruptcy Claim?
The relevant statutory provisions and rules for buyers and sellers in bankruptcy claims trading include:
- Filing Transfer Notices and Proofs of Claim (Bankruptcy Rules 3001(e)(1), 3001(e)(2), 3001(e)(3), and 3001(e)(4): Buyers can file a proof of claim if the claim has not been transferred for security. An evidence of transfer is required for claims transferred after a proof of claim has been filed. There are specific procedures for publicly traded notes, bonds, or debentures.
- Disallowance of Claims (Section 502(d) of the Bankruptcy Code): Claims can be disallowed if the holder retains recoverable property under bankruptcy avoidance provisions, even if the claim is unrelated to the avoidance action.
- Equitable Subordination of Claims (Section 510(c) of the Bankruptcy Code): Claims can be subordinated based on equitable considerations.
Bankruptcy Rule 3001(e)(1) enables buyers to file a proof of claim if the claim hasn’t been transferred for security. Bankruptcy Rule 3001(e)(2) involves evidence filing and objection procedures for claims transferred after a proof of claim. Bankruptcy Rule 3001(e)(3) deals with publicly traded securities transferred for security, and Bankruptcy Rule 3001(e)(4) mirrors Rule 3001(e)(2).
Section 502(d) of the Bankruptcy Code disallows claims if the holder retains recoverable property under avoidance provisions, impacting claims involving avoidance actions.
What Is Equitable Subordinance in Selling My Bankruptcy Claim?
Section 510(c) of the Bankruptcy Code allows claims to be equitably subordinated if a claimant engaged in unfair conduct, meaning the claim can be ranked lower than others. This applies even if the claim is in the hands of a buyer. Thus, if the seller’s actions were inequitable, the claim may still be subject to subordination after trading.
Are There Other Applicable Statutes in Selling My Bankruptcy Claim?
In certain cases where the buyer aims to gain control of the debtor, supports a Chapter 11 plan, or is part of a committee, additional Bankruptcy Rules and Code sections become relevant:
- Disclosure of Information by Committees (Bankruptcy Rule 2019): Entities in groups or committees representing multiple creditors must disclose their identities and claim details against the debtor. While claims purchasers aren’t required to disclose in their capacity, joining certain committees may trigger disclosure obligations.
- Disqualification of Votes (Section 1126(e) of the Bankruptcy Code): Claims, including those acquired to hinder plan confirmation, can be excluded from voting if not done in “good faith.” This provision helps prevent strategic manipulation of votes.
Bankruptcy Rule 2019 mandates disclosure for committee members but may apply to claims purchasers joining specific committees. Section 1126(e) prevents disingenuous voting tactics by disqualifying claims not voted in good faith.
Can I Sell My Bankruptcy Claim If It Is Impaired?
Usually disallowance happens after a trade has already been consummated. Claims purchase agreements typically outline remedies if a claim is disallowed or impaired. If part of a claim is disallowed (which is more common than complete disallowance when you buy a bankruptcy claim), the seller is usually required to refund only that portion of the purchase price subject to the disallowance. For example, let’s assume a $100,000 claim was purchased for $20,000. If the Debtor ultimately determines that the claim was only valid at $80,000, the purchase price should have only been $16,000 (20% of $80,000 instead of 20% of $100,000). Since the seller really only had a valid $80,000 claim to sell, most agreements require the seller to refund that portion of the purchase price ($4,000) to the buyer. Importantly, the buyer is retaining the repayment risk in the case. If the recovery is zero on that $80,000 claim, the buyer is still suffering a loss. The buyer does not assume the risk of certain invoices being disallowed because they weren’t the seller of the items and have very limited information as to the claim’s validity. An assumption is made up front that the invoices subject to the purchase are valid. If that changes over time most agreements require the parties to readjust the purchase price to fairly reflect the amount of invoices purchased.
Remedies might apply before actual disallowance if a claim is considered “impaired” based on agreement terms. Impairment could include scenarios like the debtor disputing the validity of the invoices, challenging the calculations for damages, reserving rights to object, objections remaining unresolved, filing of avoidance actions, issuance of a final order disallowing or reducing the claim, or judgments on avoidance actions resulting in disallowance.
