Active participation in a bankruptcy case can be time intensive and costly, particularly if a creditor has to retain legal counsel. Participating in a case can also be a distraction for a creditor’s management team, who needs to focus on day to day business operations. Bankruptcy is a specialized area of the law with a lot of complexity; most managers and business owners aren’t equipped to handle these matters by themselves.
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Why should I sell my bankruptcy claim?
Elimination of Recovery Risk
Unsecured creditors are the last in line to receive distributions. In many cases, recoveries are low or non-existent for unsecured claims after administrative expenses (lawyer and advisor fees) and secured creditors are satisfied. Selling the non-performing bankruptcy claim for cash allows you to secure a definitive recovery, eliminating the risk of an uncertain bankruptcy outcome.
Immediate Cash Conversion
The average duration of a corporate bankruptcy case is approximately two years from the filing date to the plan effective date, but many cases take far longer due to litigation, disputes between creditors, facility shutdowns, and labor issues. Selling your bankruptcy claim for cash eliminates the time risk associated with a bankruptcy case and allows you to immediately re-invest the cash into your business.
Elimination of Consideration Risk
Assuming there is sufficient value remaining at the conclusion of a bankruptcy case, unsecured creditors may receive distributions in the form of promissory notes, stock, cash or a combination thereof. Promissory notes and stock are difficult and costly to liquidate and often cannot be sold immediately. Selling your non-performing bankruptcy claim for cash eliminates the risk of receiving illiquid securities.
Elimination of Time and Cost associated with the Bankruptcy Process
Corporate bankruptcy cases involve a great deal of paperwork and correspondence between the debtor, the bankruptcy court and creditors. Selling your non-performing bankruptcy debt for cash eliminates the time, money and valuable human resources required to follow and participate in a bankruptcy case from beginning to end.
Favorable Tax Benefits
Selling a bankruptcy claim for cash may provide your company with a tax benefit by applying the loss on the uncollected portion of your bankruptcy claim against current income.
The Bankruptcy Code allows for the purchase and sale of bankruptcy debt claims. Many creditors are unaware that there is a robust market for the buying and selling of bankruptcy claims, a practice that is commonly known as claims trading. The process of buying your bankruptcy claim takes place outside of the debtor’s court proceedings, although the transfer of the claim needs to be recognized by the debtor, court and distribution agent via the buyer filing a Rule 3001 transfer on the court docket. Creditors can sell their bankruptcy claim at any time, subject only to the provisions of any plan of reorganization. Most creditors face at least three kinds of risk that buying your bankruptcy claim can avoid.Which claims can be sold?
A bankruptcy claim is either scheduled on the debtor’s Schedule of Liabilities or a proof of claim filed by the creditor with the Bankruptcy Court or third party claims agent. A filed proof of claim supersedes a scheduled claim. A seller can sell either a scheduled claim or proof of claim.
Bankruptcy claims that are stipulated and allowed by the debtor are most attractive to bankruptcy claims traders since there is no risk of claim impairment. Bankruptcy claims listed on the debtor’s Schedule of Liabilities as non contingent, undisputed and liquidated are also attractive to claim buyers. Bankruptcy claims that are listed on the debtor’s Schedule of Liabilities are contingent, disputed or unliquidated are most risky and therefore least attractive to bankruptcy claim buyers.
The process of selling bankruptcy claims
The Offer
- Creditors may receive solicitations from bankruptcy trade claim buyers to purchase their claims. Solicitations often take the form of letters, faxes, emails or phone calls. The buyer of the bankruptcy claim will provide an offer price (expressed as a dollar value or a percentage of the face amount of the claim) and will describe other key provisions. Learn more about offers in our expanded guide to selling your bankruptcy for cash.
- Our offer price for your bankruptcy claim is based on several factors, including the prospects and expected level of recovery, the estimated time until recovery, the potential for receiving illiquid stock or promissory notes, and a claim buyer’s required return. A trade claim buyer determines the prospects and expected level of recovery by assessing the debtor’s current and future financial condition, trends in the debtor’s industry, and any pending or threatened litigation against the debtor. Since a lot of information will be unknown, these determinations are often inaccurate or best guesses on the part of the bankruptcy claims trader.
The Trade Confirmation Document
- As a first step, sometimes a bankruptcy claim buyer will send a trade confirmation document (similar to a letter of intent) to a prospective seller which outlines the key terms of the purchase and sale, including the purchase price, the claim to be transferred/assigned and other key terms. This trade confirmation can be subject to the buyer’s further due diligence on the bankruptcy claim (therefore non binding) as well as negotiation of the purchase and sale contract (known as the bankruptcy claim assignment agreement). Many buyers forego the trade confirmation document in lieu of sending the complete purchase and sale contract, which is known as the claim assignment agreement.
Claim Assignment Agreement
- The claim assignment agreement is a binding legal contract between the bankruptcy claim seller (also known as the assignor or transferor) and the bankruptcy claim buyer (as known as the assignee or transferee). Usually sellers are most focused on purchase price, which is expressed as a purchase rate (percentage of face amount) times the bankruptcy claim amount. In addition to the purchase price, sellers should pay attention to other key terms, including any provision for claim impairment, seller representations and warranties, and other payment terms.
- Claim impairment, which is also called disallowance or recourse, is the concept that the bankruptcy buyer is entitled to a purchase price refund for any portion of the claim that is reduced or expunged. For example, a 20% reduction in the bankruptcy claim amount will give rise to a proportionate (in this case, 20%) refund to the buyer. Many claim buyers will also charge sellers a nominal interest rate on the amount of the refund between the initial payment date and the refund date. Buyers of bankruptcy claims are often reluctant to remove the claim impairment provision without a commensurate reduction in the purchase price to reflect the additional risk assumed by the buyer.
- Sellers of bankruptcy claims should also pay close attention to the seller representations and warranties because any breach could result in litigation with the buyer. Typical seller representations and warranties include that the seller owns and has good title to the bankruptcy claim, that the claim is valid and has not been objected to, that the seller is authorized to enter into the claim assignment agreement, and that the seller has not sold or assigned the claim (in whole or in part), and that the seller has not received a distribution on account of the claim.
- Lastly, sellers should be sure the claim assignment agreement contains detail on when the agreement becomes effective and how long a buyer has to remit the purchase price to the seller.
Evidence of Transfer of Claim
- The Evidence of Transfer of Claim is a summary of the Claim Assignment Agreement that is meant for filing with the Bankruptcy Court. It discloses the names of the buyer and seller, along with the bankruptcy claim number and claim amount (if known). It does not include the purchase price, disallowance provision, representations and warranties, or other keys terms contained in the Assignment of Claim Agreement.
- The bankruptcy claim buyer is responsible for filing a notice of transfer with the Bankruptcy Court pursuant to Rule 3001(e)(1) or 3001(e)(2). Rule 3001(e)(1) is intended for transfers of claim before a proof of claim is filed, while a Rule 3001(e)(2) is intended for transfers of claim after a proof of claim is filed.
- The Bankruptcy Court will automatically send a letter to both the assignor and assignee notifying them of the claim assignment and giving the assignee up to 20 days to object to the transfer. If an assignee objects to the transfer of claim, the Court will set a hearing.
Conclusion
It is important for creditors to take action once they receive court notification of a customer bankruptcy. The first step includes gathering information on any purchase orders or unpaid invoices, along with any contracts or agreements associated with the customer account. The creditor may decide to hire a bankruptcy attorney at this stage. The second step is to stay on top of relevant court dates, including a bar date notice. Lastly, creditors should closely read every document sent by the Bankruptcy Court or noticing agent, paying special attention to any claim objections which would require action on the creditor’s part. Creditors should keep in mind that choosing to hold the claim until the end of the bankruptcy requires them to actively participate in the case.
