At one time or another just about every creditor in a large corporate Chapter 11 bankruptcy case will receive an offer to purchase the creditor’s claim. These offers typically come from professional claims traders, most of which are in the business of buying claims at a discount to what they believe will be the claims’ ultimate value. Some claims buyers, including hedge funds and other distressed debt investors, may buy claims with the strategic objective of controlling the direction of the Chapter 11 case by owing a substantial percentage of one or more classes of creditors.
How do claims buyers find out about your claim? Within the first few weeks after a bankruptcy is filed, the debtor must file schedules of its assets and liabilities. Creditors holding secured claims are listed on Schedule D and those with unsecured claims are listed on Schedule F. These schedules show the amount the debtor believes it owes each creditor and whether it thinks the claim is disputed, contingent, or unliquidated. Claims buyers will often first contact creditors with claims listed as being undisputed, not contingent, and liquidated because those claims are less likely to be subject to litigation later in the bankruptcy case.
If you express interest in selling your claim, you may be sent a "confirmation" document with key terms such the percentage on the dollar to be paid and the amount of the claim to be purchased. The actual document that transfers the claim, however, is usually a separate "claim assignment agreement." You should carefully review all of the documentation, including the claim assignment agreement, before committing to sell your claim.
Selling a claim can sometimes be beneficial, but there are also risks. When evaluating whether to sell your claim, here are some of the key points to keep in mind:
- Liquidity. The main advantage of selling your claim is getting some cash for it now. Although creditors often believe that selling their claim will also eliminate any further risk of loss, for the reasons discussed below claim assignment agreements usually keep you at risk even after you sell your claim. If you’re willing to accept those risks, you can get immediate liquidity by selling your claim instead of having to wait months or years to receive whatever payment — which sometimes is in the form of stock or debt instead of cash — the bankruptcy estate ultimately distributes.
- Price. Given the claims buyer’s usual objective of buying at a discount, coupled with the time value of money, the price you are offered could end up being lower than the value you could recover if you held your claim and waited for distributions to be made later in the case. The price offered for claims can also rise or fall over time as more information about creditors’ likely recovery becomes available.
- Read the fine print. Occasionally, claims buyers add detailed provisions and representations to the claim assignment agreement that operate to give the buyer an option to "put" or sell all, or the disputed part, of the claim back to you upon the mere filing of an objection or other challenge to the claim — even if the objection is ultimately defeated. Why? Well, if the price paid for your claim later turns out to have been too high, the claims buyer might use the filing of a claim challenge to get its money back, plus interest. Since commonplace events such as claim objections and preference actions may be classified as triggering "challenges," it’s important to watch out for these provisions.
- Defending the claim. Often the claims buyer will put a provision in the claim assignment agreement requiring you to defend the claim against any objection at your own expense, and to pay the claims buyer back for any portion of the claim that might be disallowed. If a portion of your claim is disputed, however, you may well want the right to defend the claim so you can keep what you’ve been paid. Either way, you may incur costs in the bankruptcy case after you sell your claim.
- Setoff or other special claims. Claim assignment agreements may also include provisions limiting your right to assert a setoff or recoupment against the debtor (concepts discussed in an earlier post) or requiring you to pay back all or a portion of the purchase price if you do. If you have significant setoff rights, be careful to preserve those rights if you sell your claim. Likewise, if you have an administrative claim or reclamation claim (which could be paid at 100 cents on the dollar), be sure it’s clear how those valuable rights will be treated.
- Creditors’ committee. If you’re serving on the official committee of unsecured creditors in a Chapter 11 case, you should get legal advice on whether, or under what conditions, you may sell your claim. You likely will have received confidential information about the debtor while on the creditors’ committee, and this could restrict your ability to sell your claim. Generally, you will also have to resign from the committee if you sell your claim.
- Court-ordered restrictions. In some cases, bankruptcy courts may restrict creditors – especially those with very large claims — from selling their claims. This is done to preserve the tax benefits of a debtor’s net operating losses or NOLs, which can be lost if ownership of a large amount of claims or equity interests changes. As this example shows, these orders can be very complicated and you may want to consult with a bankruptcy attorney to determine whether any restrictions apply to you.
If you sell your claim, you will often be required to sign an additional document with a name such as "Evidence of Transfer of Claim," which does not mention the price paid and which will be filed with the bankruptcy court. Thereafter, you may receive a notice from the bankruptcy court that the claims buyer has filed the Evidence of Transfer of Claim document and giving you 20 days to object to the transfer. This notice is designed to prevent unscrupulous individuals from fraudulently assigning claims to themselves and is only a formality in a legitimate claims sale.
Claims buyers can provide creditors with a ready market for their claims, generating liquidity months or years before creditors otherwise would receive a distribution from the bankruptcy estate. Selling a claim is not risk free, however, so be sure to consult with a bankruptcy attorney for specific advice on how best to protect your rights if you do choose to sell.