Bankruptcy Claims Trading: Sellers Beware, Cole Schotz Docket

Fall 2007Attorney: Felice R. Yudkin

When a business files for bankruptcy protection, the consequences extend well beyond the troubled company itself.  For creditors, there is risk and uncertainty as to the collectability of their outstanding claims against a debtor.  Many investment firms, however, consider bankruptcy claims as valuable assets for which they are willing to pay cash to acquire.  A growing market has developed for “trading” claims against a debtor in bankruptcy whereby investment firms are willing to purchase bankruptcy claims at a portion of their face value.  While the sale of bankruptcy claims facilitates an early cash payment to creditors and eliminates the possibility of limited or no recovery, selling creditors are often asked to sign agreements with the claims trader which tend to leave as much risk as possible with the selling creditor.  Selling creditors must be aware of these provisions to protect their rights.

Most agreements to purchase claims are drafted to omit a specific date by which the claims trader must pay for the claim being acquired.  The selling creditor receiving the form agreement must ensure that the agreement provides for the buyer’s payment of the purchase price of the claim contemporaneously with the execution of the agreement.  Absent such provision, there is a risk of non-payment of the full purchase price.  Additionally, claims traders typically limit their risk by offering to purchase only those claims that are least likely to be challenged by the debtor.  As a result, the selling creditor must usually agree to defer payment on account of any disputed portion of the claim, until resolved through the bankruptcy process.  In order to protect the selling creditor, a purchase agreement must provide that the buyer is obligated to pay for the disputed portion of the claim at the same percentage rate that it paid for the initial claim. 

Claims traders tend to manage the risk of buying claims in bankruptcy by requiring selling creditors to refund, with interest, a portion of the purchase price if the claim is ultimately challenged by the debtor.  Typically, purchase agreements provide that a refund will be due, not only if the amount of the claim is reduced, but also if it is objected to or otherwise challenged, even though the objection may be resolved in favor of the claim holder.  In addition, the agreements also frequently contain standard representations and warranties about the nature of the claim, the violation of which compels the selling creditor to indemnify the buyer for losses resulting from the breach thereof, including the costs of legal fees.  Certain protections are available to selling creditors to protect them from the financial risk associated with these refund and indemnification obligations.  Selling creditors may negotiate that no refund or indemnification be due until the court issues a final order reducing the amount of the traded claim.  In the alternative, selling creditors may negotiate for the opportunity to resolve the claim objection before having to refund the purchase price. 

These are a few common examples of provisions in claims purchase agreements that may detrimentally affect a selling creditor’s rights.  Selling creditors must be aware of the “fine print” in the claim purchase agreement that shifts the risk of loss to the selling creditor.  A careful review of the purchase agreement with a knowledgeable reader can result in enhanced protections available to selling creditors.  Because many of these provisions are subject to negotiation, upon receiving an offer to purchase a claim in bankruptcy, the best practice is to immediately contact counsel who can advise you on these transactions.


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