Trade claims are unsecured obligations of the debtor. Traditional trade claims are held by the debtor’s vendors, suppliers and service providers. However, trade claims may also include claims held by other parties, such as landlords, lawyers, unions and employees, as well as claims for damages resulting from the debtor’s rejection of executory contracts.
As an alternative to waiting through the lengthy claims process with the potential for drawn-out court litigation, Creditors can opt to monetize their claim in return for immediate cash. Thus, “Claims Trading” describes the financial and legal transaction whereby a Creditor sells and transfers their ownership in the Claim to another entity, to receive immediate monetary payment from the Buyer of their claim.
The determination of whether the claims-and-recoveries function should be performed by public, private, or hybrid organisation(s) is country-specific.
Benefits of Claims Trading and Recovery
The primary motivation for a Creditor to trade their bankruptcy claim is to obtain immediate cash liquidity on an otherwise uncollectible account. The time savings and proceeds obtained from trading a claim allow the Creditor to immediately reinvest back into their company and refocus on growth.
The following is a list of 4 additional benefits for Creditors that can come from bankruptcy claims trading:
Elimination of recovery risk: Unsecured creditors are the lowest priority creditors and fall last in line to receive payouts from the bankruptcy estate. In many bankruptcy cases, the recovered amount is low or even non-existent for unsecured claims—especially after administrative expenses are accounted for, and the higher-ranking secured creditors and priority claims are paid in full. Choosing to sell a bankruptcy claim to an interested buyer for immediate cash allows you to secure a definitive recovery and avoid the risk of an uncertain outcome awaiting after the bankruptcy case.
Elimination of consideration risks: For Debtors that cannot meet the debt obligations of all their Creditors in cash payments, it is not uncommon for Debtors to structure payouts in the form of promissory notes, stock equity in the reorganized Debtor, interests in creditor trusts, or a combination thereof. For these other forms of payment consideration that are issued, it can be difficult, time-consuming and expensive to liquidate them into cash. Selling a bankruptcy claim eliminates the risk of receiving illiquid distribution or securities by receiving cash instead.
Reduction of time and money spent: A Creditor can minimize time, money and valuable resources that are utilized to participate in the bankruptcy proceedings by selling their bankruptcy claim instead.
Benefit from tax savings: Creditors can often earn a tax benefit when they sell their bankruptcy claim, especially if it is sold for an amount that is less than the original claim value. This is done by applying the loss on the uncollected portion of their receivable against their current income in their tax filings. Although tax deductions for a loss can be a possibility for Creditors who receive claim payouts from the Debtor, these Creditors who remain in the case instead of selling their claim don’t get to reap the tax benefits right away. Immediate tax savings are an additional advantage for Creditors when it comes to selling a bankruptcy claim.
How Does the Claims Trading and Recovery Process Work?
What can a Creditor expect when trading a bankruptcy claim? Claims trading is both a legally and financially complex transaction. Therefore the process can differ from trade to trade.
Bankruptcy claims can be traded at all stages of the Chapter 11 case and may begin as soon as the bankruptcy petition is filed. Claims trading can continue until final distributions are made, and even after confirmation of the Plan of Reorganization.
Claims that are successfully traded, typically follow these basic procedural steps:
1. Filing a Proof of Claim: Once the Debtor has filed their petition with the court, the Creditors will receive a Notice of Bankruptcy. The Debtor will then submit their Schedules of Assets and Liabilities which will include details about each Creditors’ bankruptcy claim. If the Creditor objects to how its claim is represented in the Schedules or wants to assert their right to repayment, the Creditor files a Proof of Claim against their Debtor.
2. Listing of Bankruptcy Claim for Sale: The Creditor separately lists their Claim for sale by looking for prospective Buyers (or receives an unsolicited offer directly from a Buyer, or indirectly via a broker to purchase their Claim).
3. Buyer contacts the Creditor: The Buyer contacts the Creditor soliciting interest in selling their Claim.
4. Providing additional documentation: Upon receiving an offer that sparks interest, the Creditor then is asked to provide additional supporting documentation to supplement their original Claim. This includes the same documentation that would be included with the Proof of Claim, such as promissory notes, purchase orders, contracts, outstanding invoices, delivery receipts or security agreements. Other pertinent documentation might include monthly statements, pay records and ledgers.
5. Buyer performs their due diligence: Once the Creditor has shown interest in selling their bankruptcy claim to the inquiring buyer and provides the supporting documentation, the buyer will perform their due diligence into the claim and the Debtor’s bankruptcy case. Bankruptcy claim traders will typically confirm whether there is any pending litigation between the debtor and the creditor and determine whether the creditor is readily identifiable as a target of avoidance of litigation. For example, a buyer would review the debtor’s statement of financial affairs, which lists all entities that received payments during the 90 days before filing for bankruptcy.
Furthermore, a buyer will also obtain a preference risk representation and other representations from the Creditor to ensure that they have not been involved in any misconduct that would lead to disallowance or subordination of their bankruptcy claim.
6. Buyer makes an offer: The Buyer will then make an official purchase offer to the Creditor. Prices for bankruptcy claims can vary depending on the bankruptcy proceedings and certain events that are transpiring within the case.
7. Creditor accepts the Purchase Offer: After reviewing the offer and consulting with legal and financial advisors or representation, the Creditor formally accepts the purchase offer.
8. Trade confirmation: The Buyer prepares and sends the Creditor a trade confirmation to formally record the trade terms and purchase price. The trade confirmation will contain a formal written record of the material terms of the agreed-upon sale.
9. Assignment of Claim Agreement: Once the Buyer and Creditor agree to the terms that are outlined in the trade confirmation, they both sign a contractual agreement, known as the “assignment of claim” agreement. This agreement will contain standard provisions that are dependent on the following: the size and nature of the claim; the relationship between the buyer and seller, and the price being paid for the claim. Creditors then review this agreement thoroughly to ensure that it does not include any non-negotiable or objectionable terms that would prevent the transaction from closing.
10. Creditor files a Claim Transfer: The Creditor files a claim transfer (“assignment of claim”) with the court, to officially transfer ownership of the claim to the new Buyer.
11. Buyer sends payment: The Buyer then sends payment to the Creditor. This step can also take place before the Creditor files a claim transfer with the court.
12. Buyer becomes the new “Creditor”: In the court register, the Buyer is now listed as the owner of the claim against the Debtor in the pending bankruptcy case. The Buyer is now effectively the new “Creditor”. The former Creditor is no longer involved with this claim in the bankruptcy case, except under specific extenuating circumstances agreed upon with the Buyer.
Oluwafemi Faniyi is an associate in the Conflict Management and Dispute Resolution Practice Group. Olufe Popoola is an associate in the Conflict Management and Dispute Resolution Practice Group