Sell Your Bankruptcy Claim for Cash in 4 Steps

The size and complexity of the marketplace for buying bankruptcy claims has changed dramatically. Once dominated by individual trade creditors hoping to receive some value for their uncollected debt in Chapter 11 bankruptcies, buying and selling unsecured bankruptcy claims has become big business. Hedge funds and investments banks have an appetite for non-correlated risk associated with the legal process of bankruptcy as opposed to the earnings and interest-rate driven stock market. The bankruptcy claim trading process offers several benefits to creditors as well.

Now, just about any unsecured trade creditor may be approached to trade claims in bankruptcy (by sale or transfer) with a bankruptcy claim buyer. When a creditor holds a claim against a bankrupt estate, they are effectively speculating on the outcome of the case.  Moreover, buying a bankruptcy claim is a conscious decision to participate in the bankruptcy process.  During the pendency of a bankruptcy case, creditors may be called on to (a) file a formal claim or motion with the court, (b) vote on a plan of reorganization, (c) defend a claim objection or (d) defend an avoidance or preference action seeking to claw money back from the creditor.  Failure to act in any of these circumstances could have disastrous effects for the creditor.  However, acting on them can be extremely expensive because it is almost always done through the retention of a creditor’s own competent bankruptcy counsel.

Who’s Selling, Who’s Buying Bankruptcy Claims

Buyers purchase bankruptcy claims:

1. To speculate on the outcome of the case (a very common reason)
2. To obtain control over the reorganized debtor
3. To block any Chapter 11 plan they oppose

In most cases, these buyers of bankruptcies are professional claims traders, who may either hold the claim or resell it to another buyer of bankruptcy claims . Trade claims in bankruptcy can be sourced directly or through a broker. These purchases can be made with the strategic objective of controlling the direction of the Chapter 11 case by owning a substantial percentage of one or more classes of creditors. (Buying more than one-half the number of bankruptcy claims, or one-third the dollar amount, provides the purchaser substantial control of a customer’s plan of reorganization.)

The seller’s motivation is:

1. To realize an immediate cash payment which can be very favorable from a tax standpoint
2. To avoid at least three kinds of risk that buying your bankruptcy claim for cash eliminates
3. To eliminate their risk of receiving illiquid stock or notes (potentially paid over the course of years) instead of cash

A seller can be any trade creditor with an unsecured bankruptcy claim. Members of Official Committees have special rights and obligations. In almost all cases a seller of a bankruptcy claim who is a member of an Official Committee resigns after selling their claim. The reason is plain: they are no longer a creditor in the bankruptcy case and have no economic stake in the outcome.

What is Being Bought and Sold

Obviously, not all unsecured bankruptcy claims are equal. The characteristics of the claim determine its level of attractiveness to a buyer of such bankruptcy claims. Buying a bankruptcy claim is more likely with the following characteristics, which command the highest prices in the market:

• Relatively large
• Undisputed in the customer’s schedule of liabilities filed with the bankruptcy court. (Sometimes a buyer may offer to buy the undisputed portion of a claim, with a further option to purchase the balance should it be recognized as valid at a later date)
• Recognized as valid by the Bankruptcy Court (stipulated by special order)
• 503(b)(9) claims, which enjoy priority of payment over other unsecured claims

How Buying Bankruptcy Claims Works

Generally, buying and selling bankruptcy claims is freely allowed in Chapter 11 bankruptcies and can be of benefit to both the creditor and the trade claims buyer.

The following steps outline the typical process involved in selling bankruptcy claims. However, if the trade creditor sells its bankruptcy claim before the customer files Chapter 11, the sale is governed by state contract law.

Note that the mechanics of buying bankruptcy claims are not set out in the bankruptcy law and the Bankruptcy Court is not involved in negotiating or approving the purchase price. The notice requirement of the bankruptcy Code is outlined in Section 3001.

Step 1: The Offer

The bankruptcy trade claims process usually begins with a buyer offering, in written or verbal form, to purchase a creditor’s bankruptcy claim. Sometimes sellers approach buyers with a bid request to buy their bankruptcy claim. Offers are expressed as a percentage of the claim amount. While there have been offers in certain bankruptcies for as high as 90% to 100+% of the claim, these are very rare. Typically, an offer of much less is made. The higher the likelihood of a good payout for the bankruptcy claim, the higher the offer may be.

Step 2: Confirmation

Often after a price is agreed upon, the bankruptcy trade claims process can move to either a trade confirmation or directly to an Assignment of Claim Agreement. A Trade Confirm outlines the key terms of the offer but is not an actual full contract. The Trade Confirm is similar to a letter of intent and generally states that the sale of the bankruptcy claim is subject to a mutually acceptable Assignment of Claim Agreement, which is the document that conveys title.

The Trade Confirm is generally a one-page term sheet that contains a bullet point list of the salient terms of the trade such as:

• Description of the bankruptcy claim which is being purchased (amount, priority level)
• Purchase price
• Other customary terms

Step 3: Assignment of Claim Agreement

This document is the full contract which will bind the parties. Key terms include:

• Description of the bankruptcy claim which is being purchased (amount, priority level)
• Purchase price
• Representations and Warranties
• Venue
• Notice requirements

Notably, the Assignment of Claim Agreement is not required to be filed with the Court, except under rare circumstances.  The trade claim buyer and trade vendor seller can be confident about the privacy of their transaction.

Step 4: Evidence of Transfer of Claim

This is the form required by Bankruptcy Code Section 3001 as a means to notify other parties of the claim transfer. .  The Evidence of Transfer only includes information important for the administration of the claim such as: buyer and seller’s name and address and description of the claim being transferred.  As described above, the key terms of the sale including the purchase price are confidential and not disclosed in this document.

FAQs

Having explored the dynamic landscape of bankruptcy claims trading and the entities typically involved, it’s clear that this market offers substantial benefits for sellers seeking immediate liquidity. Questions may arise about the finer details of these transactions or specific situations that could occur during the trading process. In the following section, frequently asked questions are addressed to further enhance understanding and prepare participants for successful involvement in bankruptcy claims trading.

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:

1. 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.
2. 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.
3. 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:

1. 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.
2. 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.

Conclusion

The buying and selling of bankruptcy claims is specifically provided for in the US Bankruptcy Code.  The practice has been ongoing for decades because it is an efficient way for trade vendors to get immediate liquidity on their bankruptcy invoices.  There can be many benefits for each party in a bankruptcy claim trade.  It is important to understand that the Assignment of Claim Agreement is a legally binding contract and it should be read carefully and treated as such.