Introduction
Although the bankruptcy claim market is formidable, its long-term sustainability will stagnate unless an ethos of transparency prevails. According to Bloomberg sources, the current market for bankruptcy claims is in excess of $263 billion, of which approximately $75 billion constitutes trade claims, and between $150 and $225 billion constitutes bank debt. Bloomberg data further suggests that hedge funds and investment banks dominate the market based on the number of notices of transfer and assignment agreements filed with the clerk of the court for any bankruptcy case.
The introduction of these players has not only created a stir within the club of bankruptcy professionals but also caught the ear of the judicial bar. This article examines the evolution of the bankruptcy claims trading market and describes how BLOOMBERG LAW information, available via the BLOOMBERG PROFESSIONALservice, can assist lawyers and financial service professionals in understanding the legal do's and don'ts of claims trading, and why the need for further transparency is so prescient.
The Impetus For Bankruptcy Claims Trading
Within the bankruptcy context, a "claim" means a right to payment or a right to an equitable remedy for breach of performance, whether or not such right or remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.
A claim most typically arises when a debtor has purchased goods and/or services from a third party that were not paid for as of the bankruptcy filing date. Claims may also arise during the pendency of a bankruptcy proceeding. These obligations are referred to as administrative expenses of the debtor.
There is no single impetus for bankruptcy claims trading. The immediate opportunity for liquidity, resource preservation, and operating losses are but a few of the more compelling reasons for an original claim holder to unload its bankruptcy claim. From the buyer's perspective, it is all about profit and/orbuilding a position within the debtor. Profit seekers, most often attracted to trade vendor claims, follow the buy low sell at a premium adage and have historically experienced internal rates of return of up to thirty (30.00%) percent. In contrast, strategic claims traders look for blocks of bond and bank debt to acquire in order to influence the reorganization process and/or receive a controlling equity stake in the reorganized debtor.
Claims Trading Procedure 101
Unlike a security, no physical trading floor or centralized platform exists for trading bankruptcy claims. Solicitation and the trade itself are conducted through massive letter writing campaigns, initiated by the claims traders, and a flurry of telephone calls between the parties until a favorable deal is struck.
Complicating the mix for all parties involved is the unavailability of an easy method to calculate a pricing index for bankruptcy claims. Although a corporate debtor's current bond price is used by many as an initial benchmark, this calibration is of little use by itself. A debtor's bond price must be adjusted, up or down, by several qualitative and quantitative factors before a fair and adequate price can be determined. Supporting documentation - including, but not limited to, purchase and/or service contracts; financing, credit, and indenture agreements; UCC statements; signed shipping documents; invoices; aged accounts payable/receivable reports; and cancelled checks - all serve to buttress a claim's value vis--vis the debtor's schedules. The classification of a claim, the debtor's solvency, intermittent case news, and the debtor's likelihood of filing a confirmable plan of reorganization are important additional factors that must be weighed to arrive at a claim's overall price.
Assuming the parties have reached an agreement on price and other terms relevant to the trade, a transfer and assignment agreement memorializing the transaction must be drafted by counsel and executed by the appropriate parties. If the claim was listed as a non-contingent, liquidated or non-disputed claim in the debtor's schedules and no proof of claim had been filed, no further action is required by the parties to the trade. However, if a proof of claim was filed, the transferee (buyer) of the claim must file, in accordance with Rule 3001(e) of the Federal Rules of Bankruptcy Procedure, a notice of transfer and assignment agreement with the court that provides the transferor (seller) of the claim with at least twenty (20) days notice to object to the transfer of its claim.
The Truth And Consequences Of Claims Trading
Claims trading can be a win-win scenario for both a buyer and seller of claims. But for the debtor, the practice has injected an interesting dynamic into what is a complex and often highly uncertain reorganization process. Thanks to claims trading, debtors are now hard pressed to identify their creditor constituency and predict this group's motivations and exit strategies. The collaborative negotiation process, once the bedrock of all corporate reorganizations, has taken a back seat to the claims traders' demand for secrecy and profit maximization. And the federal judiciary has pounded its gavel.
In Refco Inc . , the bankruptcy court ordered committee counsel to establish and maintain a website for the benefit of other unsecured creditors, which included general case filing information, access to docket filings, a calendar of significant upcoming events, an overview of the chapter 11 process, copies of significant press releases, answers to frequently asked questions and links to other relevant websites. The court's ruling was prompted in large part by the unclear language of 1102(b)(3) of the bankruptcy code, the questionable business practices of claims traders, and the traders' unfair negotiating leverage vis--vis individual creditors.
In Northwest Airlines Corporation the bankruptcy court pressed further. There, the court denied the ad hoc equity committee's motion to seal, and ordered each member to publicly file an amended Rule 2019 statement that included the name and address of each security holder, the dates on which their security and/or debt positions were acquired, and the price paid for each such position . The court's decision was fueled by the committee's purported 27 percent equity interest in the combined debtors, repeated requests to the court that management had wrongfully undervalued the equity, and intentions to contest the debtors' enterprise value at confirmation served to galvanize the court's decision.
Aware that claims traders may also hold a seat on the committee, bankruptcy courts in Interstate Bakeries Corporation et al . and Fedders North America, Inc. et al . granted motions establishing information blocking procedures and ethical trading walls to stem this group's urge to act on material inside information. Violations of these protocols can be steep and include equitable subordination, claim disallowance, loss of voting and distribution rights, and imposition of sanctions.
Perhaps the most stunning decision to address the issue of claims trading to date was that rendered by the United States District Court in the adversary proceeding captioned Springfield Associates, L.L.C. v. Enron Corp. (In re Enron Corp., et al.,) . Sitting in an appellate capacity, the district court considered whether a claim purchased in bankruptcy could be equitably subordinated and disallowed due to the alleged bad acts of the original creditor. Vacating orders previously entered by the bankruptcy court, the district court explained that equitable subordination and/or disallowance of a transferred claim depends in large part on the facts and circumstances surrounding the claim transfer. If the claim was transferred by assignment, the personal disabilities of the transferor may travel with the claim and result in equitable subordination and/or disallowance. However, if the claim was transferred by sale pre-petition and the personal disabilities are those of the transferor and not the transferee, no basis exists for equitable subordination and/or disallowance. As of the date of this article, the bankruptcy court had not issued a new decision.
Conclusion
What lessons can the professional take away from these market and legal forces affecting the bankruptcy arena? One, claims trading is here to stay. Two, the bankruptcy bar has teeth and bares them where and when appropriate to ensure that the legislative intent behind the bankruptcy process remains intact and free from abuse. And most importantly, the fight for complete transparency has regained the spotlight creating the ideal parameters for the entry of a competitive solution.
Published December 1, 2007.