In the previous article, Introduction to Bankruptcy Claims Trading, we looked at different aspects of claims trading. We focused on characteristics, motivations, structuring, and risks carried by sellers and purchasers. Now we take a look at documenting the purchase and sale of a bankruptcy claim.
Often, the first step in formally documenting a transfer of claims is negotiating a trade confirmation. Trade confirmations can be short, term-sheet style documents. Some are lengthy documents that include agreed-upon deal terms. To be binding under New York state law, a trade confirmation must incorporate price, quantity, and special conditions. New York state is the default governing law for most large claims trade transactions because of its large community of financial institutions and its experienced bankruptcy judges.
However, under New York law, a trade confirmation need not be in writing to be enforceable. As a “qualified financial contract,” it is exempt from New York’s statute of frauds, provided there is enough evidence to show a meeting of the minds.
A trade confirmation for the purchase and sale of claims should identify the specific claims being transferred — by claim number if available. It should recite any additional information the purchaser will require as a part of its due diligence evaluation or its analysis of the seller’s creditworthiness. Depending on the type of claim, this usually includes the claim “backup” (e.g., contracts, purchase orders, proofs of delivery, invoices) as well as the proof of claim, if one has been filed. It may also include any other correspondence with the court, the debtors, and/or their advisors.
Finally, a trade confirmation should state contingencies or conditions to closing or funding. This must go beyond noting that the transaction is subject to “mutually agreeable” definitive documentation. For example, does the claim need to be allowed before the buyer will fund? Will a portion of the purchase price be subject to holdback or escrow? Are third-party approvals required before closing? The parties should be in clear agreement about such conditions before proceeding to definitive documentation.
When the parties agree on the essential elements of the transaction and the purchaser’s review of due diligence is acceptable, the parties negotiate a purchase and sale agreement. There is no standard form for claims in the US (in contrast to the assignments of syndicated loans, which are often settled using Loan Syndications and Trading Association form documentation). However, there are certain market standard terms and conditions common to most claims trading transactions.
A purchase and sale agreement begins by defining the claim being transferred. While this may sound straightforward, it is important to be precise about what is being conveyed. For example, a seller may intend to sell only the claims stated on a filed proof of claim, reserving other rights it may have against the debtor. At the same time, a purchaser may try to capture any rights the creditor has against the debtor and other guarantors or obligors. In large or complex cases, it may be necessary to identify the debtor and specify whether the claim is eligible for special status or treatment like administrative priority status.
A buyer must also know clearly what is not being acquired. A prudent purchaser should insist that the agreement make clear seller obligations and liabilities that remain the responsibility of the seller. For example, the buyer will not assume preference liabilities that remain the responsibility of the seller.
Next, the agreement will specify the consideration and describe any closing deliverables, conditions, or other triggers for settlement. As noted above, the claim may need to be stipulated or allowed before the buyer will fund, so a portion of the purchase price may be held back or escrowed. Third parties, such as liquidators or receivers, may need to approve the transfer before the transaction can settle. Finally, the document should define covenants to be fulfilled during any gaps between signing the agreement and closing the sale.
Representations and warranties usually make up a large portion of any purchase and sale agreement including claim purchase and sale agreements. It is helpful to think of representations and warranties sorted into 3 buckets:
For the first bucket, typical seller and purchaser representations in claims transactions include power and authority, due authorization, and non-contravention. The seller represents that it has title to the claims and other rights being conveyed. The seller demonstrates that all such “transferred rights” are free and clear of liens or other encumbrances, and that it has not sold or otherwise conveyed any of the transferred rights to any other party.
In the second bucket, there are many “market standard” representations and warranties that are typical for sellers to make in claims purchase and sale documentation. Some speak to the seller’s own conduct or status, such as the following:
Note that the last representation above, the so-called “no bad acts” representation, is often heavily negotiated, as a savvy purchaser could attempt to use it as a back door means to recourse even in “non-recourse” trades. Buyers also may attempt to add a forward looking element to this representation, while sellers may try to strike altogether, or at a minimum add in materiality or knowledge carve-outs.
Other typical seller representations speak to the claim itself and not necessarily any status or conduct on the part of the seller. For example, purchasers often request sellers to represent that the claims are not subject to any objections, disallowance or impairment whatsoever, and that no litigation or other adversarial proceedings are pending or threatened in respect thereof. Again, depending on the original agreed terms of trade between the parties, the seller may push back on such comprehensive representations.
The mere existence (and if applicable, strength) of the aforementioned “no bad acts” and “no impairment” representations referenced above will be likely determined by the level of recourse agreed to at the time of trade. On one end of the recourse spectrum, if the parties agree to a “full recourse” trade, there would likely be robust “no bad acts” and “no impairment” representations providing protections to the purchaser, along with a provision requiring the buyer to immediately refund the seller its purchase price plus interest in the event of any claim impairment.
On the other end, an “as is, where is” trade would likely not include such representations or any right to refund in the event of a claim impairment. In the middle, a typical “limited recourse” trade would likely include negotiated representations and may also include a right to refund—but only in the event of a final order that fixes the claim amount below the amount represented by the seller.
Finally, the third bucket of representations and warranties contains statements unique to specific industries, cases, debtors, claims, or counterparties. The statements are tied to items of due diligence or developments in the underlying bankruptcy proceedings.
Indemnification is hotly negotiated in bankruptcy claims trading agreements. Under New York law, a prevailing litigant is not automatically entitled to recover attorney’s fees. Purchasers often seek to include an indemnity provision which permits reimbursement for losses and expenses — including attorneys’ fees — resulting from or related to claim impairment or breach of representation by the seller. Additionally, purchasers attempt to add an express indemnity in the event of attempted claw back of payments or distributions by the estate or a third party, perhaps a liquidator or receiver.
Generally speaking, sophisticated entities enter into bankruptcy claims trading transactions. It is customary for each party to give a “big boy” style representation. For example, each party states for the record that it had adequate information and did not rely on the other party in any way except for express representations made in the agreement.
Although the issue has yet to be fully determined by the courts, most market participants and their advisors take the position that bankruptcy claims are not “securities” subject to federal securities laws. Accordingly, it is typical to see so-called “MNPI” language in claim purchase agreements. That is, each party waives the right to assert a claim against the other party for failure to disclose material, non-public information regarding the claims, the debtors, or the underlying bankruptcy case.
Following the lengthy and often contentious discussions on representations, warranties and indemnification, the final third of most claim purchase and sale agreements is typically less heavily negotiated. Nevertheless, there are several important areas that merit further discussion.
Most agreements contain a section of post-closing covenants and further assurances. While these are generally broad and require the parties to ordinarily act in a commercially reasonable manner going forward, in certain circumstances parties may need to be specific as to what can (or cannot) be done in the future. Typically included here is language obligating the seller to pass along any claim distributions or notices/information on account of the claims it may receive after the closing date to the buyer, and also to vote or otherwise take direction with respect to the claims solely in accordance with the buyer’s instructions. If the underlying claim is not yet allowed, the agreement may include provisions regarding who is responsible (and, more importantly, who bears the cost) of any defense of the claim. Note, most purchasers will look for the seller to bear this cost.
In many agreements there is a provision which states that the purchaser is entitled to the entire “purchased claim” even if such claim ends up being allowed in an amount higher than as originally filed by the seller. A savvy seller could push back here and seek a “true up” payment from the purchaser for any such “excess” claim allowance. Also, most agreements recite that a claims purchaser is free to subsequently sell or otherwise transfer the claims without notice to or consent from the seller. Again, a seller may look to limit such freedoms on the part of the purchaser—and may seek to permit such further transfers only upon seller’s written consent.
Subject to FRBP 3001(e) as discussed further below, it is market for most claim purchase and sale agreements to contain strict confidentiality provisions.
While parties are free to choose the governing law of their contract, most claims purchase and sale agreements are governed by New York law, with consent to jurisdiction in the federal district court located in Manhattan. Finally, in most circumstances parties agree to waive their rights to a jury trial in the event of any dispute regarding the contract.
Once the agreement is final, the parties exchange a funding memo and file a transfer notice with the bankruptcy court pursuant to FRBP 3001(e) under the Bankruptcy Code. The court requires basic information, including names and addresses of the parties along with the amount and claim number of the claim assigned. Parties need not publicly disclose the purchase price. FRBP 2019 does, however, require certain disclosures about the economic interests of creditors in bankruptcy cases.
Depending on the type of claim, underlying jurisdiction of the case, or complexity of the transaction, there may be supplementary documentation that the parties still need to execute and exchange. These include escrow agreements, powers of attorney, or proxy forms.
[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each includes a comprehensive customer PowerPoint about the topic):
This is an updated version of an article originally published on June 12, 2017, and previously updated December 9, 2020. It was recently edited by Nora Willi]
©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
Timothy C. Bennett joined Fulcrum in 2017 after nearly fourteen years of law firm experience. Most recently, he was senior counsel with Seyfarth Shaw and the leader of that firm’s Global Distressed, Illiquid and Special Situations Trading practice. Prior to that role, he was an associate in the New York office of the global law…
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