In our previous article, Introduction to Bankruptcy Claims Trading, we discussed the claims trading marketplace, focusing on its characteristics, the motivations for its participants, some basics of documentation, key business and legal structuring considerations, as well as risks borne by sellers and purchasers in these types of transactions. In this article, we will take a closer look at the process of, and considerations for, documenting the purchase and sale of a bankruptcy claim.
Often the first step in formally documenting a transfer of claims is to negotiate a trade confirmation. Trade confirmations can be very short, term-sheet style documents, or may be lengthy with many deal terms already agreed and incorporated. Regardless of format, in order to be binding under New York law, a trade confirmation must incorporate the essential elements of the trade, such as price, quantity and any special conditions precedent to closing.
However, under New York law, it is not necessary for a trade confirmation for the sale to be executed (or even in writing) in order for it to be enforceable. As a “qualified financial contract”, it is eligible for an exemption from New York’s statute of frauds, provided there is sufficient evidence to indicate that a contract otherwise has been made. (New York is generally regarded as the default governing law for most large claims trade transactions, due to the presence of many financial institutions and the experience of its bankruptcy judges.)
A trade confirmation for the purchase and sale of claims should identify the specific claim or claims being transferred (i.e., by claim number if available). It should recite any additional information that the purchaser will require as a part of its due diligence evaluation of the transaction 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 any contingencies or conditions to closing or funding—beyond simply 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 any third-party approvals required before the transaction can be closed? The parties should be in clear agreement with respect to such conditions before proceeding to definitive documentation.
Assuming the parties agree on the essential elements of the transaction, and the purchaser’s review of due diligence is found to be acceptable, the parties will negotiate a purchase and sale agreement. While there is no standard form purchase and sale agreement for claims in the U.S. (in contrast to the assignments of syndicated loans, which are often settled using Loan Syndications and Trading Association form documentation), there are certain market standard terms and conditions which are common in most claims trading transactions.
Typically, a purchase and sale agreement for a claims transaction begins by defining the claim being transferred. While this may sound straightforward, it is important to be precise as to what is being conveyed. For example, a seller may intend to sell only the claims stated on a filed proof of claim and reserve all other rights it may have against the debtor for itself, while a purchaser may try to capture any and all rights that the creditor may have against not only the debtor but any other guarantors or obligors. Additionally, in large or complex cases, it may be necessary to identify the particular debtor against whom the claim has been asserted, as well as whether the claim is eligible for any special status or treatment (such as administrative priority status).
From a buyer’s perspective, it is also important to make clear what is not being acquired. A prudent purchaser should insist that the agreement clearly states any obligations or liabilities of the seller (e.g., with respect to preference liabilities) are not being assumed by the purchaser and remain the responsibility of the seller.
Next, the agreement will recite (or make reference to) 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 and, accordingly, a portion of the purchase price may be subject to holdback or escrow. Further, third parties such as liquidators or receivers may need to approve the transfer before the transaction can settle. Additionally, if there is a gap between the signing of the agreement and the actual closing, any covenants that need to be fulfilled during such a time period should be clearly stated.
Representations and warranties usually make up a large portion of any purchase and sale agreement, and the same is true for claim purchase and sale agreements as well. It is helpful to view representations and warranties in three distinct “buckets:” those that are common in any contract; those that are for the purchase and sale of claims generally; and those that are unique or specific to a particular case, claim, or counterparty.
For the first bucket, as with any contract, typical seller and purchaser representations in claims transactions include power and authority, due authorization and non-contravention. The seller typically represents that it has title to the claims and other rights being conveyed, that all such “transferred rights” are free and clear of any 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 specific statements unique to a particular industry, case, debtor, claim or counterparty. Often, they are directly tied to concerns with items of due diligence or developments in the underlying bankruptcy proceedings.
Another hotly negotiated provision in claim purchase and sale agreements is indemnification. Under New York law, a prevailing litigant is not automatically entitled to recover attorney’s fees, so purchasers often seek to include an indemnity provision, which permits reimbursement for losses and expenses—including attorneys’ fees—that result from, or are related to, a breach of a representation by the seller and/or any claim impairment. Purchasers also often attempt to add in an express indemnity in the event of any attempted clawback of payments or distributions by the estate or a third party, such as a liquidator or receiver.
Finally, claim purchase and sale transactions are typically entered into by and between sophisticated entities. Accordingly, it is customary for “big boy” style representations to be given by each party. For example, each party typically recites for the record that it had adequate information and did not rely on the other party in any way (except for the express representations made in the agreement) when entering into the transaction.
Further, although the issue has never been fully and finally determined by the courts, most market participants (and their advisors) take the position that bankruptcy claims are not “securities” and thus are not subject to the federal securities laws. Accordingly, it is typical to see so-called “MNPI” language in claim purchase agreements (i.e., each party waiving the right to assert a claim against the other party for the failure to disclose any 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 typically exchange a funding memo and file a transfer notice with the bankruptcy court pursuant to FRBP 3001(e) under the Bankruptcy Code. Only very basic information needs to be filed with the court (the name and address of the parties, and the amount and claim number (if available yet) of the claim assigned). The purchase price does not need to be disclosed publicly. It is important to note that FRBP 2019 does, however, require certain disclosures about the economic interests of creditors in bankruptcy cases.
Finally, as with any deal and depending on the type of claim, underlying jurisdiction of the case or complexity of the transaction, there may be ancillary documentation to be executed and exchanged (e.g., escrow agreements, powers of attorney or proxy forms).
©All Rights Reserved. December, 2020. DailyDACTM, LLC
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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