When a business files for bankruptcy, it can be a confusing and frustrating time for the debtor’s creditors. If an investment firm reaches out with an offer to purchase a creditor’s claim against the debtor, it may appear to be a great opportunity to be paid at least some cash now. The sale of a bankruptcy claim may also be attractive because it allows the creditor to avoid the time and expense involved in protecting its rights in the bankruptcy case. While the sale of a claim may be the right decision for a creditor, before it jumps at the first opportunity presented, there are several simple steps that should be taken to ensure that it maximizes the amount received for the sale of its claim.

(1) Evaluate the claim

The first step a creditor should take after being approached by a bankruptcy claims trader is to evaluate what type of claim it has against the debtor. This is important because different types of bankruptcy claims can be treated vastly different from one another under the Bankruptcy Code. For instance, a secured claim is treated much more favorably with respect to repayment under the Bankruptcy Code than a general unsecured claim. First, a secured creditor may be able to enforce its rights against its collateral or seek payments from the debtor prior to the entry of an order confirming a plan. Also, a chapter 11 plan must provide for a secured creditor to retain its lien on its collateral and for the debtor to make cash payments over time to the creditor that are at least as much as the value of the creditor’s interest in its collateral, or in other words, payments of at least the lesser of (a) the total amount of the secured debt, or (b) the value of the collateral.

Several categories of unsecured bankruptcy claims are also given priority in repayment over other unsecured claims. A few examples of claims that are provided priority in repayment include: (a) claims based on goods received by the debtor within 20 days before the filing of the bankruptcy case; (b) domestic support obligations; and (c) wages, salaries and commissions earned within 180 days before the filing of the bankruptcy case. In a chapter 11 case, all of these claims must be paid in full in order to confirm a plan.

Due to the different repayment requirements under the Bankruptcy Code, administrative claims or priority unsecured claims are much more valuable than general unsecured claims. Therefore, if a creditor can determine that it has an administrative claim or priority unsecured claim, it should communicate this to the bankruptcy claims trader, who may be unaware of this fact. A creditor that knows it has an administrative claim or priority claim is in a better negotiating position to demand a premium for the sale of its claim compared to general unsecured creditors.

(2) Evaluate the bankruptcy case

A creditor should learn as much as possible about the status of the bankruptcy case before it begins any negotiations with the bankruptcy claims trader. The more information a creditor has about a bankruptcy case, the better position it will be in to evaluate what exactly is being given up in the sale. While examining every word of every piece of paper received in a bankruptcy case may seem overwhelming, there are a few key documents that a creditor can focus on that will provide important information regarding what a creditor may receive if the creditor retains its claim in the bankruptcy case. First and foremost, a creditor should review the “Disclosure Statement” and “Plan” documents, if it has received them. These documents will specifically provide the terms of repayment of a creditor’s claim. In particular, within the Disclosure Statement, a creditor should review carefully (a) the description of the payments for the class that contains its claim and (b) what is often referred to as the “Best Interest of Creditors Analysis” or “Liquidation Analysis,” which may be located either within the Disclosure Statement or as an exhibit to the Disclosure Statement. One or both of these sections should provide the estimated percentage of recovery that a creditor should receive if it keeps its claim. Also, within the Plan, a creditor should review the treatment of the class that contains its claim, which will detail exactly how the claim will be repaid. Also, if a creditor has received any documents regarding the sale of substantially all of the debtor’s assets, this may or may not also contain information regarding the estimated distribution to creditors in the case.

Alternatively, if a creditor has a good relationship with the debtor, it may want to briefly discuss the status of the case with the debtor’s attorney, or if one has been appointed, the creditors’ committee’s attorney. From just a quick phone call, a creditor may learn that all creditors are expected to be paid in full quickly from the sale of assets or, on the other hand, that the case may continue for a significant period of time and the terms of repayment to creditors is still uncertain.

If a creditor can determine that its claim will receive a large estimated recovery in the bankruptcy case, it should share this information with the bankruptcy claims trader as it negotiates the sale price. If the claims trader understands that a creditor knows that it should receive a large recovery in the bankruptcy case, it may be willing to offer that creditor a higher price for its claim than if the claims trader thinks it’s negotiating against someone that does not have that information.

(3) Read the sale documents carefully

A creditor should very carefully read the sale documents it receives from a bankruptcy claims trader. Since “[o]ther than a few notice requirements, claims trading in bankruptcy is virtually unregulated,” Norton Journal of Bankruptcy Law and Practice, 18 J. Bankr. L. & Prac. 1, Art. 1 (Jan. 2009), there is really no such thing as “standard language.” A creditor should enter into negotiations with the claims trader with the mindset that everything within the sale documents is negotiable. A creditor should read each provision closely because some of the “fine print” can be just as important as the sale price. For instance, sale documents may require the seller to refund the sale price if an objection is filed against the claim. It may be possible to negotiate that the sale price only needs to be refunded if the objection is sustained by the court. Similarly, a creditor should be careful to look for any provisions that require it to pay interest with the refunded sale price, if the sale price needs to be returned. Obviously, a creditor should negotiate for the lowest interest rate possible. Also, sale documents may fail to include the specific date by which the purchaser must pay for the claim. A deadline for the bankruptcy claims trader to pay for the claim should always be negotiated into the sale agreement. These are just a few examples of the types of provisions that may significantly change the true value of a purchase offer.

(4) Solicit offers from other bankruptcy claims traders

A creditor should solicit offers from as many bankruptcy claims traders as possible. The bankruptcy claims trading market is very large with numerous claims purchasers. See Prof. Adam J. Levitin, Bankruptcy Markets: Making Sense of Claims Trading, 68 Brook J. Corp. Fin. & Com. L. 67, 77 (2010) (stating that “academic articles place the [claims trading] market at hundreds of billions” of dollars, but that there is no real data on the exact size of the market) (citations omitted). Therefore, finding other interested claims traders should not be difficult. In fact, a quick internet search will disclose numerous bankruptcy claims trading websites where a creditor can fill out a simple online form to receive an offer for the purchase of its claim. Reaching out to several different claims traders may start a bidding war that can significantly increase the ultimately accepted sale price.

(5) Contact an attorney

It may make good business sense for a creditor to hire an attorney to represent it with respect to the sale of its bankruptcy claim. A creditor may want to consider hiring an attorney if it finds it difficult trying to (a) determine the type of claim it has, (b) understand the papers filed in the bankruptcy case, or (c) understand the language in the proposed sale documents. Also, even if a creditor has a strong grasp of the relevant information, it may still be advisable to have an attorney, who is an experienced negotiator, advocate on its behalf. If a creditor has a significant claim, paying an attorney to review the necessary documents and negotiate the highest purchase price possible may pay off several times over in the increased sale price the creditor ultimately receives compared to what the creditor would be able to negotiate on its own.

Conclusion

The sale of a bankruptcy claim may seem like a great opportunity to receive quick cash and avoid the headaches involved in an often long, drawn out bankruptcy process. However, creditors should still take certain steps such as considering the type of claim they possess, reviewing bankruptcy pleadings they’ve received or discussing the case with an attorney involved in the case, reviewing the sale documents closely, seeking out other purchase offers and obtaining counsel to represent them, before accepting the first purchase offer they receive. Taking these steps will help a creditor maximize the price received for its claim.