As our loyal readers know, the Weil Bankruptcy Blog is running a series of posts discussing the various interesting topics covered in the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 Final Report and Recommendations. In this installment, we cover the Commission’s review of rules relating to claims trading – discussed in section VI.D. of the Report.
Claims trading is a hot topic. The claims trading industry has been growing exponentially in recent years. Indeed, the Report notes that in 2012, amid a slowdown in large corporate chapter 11 cases, distressed investors still bought and sold more than $41 billion in bankruptcy claims. With an inevitable change in the economic cycle on the horizon (and perhaps even closer for the currently-troubled oil and gas industry), any changes to rules governing claims trading will be of interest for a large – and growing – audience.
So what did the Commission recommend on this important topic? Well, nothing. The Commission, which focused primarily on disclosure, did not suggest any material changes to the claims trading disclosure requirements. As discussed below, this recommendation of no change is significant.
The Commission pointed to two relevant rules relating to claims trading and disclosure:Bankruptcy Rules 3001(e) and 2019. The Commission observed that these rules serve somewhat cross purposes. Rule 3001(e) governs the mechanics of filing and preserving transferred claims. It was designed to limit the court’s role in adjudicating claim transfer disputes and, incidentally, limits the information disclosed when claims were transferred. Indeed, a predecessor rule required a transferor to divulge the consideration received for their claim, which, from the perspective of a trader, would be highly sensitive information for various reasons and may serve to chill trading in claims. Rule 2019, on the other hand, mandates certain disclosures be made in bankruptcy cases by holders acting in a coordinated group or through an ad hoc committee, which frequently, but not always, include claims purchasers. Recent amendments to Rule 2019 increased the disclosure required.
The Commission considered the arguments on both sides of the question of whether claims trading is overall a good or bad thing. Critics took the view that claims trading destabilizes reorganization efforts, depresses the value of a debtor’s estate, and provides arbitrage and takeover opportunities for investors at the expense of other creditors. Proponents pointed out that claims trading creates liquidity and can provide reluctant creditors a way to exit the case, encourages the consolidation of claims against the debtor in a way that facilitates negotiations and a consensual plan, and increases access to DIP and exit financing by encouraging well-capitalized investors to participate in the restructuring process.
Although the Report notes that the Commissioners were of varying views on this issue, the Commission agreed that the robust secondary market for claims trading enhances liquidity opportunities for debtors and creditors, and thus “perceived little benefit to increased regulation of claims-trading activities” in general.
For example, the Commissioners considered whether it would be favorable to require claim purchasers to disclose the price they paid for claims. Noting the common view on the Commission that the price paid for a claim is irrelevant to its substantive and economic merits, and the ability for the court to sanction inappropriate conduct through equitable subordination and vote designation, the Commission came out in favor of the status quo—recommending no changes to claim trading disclosure requirements.
We learn from this that it’s not just the areas where the Commission recommended changes that are important; it’s also important to note where the Commission recommended no change. Those who invest in distressed debt (aka “claims traders”) often fear attack from the “haters” (my word) who may be resentful of their creative, and often aggressive, tactics. The Commission’s conclusions not to recommend increased regulation or disclosure will undoubtedly influence any future debate on these issues and any further attempt to amend the Bankruptcy Code or Bankruptcy Rules to address them. Thus, distressed debt investors can count this one as a win in their column.
That being said, the Commission did recommend a strident change in the law of vote designation (to be explored on a later post), which in effect would allow a court to designate votes that are exercised “in a manner manifestly adverse to the economic interests of the other creditors in the class.” This, and many other changes, should be on the mind of claims traders, equity sponsors, and other investors with activist strategies. It also serves as a reminder that understanding the implications of the Commission’s proposed changes on claims trading requires looking beyond the particular sections in which it is specifically addressed. Thus, those who want to have a voice in the debate over the future of claims trading in chapter 11 (or at least know where the debate is going) should be on the lookout for other posts in this series.