On June 20, 2018, the United States Bankruptcy Court for the District of Delaware issued a decision sustaining the debtors’ objection to the proof of claim filed by Contrarian Funds, LLC. The bankruptcy court found that the relevant anti-assignment clause in certain promissory notes that were the subject of the proof of claim was enforceable under Delaware law, general tenets of contract law, and the Uniform Commercial Code (“UCC”). As a result, the assignment was of no force and effect and the assignee had no valid claim in the bankruptcy case.

Background

On December 4, 2017, the bankruptcy cases of Woodbridge Group of Companies, LLC and its affiliated debtors were filed in Delaware. Prior to the bankruptcy filing, debtor Woodbridge Mortgage Investment Fund 3A, LLC issued three promissory notes to Elissa and Joseph Berlinger in the principal amount of $25,000 each. The promissory notes contained an anti-assignment clause, which provided that the notes were not assignable without the borrower’s written consent, and that any attempted assignment without such consent shall be null and void. Moreover, the underlying loan agreement provided that the lender shall not assign any of its rights under such agreement without the prior written consent of Woodbridge, and that any such attempted assignment without consent shall be null and void.

In February of 2018, the Berlingers and Contrarian entered into an agreement by which the Berlingers would “sell, convey, transfer and assign” the promissory notes and rights thereunder to Contrarian. On March 1, 2018, Contrarian filed a proof of claim in Woodbridge’s bankruptcy case, asserting a secured claim in the amount of $75,000. On March 21, 2018, the debtors provided notice that they would impose a temporary moratorium on consideration of consent to any transfer of notes for the next 90 days. On April 16, 2018, the debtors filed an objection to Contrarian’s claim based on the anti-assignment provisions, claiming that Contrarian had no ability to assert claims under the promissory notes as the transfer of such notes was of no force or effect.

Decision

The bankruptcy court sustained the debtors’ claim objection. First, the court held that Delaware law permits anti-assignment clauses that restrict the power to transfer. The bankruptcy court distinguished between the right to assign versus the power to assign. When a provision restricts a party’s power to assign, it renders any assignment void as opposed to merely giving rise to a breach of contract claim against the assignor. However, for a contract’s clause to prohibit the power to assign and render the transfer null and void, there must be express language that any subsequent assignment will be void or invalid. Without such language, the contract merely restricts the right to assign, in which case any subsequent assignment will be valid and enforceable, but will generate a breach of contract action for the non-assigning party. Here, the bankruptcy court found that the language of the agreements clearly and unambiguously provided that any assignment of the note or rights thereunder, absent consent, was null and void.[1] Because the assignment to Contrarian was void, the bankruptcy court found that Contrarian possessed no valid right of payment under applicable non-bankruptcy law and sustained the debtors’ claim objection.

The bankruptcy court also rejected Contrarian’s argument that Woodbridge may not enforce the promissory note because of its prior breach. The court reasoned that a party may not emerge post-breach with more rights than it had pre-breach, which would have been the case if the debtors’ objection to Contrarian’s claim was overruled. And finally, the bankruptcy court rejected Contrarian’s argument that certain anti-assignment language of UCC overrides the effect of the anti-assignment provision in the promissory notes.[2] The court held that the UCC only prohibits restrictions on the assignment of a security interest in a promissory note, as opposed to assignment of rights under the promissory note itself. Moreover, the court noted, if Contrarian were correct, no promissory note could ever contain an anti-assignment clause, which clearly is not the case.

Discussion

Although the bankruptcy court sustained the debtors’ claim objection, it acknowledged that the modern and robust claims trading market allows for liquidity for noteholders on the one hand and profitability for traders on the other. Contrarian argued that neither the debtors nor the bankruptcy court should attempt to police the claims trading market; however, the bankruptcy court did not find any basis for impairing its authority to enforce applicable non-bankruptcy law concerning contract provisions that may restrict the trading of claims. Moreover, the purchasers of claims, who are generally highly sophisticated entities, are capable of performing complete due diligence on the ability of the seller to assign, prior to consummating any claim acquisition. Although Delaware courts generally construe clauses that restrict rights of assignment narrowly because of the importance of free assignability, the bankruptcy court noted that “there is a big difference between narrow construction and ‘wholesale obliteration.’”

This decision is a reminder that as part of their diligence process, claims purchasers should carefully review any applicable anti-assignment provisions and consider further protections in the form of seller representations and warranties regarding transferability of the claims in the claim transfer documentation.