Bankruptcy Claims Trading
Claims trading plays a huge role in bankruptcies. In 2018, it is reported that there were nearly 8,000 claims traded with value of $40 billion. More than half of those trades were on claims worth under $250,000, meaning the majority of claims being purchased were likely held by smaller companies who do not regularly sell claims or regularly appear in bankruptcies.
Bankruptcy claim sales are effectuated through a sale/assignment agreement coupled with the filing of an evidence of transfer of claim. The standard sale/assignment agreement is usually 5-10 pages consisting of 10 single-spaced small-font paragraphs. Sellers will often skim the dense document and only focus on the purchase price. What claim sellers will often miss is the crucial Disallowance or Impairment Paragraph. That paragraph is the one that can end out requiring the seller to return the purchase price plus interest. New York’s Appellate Division First Department issued a recent decision addressing such a situation.
In TRC Master Fund, LLC v. AP Gas & Electric (TX) LLC, AP Gas, the seller, sold its claim to TRC, the purchaser. The underlying agreement’s impairment paragraph stated that the filing of an objection to the purchased claim was an impairment and that upon the occurrence of an impairment, the purchaser could immediately demand repayment of the purchase price plus interest.
What happened? An objection was filed to the claim and the purchaser immediately demanded the claim be repurchased with interest. The seller contacted the objecting party and was able to get the objection withdrawn within 37 days. The seller then refused the purchaser’s demand, causing the purchaser to sue the seller. The seller filed a motion to dismiss the complaint. The court granted it reasoning that because the objection to the claim was withdrawn, the claims purchaser received the benefit of its bargain under the agreement and thus sustained no damages.
Earlier this year, the Appellate Division reversed the lower court’s decision. In doing so, the appellate court held that the “objection constitutes an impairment under the agreement, triggering plaintiff’s right to demand immediate payment under the agreed-to formula, notwithstanding that the impairment was later removed.” The court rejected the seller’s contentions stating that the seller’s “reading of the agreement … requires a deviation from the express text, impermissibly rendering certain provisions without meaning or effect.” With the decision reversed and the complaint reinstated, it seems likely that the buyer will prevail and the seller will be forced to return the purchase price plus interest.
The provision relied upon by the Appellate Division is standard in first drafts of such agreements, and is often overlooked by unrepresented sellers. Sellers with the advice of counsel typically revise that paragraph so that the repurchase trigger must be either a granted objection (not just a filed one) or at least an objection that is not resolved, withdrawn or denied within a set number days. Any party interested in selling a claim in bankruptcy would be served well to hire counsel so as to fully understand the agreement and not get surprised with a repurchase demand a few years after the sale.