Bankruptcy is not a position that any business owner expects to be in. It is often perceived as failure and portrays the Debtor in a negative light. However, Chapter 11 Bankruptcy is a type of bankruptcy that is actually more of an opportunity than a failure, as it allows the Debtor to reorganize its debts and stay in business. Despite the financial distress and hardship that led up to the decision to file, Ch.11 Bankruptcy provides the Debtor with the breathing room, assistance, and fighting chance they need to re-emerge as a financially stable business again.
The Chapter 11 process is not as favorable for the Creditors involved, however. These individuals and companies have already been overwhelmed with outstanding invoices, bills, and their own financial distress caused by the Debtor’s inability to settle their debts. Now, they are forced to endure a complex and grueling bankruptcy case in hopes to receive some form of retribution.
Unfortunately, many Creditors are not guaranteed a payout. Depending on the status of their Bankruptcy Claim and business relationship with the Debtor, it is possible for a Creditor to recoup only a portion of their Claim value or nothing at all. There are several factors during the pendency of the Ch.11 process that can affect Creditor recovery.
Waiting it out, however, is not the only option. Creditors can pursue an alternative opportunity to recover their lost revenue and earn immediate liquidation of their bankruptcy claim–by selling it.
Claims Trading is a legal and safe practice that has existed for several years. Creditors can list and sell their Bankruptcy Claim to interested Buyers at a discounted price in order to avoid the complexities of the Ch.11 process and get back to running their business. The new holder of the Bankruptcy Claim will take the Creditor’s place and participate in the court proceedings with the intention of gaining interest or equity in the Debtor’s reorganized company upon conclusion of the case.
While Claims Trading may seem like the preferred option, it is important for the Creditor to understand both the pros and the cons of selling their Claim so that they can objectively consider their options. The following article outlines the benefits and the drawbacks of the claims trading process.
Benefits of Trading a Bankruptcy Claim
1. Receive Immediate Liquidation
The first and most obvious benefit of trading a Bankruptcy Claim is the opportunity to earn immediate cash. Due to certain procedural dependencies of the Ch.11 process, several Creditors are not guaranteed a payout. By selling their Bankruptcy Claim instead, they can avoid the risk of having a defective Claim that won’t be repaid and liquidate their debt for instant liquidity.
2. Avoid Delayed Recovery
Claims trading allows Creditors to avoid participating in the lengthy court proceedings and waiting on a delayed recovery. On average, Ch. 11 Bankruptcies can take two years for the court to finally confirm the Debtor’s Plan of Reorganization, while more complex cases last even longer. And upon confirmation of the Plan, it can still take several months for payments to be distributed.
The Claims Trading process is an efficient way for Creditors to recover their debt in the form of immediate liquidation. The timeline of listing a Bankruptcy Claim, connecting with interested Buyers and finalizing the sale of the Claim can be settled in as little as a couple of weeks.
3. Avoid Risk of Illiquid Recovery
Instead of cash distributions, Creditors can end up being repaid in other forms, including equity in the Debtor’s reorganized business, promissory notes, or interest in Creditor trusts. Because of certain restrictions on transfer in the instruments themselves, these securities, notes, and trust interests may or may not be liquid. This could also be because the purchasers are not willing to provide these distributions in cash form.
When a Creditor trades their Claim, it is a cash only transaction. Creditors can rest assured that they will receive payment in the form of liquidity.
4. Avoid Additional Expenses
As a Creditor, participating in the court proceedings of a Ch.11 Bankruptcy to protect and preserve their right to payment can rack up an extensive list of expenses. The cost of hiring and retaining legal or financial counsel for the duration of the Bankruptcy Case, plus traveling to and from hearings, meetings, and other case activities can lead to a substantial amount of money spent. There is also the time reserved for dealing with court issues and keeping up with the case—time that could be spent taking care of their own business matters.
Rather than investing time and money into the uncertainty of the Ch.11 process, Creditors can avoid the additional expenses and sell their Claim.
5. Obtain a Tax Deduction
If a Creditor sells their claim for less than its full value, which is typical in Claims Trading, they may be able to obtain a tax deduction for the loss. By selling their Claim for immediate cash, they can leverage the tax deduction in the same tax year.
6. Get Back to Business As Usual
Chapter 11 Bankruptcy can cause a major disruption in a Creditor’s business and operations. It is an extensive process that requires careful attention and time in order for the Creditor to assert their right to payment.
By selling their Bankruptcy Claim, a Creditor can disengage from the bankruptcy case and return to business as usual. Not to mention, they can remedy their financial situation with the immediate cash they have recovered. From an accounting perspective, the debt that they have not been able to collect on can finally be removed from the balance sheet.
Drawbacks of Trading a Bankruptcy Claim
1. Preserve Setoff or Recoupment Rights
Setoff or recoupment rights are a key component of the Ch.11 process due to the fact that they can potentially change a Creditor’s liability in the Debtor’s bankruptcy estate. If a Creditor has significant setoff or recoupment rights against the Debtor, it is wise to consider the value of these rights and whether they can preserve them as part of a Claim sale.
Creditors with a right of setoff have the ability to offset mutual debts. They can use their right of setoff (if applicable under the Bankruptcy Code) against the amount of their Claim. Creditors with setoff rights are typically secured which means they are guaranteed payment from the Debtor’s bankruptcy estate. This means that their Bankruptcy Claim may be worth more if they wait it out, as opposed to trading their Claim.
Recoupment rights allow a Creditor to hold onto funds to offset a debt that has derived from the same transaction. Creditors with recoupment rights can assert them at any point, regardless of the timing or other requirements set forth by the Bankruptcy Code. They are also permitted to recoup pre-petition debts from the post-bankruptcy payments owed without violating the automatic stay.
A Creditor with setoff or recoupment rights may be eligible for a full recovery and therefore may benefit more from waiting out the bankruptcy proceedings.
2. Creditor’s Committee
A Creditor’s Committee has a significant role in the Chapter 11 process. Appointed by the trustee, it is their responsibility to consult with the Debtor (or trustee) and negotiate the terms of the Plan of Reorganization on behalf of the other Creditors in their class.
If a Creditor sits on a Creditor’s Committee or other committee in a Ch.11 bankruptcy case, they may owe fiduciary duties and should consider such duties when deciding whether or not to sell their Claim. They may also be subject to specific or general court orders regarding Claim sales. For this reason, it is imperative that the Creditor seek legal counsel prior to finalizing any Claim sale.
3. Forfeit Involvement in Case
When a Creditor chooses to sell all of their Claims against the Debtor, they may lose their formal standing to appear and be heard in the Bankruptcy Court. They also risk losing their influence on the proceedings of the bankruptcy case. Creditors that wish to play an active role in the Ch.11 case may be better off deciding to keep all or some of their Claim(s).
4. Wait for a Better Outcome
After receiving an offer for their Bankruptcy Claim, a Creditor may decide that it is in their best interest to wait and see how the Ch.11 case plays out. While it is difficult to anticipate, they may be able to receive a more favorable outcome under the terms of the Debtor’s Plan of Reorganization.
By first obtaining an offer from a Buyer, a Creditor will at least have a purchase price to consider when making the decision.
Creditors are often put in a difficult financial position when faced with a Chapter 11 Bankruptcy. Participating in the lengthy bankruptcy proceedings can be complicated, expensive and the outcome is practically impossible to predict for most Creditors. It can cause the Creditors involved to end up in their own financial distress.
Fortunately, Claims Trading offers an efficient, reliable alternative to waiting out the bankruptcy case. Creditors can earn immediate cash for their Bankruptcy Claim and avoid the stress, time and hefty cost of the Ch.11 process. By choosing to trade their Bankruptcy Claims, Creditors can refocus their energy on their own company and reinvest their recovered debt into the future of their business.