The recent bankruptcies of crypto exchanges and lending platforms have turned millions of customers into involuntary creditors that hold bankruptcy claims. Many of these affected customers have decided to sell – or are considering selling – their claims at a discount rather than wait for distributions from the bankruptcy cases. This has led to an active market in crypto bankruptcy claims, a growing share of which takes place on electronic trading platforms. These platforms provide buyers and sellers with options and advantages that have historically been limited or unavailable, including ready access to recent trading prices, the ability to run competitive auctions, and to transact on the platform’s frequently-used form documentation.

While selling claims has certainly become easier, many creditors may be unfamiliar with the specifics. Creditors may have questions about the sale process or key provisions of the sale agreement, particularly as they relate to crypto claims. This article hopes to answer some of these questions.

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1. Background

Claim Transfers in Chapter 11

Any person or entity that believes it has a right to payment from a company that has filed under Chapter 11 holds a “claim.” The classification and treatment of claims is addressed through a Chapter 11 plan.  The ultimate recoveries are dependent on a variety of factors, including the assets available for distribution to creditors relative to the overall claims pool, whether the company will pursue a plan of reorganization or liquidation and/or one or more sales of assets, and the efficiency with which the company is able to formulate a plan and exit bankruptcy. 

Because Chapter 11 cases are often impossible to predict with certainty sometimes even well into the bankruptcy process, many creditors determine that selling their claims at a discount is the right move for them¹. Selling allows a creditor to obtain immediate liquidity, minimize the risk of additional losses and/or avoid the distraction and stress of monitoring the bankruptcy case over a period of months or years.   Creditors may also be motivated by individual business, tax or other factors, including the desire to redeploy capital into other investments or the need for immediate funds.  

On the opposite side of these transactions, claim buyers are willing to take on the risk of the bankruptcy process in exchange for potential returns. These buyers are typically hedge funds or other distressed debt investors with deep restructuring expertise (although as recoveries become more certain, different types of buyers with different risk profiles may emerge). Some buyers are active investors who may seek to influence the outcome of the case, while others are passive investors who have formulated a view on the timing, process and recovery prospects of a given bankruptcy case. Furthermore, accumulating larger positions makes it more cost-effective for these investors to spend the relatively significant amount of time and money that is usually needed for “distressed assets” as compared to some other types of investments.  

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Claim Diligence 

Buyers almost always require the seller to provide all documents supporting the claim, along with a representation that the seller has provided all such documentation in its possession. The buyer’s due diligence of these documents is central to the terms of the agreement it will sign, or if it wants to proceed with the transfer at all.  

Trading platforms offer a major advantage in this regard. Sellers provide key underlying documents when they list their claim, giving buyers an opportunity to review them before making an offer. Accordingly, the bids are realistic both in price and certainty of closing. While bids are still almost always subject to the buyer’s confirmatory due diligence, this process makes it far less likely that a buyer can in good faith renegotiate its original offer as a result of due diligence, or worse, walk away from the transaction altogether. In addition, trading platforms can provide guidance to sellers based on an initial review of the documents, helping them set an appropriate price and terms.  

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Claim Transfer Documentation

The transfer of a claim is typically documented in one or two steps. The parties may simply negotiate the main claim transfer agreement that includes all agreed-upon terms. Other times, parties will first agree on a trade confirmation (or term sheet) that memorializes the main terms of their trade before negotiating the full transfer agreement. Whether the parties decide to document the trade in one or two steps can depend on several factors, including the size and complexity of the transaction, and the number of issues the parties anticipate having to – or being willing to – negotiate over. When signing a trade confirmation first, parties should only agree to key non-negotiable terms up-front and only bind themselves to the extent they wish to be bound. In practice, this typically means that parties are obligated to negotiate in good faith to complete the transaction within a certain time frame.  

When trading on a platform, buyers and sellers have the option of using their own sale documents, or of using the platform’s “form” agreements. One advantage of committing in advance to use the platform’s form agreements is that it significantly cuts down on the time and expense historically associated with negotiating a claim transfer.  This can be especially important – and may in fact be the only practical option – for sellers of smaller claims for whom the cost of hiring an attorney may significantly eat into expected claim sale proceeds.  A seller can choose to take more ownership of the sale process by accepting offers only on form agreements, allowing for ease of comparison between offers, or on a modified form, adjusted as it sees necessary. However, to maximize the number, speed and quality of bids, any modifications to form agreements should only reflect non-negotiable terms.  A “wish list” of terms or extensive stylistic edits that require the buyer to engage expensive counsel of their own may chill bidding and depress pricing.   

In general, form agreements are meant to reflect what would in most circumstances be considered “middle of the road” terms, and to not favor the buyer or seller. Nevertheless, parties that decide to use form agreement should carefully review them (ideally with an attorney) to ensure that they understand the terms, that the terms reflect the business deal as they understand it, incorporate the protections they expect and do not expose them to unintended risk based on their unique situation.  

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2. Main Types of Agreements: Recourse vs. Non-Recourse

Other than ensuring that the claim transfer is legally effective, the main objective of a claims transfer agreement is to allocate risk. This risk may be claim-specific (e.g., the extent to which a claim is subject to disallowance or an objection by the debtor), or case-specific (e.g., the extent to which a class of claims will recover under a plan of reorganization and the certainty and timeline of plan implementation). In addition, particularly from a buyer’s perspective, there is risk of collecting from – or even being able to sue – the counterparty if it breaches the agreement. How parties decide to address these various risks will determine the overall type of trade the parties choose to enter into, which is usually either a recourse or non-recourse trade².   

From a legal perspective, a recourse trade gives the buyer more rights or remedies against the seller as compared to a non-recourse trade. From an economic perspective, this means the buyer gets a potential source of compensation (i.e., the seller) if certain events occur that render the claim less valuable, which are typically described in trade documents as a claim “Impairment.” Impairment may include partial or complete disallowance, subordination, or merely the threat of such treatment. Recourse trades are often called “put back trades” because the seller agrees to repurchase the claim from the buyer in these situations.  

In contrast, in a non-recourse trade the buyer may only pursue legal remedies against the seller in limited circumstances. As a result, the buyer’s economic recovery in most situations is limited to the value of the claim. The buyer’s rights and remedies in non-recourse trades are generally triggered only if the seller is determined to have made misrepresentations to the buyer about the claim (either objectively or only if it was untrue to the seller’s knowledge) or the seller’s relationship with the debtor, or if the seller is found to have interfered with the buyer’s recovery in any way. While a misrepresentation or breach of warranty or covenant often trigger the buyer’s remedies in both recourse and non-recourse trades, they are typically the buyer’s only basis for a remedy in a non-recourse trade³.   

Importantly, some agreements will combine aspects of recourse and non-recourse trades. An agreement may, for example, give the buyer recourse rights but have a carve-out for some types of claim “Impairment” that are non-recourse.  

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3. The Claim Transfer Agreement: Key Provisions

Description of the Transferred Claim and Associated Rights

The claim transfer agreement will describe in great detail the “Claim” and all associated rights that are being assigned to the buyer. The description almost always encompasses the seller’s basic legal right to payment from the debtor and all underlying documentation, including the seller’s proof of claim (the amount the creditor asserts it is owed in a filing with the bankruptcy court).  

A typical agreement provides that all rights and proceeds associated with the underlying claim are also being assigned to the buyer, including the rights to:

• receive all future distributions (along with an obligation that the seller hold in trust any future distributions received and promptly remit them to the buyer), 
• vote on behalf of the claim, 
• bring causes of action arising out of the claim, and
• related substitution and power of attorney as it relates to the claim.  

The definition should also distinguish between claim components that will – or may – be subject to different treatment under the bankruptcy code or the debtors’ plan of reorganization. For example, the agreement may distinguish between the scheduled amount of the claim (i.e., the amount the debtor has conceded it owes) and the amount the creditor asserts. Similarly, the description may make clear that part of the claim will (or may) be entitled to priority under the Bankruptcy Code over general unsecured claims. In recent cases like Celsius and BlockFi, many claim sellers had multiple accounts with the same exchange, such as “custody”, “wallet” and “Earn” accounts, that were subject to different recovery rates and timing. Vendors may have priority claims for goods shipped to the debtor in the 20 days before the bankruptcy under section 503(b)(9) of the bankruptcy code. Distinguishing the different claim aspects is also important because sellers may be unable or unwilling to make uniform representations and warranties regarding all aspects of a claim. 

In some limited circumstances, the seller may only be transferring a percentage of its claim or only assigning some of the rights related to the claim. In such circumstances, the parties’ post-sale rights and obligations (discussed below) will be carefully drafted. Similarly, if a seller wishes to retain certain contingent rights arising out of the claim, such as the right to bring a tort action, that should be clearly excluded from the description of the claim. Because these types of agreements are more tailored, they require more drafting and negotiation. Nevertheless, provided the economics work, claim buyers, intermediaries and law firms specialized in this area will get creative to identify the right legal structure to accomplish the parties’ objectives. 

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Liabilities Excluded 

Just as buyers generally want the transfer to include all possible rights and obligations related to a claim, they want to exclude all potential liabilities associated with the claim. Claim transfer agreements almost always include one or more provisions to this effect.

One notable liability that is typically excluded is the seller’s “preference risk”— the risk the debtor asserts an action to claw back amounts transferred to a creditor in the 90 days before the bankruptcy filing (or one year in the case of insiders). If the seller is the recipient of a preferential transfer that has not been resolved, the debtor may seek to disallow the seller’s claim under section 502(d) of the Bankruptcy Code if and until the preference is paid.  Moreover, a debtor may also disallow a claim transferred to the buyer because the seller remains liable for the preference⁴. Recourse trade agreements often stipulate that such disallowance (or attempt to disallow) will trigger the buyer’s put-back right and/or constitute a breach of the seller’s representations.  

However, in cases like FTX where millions of creditors withdrew funds from their accounts in the 90 days before the bankruptcy filing and the debtor has offered uniform settlements to resolve the potential preference actions arising out of these withdrawals, it has become common for agreements to exclude the materialization of seller’s preference risk from the set of conditions that trigger a buyer’s recourse or other remedies.  

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Pricing and Payment Mechanism 

The price paid for a claim is typically expressed as a percentage multiplied by the asserted amount (or “face amount”) of the claim. In the industry, parties commonly refer to this purchase rate as “cents on the dollar” with $1.00 meaning 100% of the face amount. Other than in limited circumstances, the face amount of a claim is calculated in U.S. Dollars as of the date and time of the bankruptcy filing⁵.    

On a claims trading platform or in a brokered auction, sellers will often receive more than one offer, and have the opportunity to choose a winning bidder. While a seller may be tempted to simply choose the best price, it may not come with the best terms or from a counterparty that is easy to work with. Using form documents as a starting point and requiring all buyers to provide a markup with their bids is a good strategy that helps sellers more easily compare apples to apples when comparing bids. A claims trading platform can help with this and can also provide valuable insight into a prospective buyers’ ability to pay, their negotiation tactics and their ability to close on a timely basis.  

The claim transfer agreement will also specify when and how the seller is paid. On a trading platform, the buyer may have already agreed to standard payment terms for all platform trades, often requiring payment within two days of the seller’s satisfaction of all closing conditions⁶. Generally, the seller will have satisfied all obligations at the time the claims transfer agreement is signed and the clock on payment starts immediately thereafter. On large or complex deals, payments may be made in tranches or delayed until certain events occur.  

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Representations and Warranties

A claims transfer agreement will include several representations by the seller regarding the claim. Some representations and warranties can be heavily negotiated. Others are more or less standard, including that the:

• seller owns the claim free and clear of any liens or other encumbrances;
• seller has not previously sold the claim;
• seller’s claim is valid, liquidated, enforceable, non-contingent and/or undisputed in an amount not less than the amount set forth in the agreement;
• seller has the authority to sell the claim; 
• seller has provided the seller with all relevant documentation in its possession regarding the claim; and
• seller has never been an insider of the debtor. 

Transfer agreements may also include representations by the buyer, either as a stand-alone provision or part of mutual representations. They are typically far more limited and “boiler-plate” than the seller’s representations, covering provisions such as authority to enter into the agreement and compliance with applicable law.  Relatedly, some buyers – often those involved in the bankruptcy case as part of “ad hoc” groups, bidders in 363 sales or otherwise – include provisions in which the seller acknowledges that it has decided to proceed with the transaction even though buyer may have information that seller does not. 

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Post-Sale Rights and Obligations 

Many agreements provide for ongoing rights and obligations after the sale has closed. Most notably, as discussed above, in a recourse trade the buyer will have the right to sell all or part of the claim back to the seller if certain events occur.  

The buyer and seller may also agree to other continuing obligations. For example, if the claim is not allowed, the parties will heavily negotiate their rights in the event of an objection by the debtor. The seller may negotiate a provision that gives it a certain period of time to try to resolve any objection before the buyer’s rights against the seller are triggered or before the buyer can intervene with respect to the debtor. The length of time provided for the seller to retain exclusive control of negotiations/litigation vis-à-vis the debtor is a critical negotiating point that impact’s the risk and reward of the trade for both parties.   

In a recourse trade, the agreement may provide that only that portion of the claim that is objected to (or otherwise impaired) may be sold back to the seller. If the buyer responds to the objection, the agreement may require some level of responsiveness from the seller in connection with its response. Even in non-recourse trades, sellers are often obligated to cooperate with the buyer (at the buyer’s direction and expense) to reasonably assist the buyer in defending against any claim objection. 

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4. Settlement and Noticing

After the parties have executed the transfer agreement and the buyer has paid the seller the purchase price, the buyer may file a notice of claim transfer with the bankruptcy court to provide notice to the court, the debtors and the universe of creditors that the claim has traded (the transfer agreements themselves are almost never filed publicly and are subject to confidentiality).  Bankruptcy Rule 3001(e) requires the buyer to file notice of the transfer if a proof of claim has already been filed. The notice is meant to give the seller a 21-day opportunity to object in the event it believes the transfer is not valid. This is purely a procedural step assuming the transfer agreement was properly executed, and the seller will have often waived the right to object to the notice in the transfer agreement. When transacting on a marketplace, the platform itself may file the notice as a service to the buyer, removing the need for the parties to ensure compliance with the Bankruptcy Rules. 

Even when a transfer notice is not required, buyers will generally file notices to ensure that the claims register maintained by the clerk (or the debtor’s claims agent in a mega case) is updated to reflect the buyer as the claimholder. Although not a perfect system, this helps to ensure that any distributions are made to the buyer and not the seller. 

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Conclusion 

Claims trading platforms have dramatically changed the landscape by streamlining the transaction process and making price discovery much simpler and more transparent. This has become especially valuable in light of the crypto exchange bankruptcies. The existence of millions of creditors with claims that are substantially similar has facilitated a far greater amount of standardization of transfer agreements than has historically been possible, as well as accelerate the development of commonly accepted “market” terms and prices. Nevertheless, the nature of bankruptcy claims makes it impossible to completely standardize claims transfer agreements for all types of claims and bankruptcies, and buyers and sellers will want to ensure that the terms of the agreement accomplish their individual goals and are in line with their appetites for risk.

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_{1. Factors important to deciding whether to sell or hold a claim are outside the scope of this article, and are highly dependent on the details of the claim and the case. Creditors deciding between selling and holding but who are unfamiliar with bankruptcy would benefit from consulting an attorney, financial advisor and/or other professional with bankruptcy experience.}

_{2. Two less common forms of trades are as-is and escrowed trades. As-is trades involve minimal representations by the seller and remedies for the buyer, usually for a lower price than would otherwise be available. Escrowed trades usually achieve the opposite objective with minimal risk to the buyer by having the purchase price held in escrow and released to the seller only when the claim is allowed or some other future event occurs.}

_{3. The buyer’s right to seek damages for these types of breaches of contract will likely exist even without express provisions granting those rights. Nevertheless, agreements will often include a more robust right to seek compensation for these breaches in the form of an indemnification clause, which typically require the seller to indemnify the buyer for any losses (including attorney fees) due to seller’s misrepresentation or breach of warranty or covenant. While indemnification clauses are typical, sellers should ensure that they are only as broad as intended and do not give the buyer the right to seek losses for risks that the buyer was supposed to bear.}

_{4. E.g., In re KB Toys Inc., 736 F.3d 247 (3d Cir. 2013); In re Firestar Diamond, Inc., 627 B.R. 804 (S.D.N.Y. 2021).}

_{5. Claim valuation disputes often arise when the underlying asset can be valued in multiple ways and/or is particularly volatile. Cryptocurrency is but one example of this. Bankruptcy plans have “dollarized” claims originally held in crypto in order to calculate the amounts that will be distributed to creditors. As a result, the price used to calculate a crypto claim can have a significant impact on recoveries. This has been most noticeable in FTX, where the debtors proposed prices of cryptocurrencies for distribution purposes but those prices were subject to multiple objections and counter-proposed prices. Claim buyers and sellers can address this potential volatility in multiple ways, including through “true-up” provisions that require one or both parties to pay the other the difference between the pricing in the agreement and the debtor’s ultimate pricing.}

_{6. As one of these closing conditions, buyers of FTX customer claims often require the seller to validate or transfer their FTX credentials to the buyer before payment is made.}

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_{Article written by Sam Ashuraey, Founder and Managing Attorney at Ashuraey Law PLLC.  With gratitude to Andrew Glantz, Chief Strategy Officer at Xclaim, for helpful comments and insights.  This article is intended for general informational purposes only.  It does not constitute legal advice, is not meant to be a substitute for advice of counsel, and its distribution does not create an attorney-client relationship.  While every effort has been made to ensure the accurateness of this publication, its contents is not guaranteed to be correct, complete or up-to-date, and may contain inaccuracies and/or typographical errors.  No party, including Ashuraey Law PLLC or the author, assumes any liability in connection with this publication.  Any opinions contained herein do not necessarily reflect the opinions of Ashuraey Law PLLC or any of its clients or employees.  Please feel free out to reach to Sam Ashuraey if you have any questions about this publication.  The contents of this publication may not be quoted or attributed without the express consent of Ashuraey Law PLLC.}  

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