Contributed by Brian Wells
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.
(e) TRANSFERRED CLAIM.
(1) Transfer of Claim Other Than for Security Before Proof Filed. If a claim has been transferred other than for security before proof of the claim has been filed, the proof of claim may be filed only by the transferee or an indenture trustee.
(2) Transfer of Claim Other than for Security after Proof Filed. If a claim other than one based on a publicly traded note, bond, or debenture has been transferred other than for security after the proof of claim has been filed, evidence of the transfer shall be filed by the transferee. The clerk shall immediately notify the alleged transferor by mail of the filing of the evidence of transfer and that objection thereto, if any, must be filed within 21 days of the mailing of the notice or within any additional time allowed by the court. If the alleged transferor files a timely objection and the court finds, after notice and a hearing, that the claim has been transferred other than for security, it shall enter an order substituting the transferee for the transferor. If a timely objection is not filed by the alleged transferor, the transferee shall be substituted for the transferor.
(3) Transfer of Claim for Security Before Proof Filed. If a claim other than one based on a publicly traded note, bond, or debenture has been transferred for security before proof of the claim has been filed, the transferor or transferee or both may file a proof of claim for the full amount. The proof shall be supported by a statement setting forth the terms of the transfer. If either the transferor or the transferee files a proof of claim, the clerk shall immediately notify the other by mail of the right to join in the filed claim. If both transferor and transferee file proofs of the same claim, the proofs shall be consolidated. If the transferor or transferee does not file an agreement regarding its relative rights respecting voting of the claim, payment of dividends thereon, or participation in the administration of the estate, on motion by a party in interest and after notice and a hearing, the court shall enter such orders respecting these matters as may be appropriate.
(4) Transfer of Claim for Security after Proof Filed. If a claim other than one based on a publicly traded note, bond, or debenture has been transferred for security after the proof of claim has been filed, evidence of the terms of the transfer shall be filed by the transferee. The clerk shall immediately notify the alleged transferor by mail of the filing of the evidence of transfer and that objection thereto, if any, must be filed within 21 days of the mailing of the notice or within any additional time allowed by the court. If a timely objection is filed by the alleged transferor, the court, after notice and a hearing, shall determine whether the claim has been transferred for security. If the transferor or transferee does not file an agreement regarding its relative rights respecting voting of the claim, payment of dividends thereon, or participation in the administration of the estate, on motion by a party in interest and after notice and a hearing, the court shall enter such orders respecting these matters as may be appropriate.
(5) Service of Objection or Motion; Notice of Hearing. A copy of an objection filed pursuant to paragraph (2) or (4) or a motion filed pursuant to paragraph (3) or (4) of this subdivision together with a notice of a hearing shall be mailed or otherwise delivered to the transferor or transferee, whichever is appropriate, at least 30 days prior to the hearing.
Rule 2019. Disclosure Regarding Creditors and Equity Security Holders in Chapter 9 and Chapter 11 Cases
(a) DEFINITIONS. In this rule the following terms have the meanings indicated:
(2) ‘‘Represent’’ or ‘‘represents’’ means to take a position before the court or to solicit votes regarding the confirmation of a plan on behalf of another.
(2) Unless the court orders otherwise, an entity is not required to file the verified statement described in paragraph (1) of this subdivision solely because of its status as:
(B) an agent for one or more other entities under an agreement for the extension of credit;
(C) a class action representative; or
(D) a governmental unit that is not a person.
(B) with respect to an entity, the employment of the entity, including the name of each creditor or equity security holder at whose instance the employment was arranged;
(B) the nature and amount of each disclosable economic interest held in relation to the debtor as of the date the entity was employed or the group or committee was formed; and
(C) with respect to each member of a group or committee that claims to represent any entity in addition to the members of the group or committee, other than a committee appointed under § 1102 or § 1114 of the Code, the date of acquisition by quarter and year of each disclosable economic interest, unless acquired more than one year before the petition was filed;
(B) the nature and amount of each disclosable economic interest held in relation to the debtor as of the date of the statement; and
(e) DETERMINATION OF FAILURE TO COMPLY; SANCTIONS.
(2) If the court finds such a failure to comply, it may:
(B) hold invalid any authority, acceptance, rejection, or objection given, procured, or received by the entity, group, or committee; or
(C) grant other appropriate relief.