The bankruptcy trade claim market has become especially dynamic with recent headline bankruptcies of Toys "R" Us and Sears. Notwithstanding the nostalgia that these iconic retailers inspire in many of us, the world has embraced a new reality of one-click shopping. The markets have responded with strong interest in such high-profile corporate bankruptcies, thus creating a vibrant market where bankruptcy claims are bought and sold, either directly between buyer and seller or with the assistance of a broker, and this deserves our attention.

There is an argument to be made that the trade claim market should be automated on an online trading platform, on the basis that this would simplify the transaction process and streamline the documentation. But for sophisticated market players, such action should be considered with due caution. On the one hand, centralized systems do hold the promise of being efficient, cost-effective and potentially equitable to both a buyer and a seller. On the other, current proposals for centralized platforms overlook key legal issues that could leave investors with a worthless claim if the form agreement generated does not sufficiently protect their interests. This article highlights legal issues that may be oversimplified in current platforms and pose significant risks to buyers and sellers. While there are additional types of claims traded in the market, this article will focus on trade claims, also known as vendor claims.

Market participants buy and sell claims against companies seeking relief under the U.S. Bankruptcy Code (the Bankruptcy Code). Generally speaking, a "claim" is broadly defined in the Bankruptcy Code as a right to payment, whether or not such right is liquidated or secured. In the claims trading market, illiquid assets, such as a trade claim, are liquidated by way of a cash transaction between buyer and seller.

A trade creditor in the Toys "R" Us bankruptcy, for instance, may be a vendor that supplied dolls to the retailer's stores. At the time of the bankruptcy filing, if the vendor is still owed money on goods previously delivered, perhaps under an agreement that involves 30- to 60-day payment terms, the vendor would file a claim against Toys "R" Us for the money owed, thus becoming a trade creditor of Toys "R" Us. In the event the trade creditor wants to liquidate its trade claim, the trade creditor can then sell its bankruptcy claim in the trade claims market to a fund or asset manager that invests in distressed assets.

The benefits of such a transaction for the vendor include receiving a prompt cash payment for its claim, albeit at a discount, and avoiding complex bankruptcy proceedings that can distract from its core business activities. For the investor, the acquisition of the distressed asset is a strategic transaction that can help diversify its portfolio and deliver a hopeful return when it is ultimately disposed. The investor may hold the claim through the bankruptcy action or trade it in the market at some point during the process.

Current proposals for online claim trading markets call for the use of a simplified transfer of claim agreement (a Simple Agreement) in order to transfer the rights in the creditor's trade claim to a buyer. Market participants on both sides should exercise caution when using a Simple Agreement that has been automatically generated because, as mentioned above, nuanced issues may be oversimplified in the process and lead to an unintended consequence.

Following are important considerations for those buyers considering the use of online systems for their claim trading contracts:

Diligence

A Simple Agreement is insufficient because it does not enumerate the specific items that should be accounted for in a diligence review. Therefore, it may not account for details that are critical to the specific transaction being contemplated. A claim, for example, must be evidenced and substantiated by invoices and contracts, among other items. A claim can also arise from receivables due to a trade creditor. An agreement must be tailored to account for relevant diligence outs for the buyer. And in the event the buyer cannot substantiate the amount of the claim asserted by the seller, the buyer should be able to walk away from the transaction.

Assignability of Underlying Contracts

Part of the diligence exercise is reviewing the underlying contracts and agreements that substantiate the claim at issue. An agreement may have an express anti-assignment clause providing that the parties to the agreement cannot assign their interests in the contract. This is a critical issue when conducting due diligence on trade claims that can be overlooked in an automated process. As well, there are additional issues that exceed the scope of this article that involve whether or not anti-assignment provisions in agreements are enforceable under common law and Article 9 of the Uniform Commercial Code.

Representations

An assignment agreement can be highly negotiated between buyer and seller in order to account for the amount of risk each party is willing to accept. The buyer is interested to purchase a valid claim, and the seller is representing and warranting that the subject claim is in fact a valid claim. If there is an issue with the claim, the representations provide the buyer with certain recourse and remedies. In fact, representations are the heart of the document for the buyer.

For instance, title is a key representation and warranty provided by the seller to the buyer. The seller should represent and warrant (1) that it has a good and marketable title to the claim and (2) that the basis for the claims is accurately and completely set forth in the diligence materials provided to the buyer. This representation is important if there are liens on the asset at issue, and it should be tailored to that specific claim. An additional representation involves the nature of the claim, such as whether it may arise from a mechanic's lien or unpaid contract invoices. The assignment agreement should clearly provide what substantiates the claim; however, a Simple Agreement fails to incorporate this fact-specific component.

Put-Back Rights

These are also highly negotiated terms within an assignment agreement. They are critical to preserving the buyer's right to put back (or return) to the seller a claim that is subsequently found to be impaired. Generic clauses within a Simple Agreement do not adequately protect the buyer, and there are also deficiencies in provisions that govern how the seller will be required to defend any claims of impairment or if the claim is disallowed by the bankruptcy court.

Is There a Trade?

Key case law in the distressed trading market highlights the importance of the issue as to whether or not there is a binding contractual agreement. This is a critical issue. Problems arise when it is not clear whether or not there is an enforceable, binding agreement between the seller and buyer or among the seller, buyer and broker. Current proposals in the Simple Agreement rely on checking a box online. Issues can arise when the material terms of trade are not expressly stated and signed in agreement by both buyer and seller.

In summary, the modernization of the claims trading market is inevitable and will likely lead to increasing use of online trading platforms. But caution is warranted because the advent of these developments will also require the associated legal documents to be carefully tailored and adapted to the needs of the specific buyer and seller, as well as the relevant bankruptcy.

Jennifer Pastarnack is an associate at Clifford Chance in New York.