Daily Development for
Thursday, January 8, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

In light of Jack Murray's comments yesterday on the claims purchasing frenzy in the La Salle Street Partnership case, I thought I'd post the following two cases, also reported by Jim Stillman, on the subject of claims purchasing as a bankruptcy strategy.

BANKRUPTCY; ACQUISITION OF CLAIMS; INSIDER STATUS: Where a long-time business associate of the debtor's general partner acts as an "insider" in arranging for the friendly purchase of certain unsecured claims pre-petition, the vote to accept the debtor's plan cast by the claims acquirer would not be counted, and the debtor's plan of reorganization will not be confirmed if it fails to garner the support of at least one class of the remaining impaired claims.

In re Three Flint Hill Ltd. Partnership, 213 B.R. 292 (D.Md. 1997).

Strategic claims acquisition was waged by both sides in the case; the debtor arranged for its friendly purchaser to buy certain claims pre-petition; the creditor bought hostilely (to block confirmation) post-petition, at 100 cents on the dollar. The testimony of the friendly acquirer that he would not accept the creditor's claims purchase offer at full value, even with a 30% premium, demonstrated to the District Court that the purchaser was motivated "by affinity rather than independent business judgment" (p. 300) and was therefore an insider. The debtor's argument that there was no control relationship between it and the acquirer was not dispositive of the question whether the purchaser had acted as an insider in this transaction. The creditor's competing, liquidation plan was not proposed in bad faith, and confirmation of the creditor plan was upheld.

Editor's Comment: Although the editor acknowledges that the bizarre world created by federal bankruptcy policy often compels difficult inquiries, but the inquiry into whether an "economic affinity" is or is not an "independent business judgment" seems to be one that is fraught with difficulty. What if, for instance, the claims purchaser was holding out for a 40% premium? Note that the other creditor already had offerred a 30% premium, so the face value of the claims clearly is not the market price.

For that matter, if the creditor who has the claims in question was not in an identity of interest with the debtor, but saw some economic gain in frustrating the other creditors in their objectives in the bankruptcy, what's the matter with that? It's all about money, after all. If the creditors are independent economic interests, and not in fact the debtor's alter ego, the editor says, let their money talk!!

BANKRUPTCY; ACQUISITION OF CLAIMS; PURCHASE BY FIDCUIARY: A claims purchaser who controlled a seat on the debtor's board of directors could not profit from the $50 million discount at which it purchased first and second priority notes during the bankruptcy.

In re Papercraft Corp, 211 B.R. 813 (W.D.Pa. 1997).

"A fiduciary is not entitled to any profits resulting from the purchase of claims against an insolvent debtor." (p. 826)

Reporter's Comment: The Bankruptcy Court went too far, however, in announcing a per se rule that such a purchaser could participate (pro-rata) in the plan only on the basis of its purchase price. For purposes of calculating their distribution share, the acquired claims are to be measured against other claims at face value; it is the total distribution amount that must not exceed the purchase price. But the District Court remanded the case, for the Bankruptcy Court to consider whether specific factual findings could be made to support equitable subordination of the acquirer's share, as an additional sanction.

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