How to sell a creditor claim
/Overview of Selling a Creditor Claim
Customers sometimes go bankrupt, in which case a seller can file a claim with the bankruptcy court to be paid for any outstanding receivables issued to those customers. Though a seller may eventually receive compensation, it may not be for a long time, and for much less than the billed amount. Alternatively, and worse, the seller may be paid with ownership shares in the customer, which can be quite difficult to liquidate.
To avoid the prolonged process of being paid through a bankruptcy court, it may instead be possible to sell the claim to a third party investor immediately, for cash. The investor takes responsibility for pursuing the claim, hoping to eventually earn a reasonable return on the initial investment, as paid to the seller. Alternatively, the investor may collect a number of these claims and use them to:
Gain control over the customer; or
Block reorganization plans; or
Resell the combined claims for a higher price to another investor.
In order to sell a claim to an investor, a company must verify with the customer that the claim for payment is not disputed. If so, the investor is much more likely to be willing to buy the claim. The investor then estimates the amount of the claim that will eventually be paid, discounts the result for the estimated amount of time that will pass before payment is made, and factors in a profit to arrive at an amount to offer the seller for the claim.
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The Assignment of Claim Agreement
As part of the sale, the seller and investor must agree upon the terms of an assignment of claim agreement. The investor then notifies the bankruptcy court of the sale, which forwards the notification to the customer. If the customer has no objection, the bankruptcy court substitutes the name of the investor for the name of the original seller as the owner of the claim.
The seller should be wary of a number of terms on an assignment of claim that are intended to shift the risk of bankruptcy court nonpayment from the investor to the seller. These issues include:
The seller must repurchase the claim from the owner if the claim is not paid
The seller must also pay the investor interest charges if the claim is not paid
The seller must repurchase all claims subsequently disputed
The investor is allowed to delay payment to the seller
If these terms are excessively onerous, the seller should strongly consider retaining its claim and waiting for a payout from the bankruptcy court.
Advantages of Selling a Creditor Claim
The main advantage of selling a creditor claim is that the seller obtains immediate use of the associated cash. This can be a major concern when the seller is having cash flow difficulties, and especially when there is little prospect for a near-term payout by the bankrupt entity. A further advantage is that selling the claim removes an extremely aged receivable from the seller’s aged accounts receivable report, which may notably reduce its days receivable outstanding metric.