buys claims at a steep discount while
also “shorting” the debtor’s stock2).
One issue for any distressed debt
investor to consider is that a court may
increase its scrutiny of a party that is a
latecomer to the bankruptcy process.
Anticipating this risk, an investor that
has been focused on a distressed
debtor may be able to purchase debt
before the debtor files for bankruptcy
protection. The market for distressed
debt (including bank, bond, and trade
debt) does not commence with the
filing of the bankruptcy proceeding, but
instead when the company is perceived
to be insolvent or substantially stressed,
which may occur months or more
before a bankruptcy filing. A couple
of hypotheticals help to illustrate.
HypOTHe TicAl 1 A buyer is
considering purchasing a general
unsecured claim of a vendor against
the Acme Widget Company in the
face amount of $500,000 shortly
after the Chapter 11 case is filed.
Due Diligence. Before purchasing the
claim, the buyer should ensure during
its negotiations with the seller, to the
extent possible, that the company
will not dispute the subject claim
(either in amount or entitlement) by
obtaining from the seller all relevant
documentation and support, as well as
by conducting its own due diligence
(including a review of bankruptcy
documents, U.S. Securities and
Exchange Commission filings, etc.).
The buyer might consider structuring
the transaction so that payment on any
disputed portion is deferred until that
portion of the claim is resolved favorably.
Some red flag factors that the
buyer should watch for include:
• The claim is inconsistent with
Acme’s books and records (set forth,
for example, in the filed schedules).
The buyer should push the seller
to fully explain the discrepancies.
In some cases, it may be desirable/
feasible for the buyer to push the
seller to enter into a stipulation
with Acme, which could also
include the company’s waiver of
any potential avoidance actions.
• The buyer learns that the seller might
have committed some questionable
conduct, even conduct unrelated
to the subject claim, that may lead
to equitable subordination or other
reduction or disallowance of the
claim in the bankruptcy case. Some
authorities suggest that assigned
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