In the trading world for bankruptcy claims, traders often ask their lawyers, “Do I have a binding trade?” This is a critical question on which both risk management and subsequent trading strategy depends. Often, however, the answer is unclear. Unlike markets for distressed bank debt or restructured equity, there is less certainty as to whether a binding claims trade exists at the moment the parties reach agreement on the asset, price and size. Claims trades commonly involve extended negotiations of bespoke terms, involving commercial actors who are not professional traders. As such, determining when a legally binding trade exists can be a complex and fact-specific undertaking where expectations that may be valid in other markets do not necessarily apply. The complexity of such analysis is illustrated in a recent decision by U.S. Bankruptcy Judge Michael Wiles in In re Westinghouse Electric Co., 588 B.R. 347 (Bankr. S.D.N.Y. 2018). His decision rejected a contention that two parties had reached a binding agreement to trade and offers valuable lessons for parties who wish to avoid a similar fate.
Claims Trading Market Practice
Trading practices in the claims market differ from practices in related markets, such as the over-the-counter market for syndicated bank debt. Original holders of claims against bankrupt debtors are regular participants in this particular market. Such holders are typically not market professionals and may have no familiarity with trading conventions or practices. Transaction terms are often heavily negotiated. No widely-accepted standardized claims trade documentation exists.
As in the syndicated loan market, buyers and sellers conduct negotiations and reach initial agreement on material terms verbally or through an exchange of emails or Bloomberg messages. In the loan trading market, for example, it is a long-standing industry custom that a binding trade exists at the time of that initial agreement. A binding trade occurs in that market even where the parties agree, as they commonly do, that the trade is “subject to documentation.”
In the claims market, however, the consensus as to when a binding trade exists is not as well-established, due in large part to the bespoke nature of the underlying asset and the transaction agreements. Moreover, because claim diligence and negotiation of a written agreement for a claims trade may require substantial time to complete, there is a higher failure rate for such trades than for loan trades. When a bankruptcy claims trade does fall apart, conditional or qualifying language in the parties’ preliminary agreement can create legal uncertainty as to each side’s rights and obligations.
Binding or Not Binding? And Binding as to What?
Judge Wiles’ decision in Westinghouse presents a window into the sorts of issues presented in this claims trading market. In that dispute, the holder of a bankruptcy claim (Landstar) entered into discussions to sell its interest to a potential buyer (Seaport, as a broker for Whitebox). Seaport and Landstar exchanged emails relating to terms of a trade. Seaport provided language that Landstar could use to document a trade. This language included a caveat that “[t]his offer shall be subject to agreement of terms and conditions and execution of documentation.” Landstar utilized this language to send an offer to sell. Its leading witness testified that she also verbally communicated to Seaport that the trade’s terms had to be reviewed and approved by counsel.
Seaport responded by adding a qualification that the purchase price would be subject to a recourse mechanism. This term apparently could require Landstar to refund a portion of the purchase price plus interest under certain circumstances. Upon a request for clarification from Landstar, Seaport advised that “[t]his commits both you (and my client) to the 78% Purchase Price, subject to agreement of terms and execution of documentation,” including a trade confirmation. Landstar responded, “Sounds good. Please send the documents so I can get the review process started.” A draft confirmation was never signed and Landstar ultimately decided not to move forward with the trade.
Whitebox filed Bankruptcy Rule 3001(e) transfer notices to evidence the transfer of Landstar’s claim, which would be the last step in the settlement of a sale trade after payment of purchase price by the buyer, but Whitebox did not pay the purchase price. Landstar objected, contending that there was no binding agreement to sell the claim. After discovery, the court conducted a bench trial. During the course of the trial, Whitebox abandoned its initial theory that there was a binding agreement as to all terms and argued instead that Landstar had entered into a binding preliminary agreement or so-called “Type II” contract. Under certain federal cases applying New York law, a Type II contract is created when the parties agree on certain major terms but leave other terms open for further negotiation. In contrast to a fully binding contract, a binding preliminary agreement “does not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith in and attempt to reach the … objective within the agreed framework.” Adjustrite Systems v. GAB Business Services, 145 F.3d 543, 548 (2d Cir. 1998).
After weighing the evidence, Judge Wiles rejected even this more limited theory of a Type II contract. He held instead that there was no binding agreement of any sort and based this decision on two principal findings.
First, he concluded that there was no meeting of the minds. He found that the addition of a recourse requirement by Seaport constituted a counteroffer to Landstar, rather than an acceptance of Landstar’s original offer. Without an offer and an unequivocal acceptance of that offer, by definition there is no agreement.
Second, Judge Wiles found that the totality of the communications reflected an intention by Landstar not to be bound to a trade or to an obligation to negotiate. In its findings, the court highlighted Landstar’s verbal communication to Seaport that the trade was subject to review and approval by counsel. The court also deemed relevant the parties’ statements that the transaction was “subject to … documentation” and, based on witness testimony, found that both parties understood this language to mean that Landstar would not be bound unless and until a written contract was signed.
The court’s discussion of the legal importance of the “subject to … documentation” language is particularly noteworthy. The court rejected Seaport’s argument that, as a matter of law, such language had no or only limited effect. In support of its position, Seaport cited the New York Court of Appeals’ decision in Stonehill Capital Management v. Bank of the West, 28 N.Y.3d 439 (2016). Stonehill involved an auction of syndicated bank debt. The Court of Appeals there held that two parties had entered into a binding trade upon acceptance of the winning bid even though that acceptance recited that it was “subject to mutual execution” and no agreement was ever signed. Noting that the auction context of Stonehill was different than the situation before him, Judge Wiles declined to apply a categorical rule. Instead, he looked to all the evidence as to whether there were “forthright, reasonable signals” not to be bound.
In reaching his decision, Judge Wiles appeared to be particularly concerned by what he characterized as the tactical use of ambiguous language by trading professionals at the expense of occasional and novice market participants. He criticized the use of trading language that “reassures sellers that nothing is binding until the whole deal is done, and that permits the people in the industry to take different positions in different cases as to what the language means and what the customs allegedly are, depending upon the participants’ self-interest in those individual cases.” He also offered these words of caution:
[I]f claims traders want their customs to be binding when they deal with non-professionals …, it is incumbent on them to set forth the terms in a clear and unequivocal way. Contracts are supposed to be matters of voluntary agreement. They are not supposed to be traps for the innocent and unwary.
As the Westinghouse decision underscores, prudent parties should make their intentions plain when discussing a potential claims trade. The involvement of experienced counsel here can pay real dividends in promoting clarity and avoiding trade disputes. At a minimum, traders should consider some common sense rules of the road:
• In order to accept a party’s offer and create a binding contract, the offer should be accepted without change. If the accepting party does not intend to accept the offer until certain conditions are met, it should confirm with the offeror that the offer stays open until the conditions are met.
• Where a party desires an offer to be binding when accepted, it should say so. Using ambiguous phrases in an attempt to preserve optionality as to whether a binding agreement exists is a perilous tactic that may well backfire.
• Where a party does not intend to be bound, it should be cautious in communicating words that could in any way be construed as indicating its assent. Such a party should consider using language making clear that there is no trade “unless and until” certain requirements are met and should not otherwise communicate that the transaction is “binding” or, in traders’ speak, “we’re done” or “we’re good.”
• The mere use of the phrase “subject to documentation” is not dispositive. By itself, it neither precludes nor requires a finding that a binding agreement exists.
• Finally, traders should not expect that industry customs used in the syndicated loan market will automatically apply to the market for bankruptcy claims. Different standards may well govern, particularly when dealing with those who are not market professionals.
Julia Lu is a partner in Richards Kibbe & Orbe’s corporate practice in New York, where she focuses on derivatives, distressed debt and financing transactions. David Daniels is a partner in the firm’s Washington, D.C. office, where he litigates disputes involving securities and capital markets.