Don’t Lose Your Consolation Claim

April 2003

In this case, after an involuntary bankruptcy petition was filed against it, the debtor made payments to the lender which were not authorized by the bankruptcy court or any provision of the Bankruptcy Code. The lender subsequently sold essentially all of its claims to a third party, pursuant to an agreement that provided that the lender transferred "all claims . . . suits, causes of action . . . whether known or unknown, against the . . .Borrower."

The debtor then brought an action against the lender seeking to avoid the unauthorized post-petition payments and, in fact, the bankruptcy court ruled that the lender was required to return those payments. The lender and the creditors committee agreed that, after it returned the funds, the lender would be granted a pre-petition "consolation" claim equal to the amount returned. The lender contended that this claim should be a secured claim, since its original claim was secured. Naturally, the committee argued that the lender should receive only an unsecured claim.

The bankruptcy judge ruled that both parties were wrong. The Court noted that the lender had already absolutely and unconditionally assigned all claims and proceeds thereof, whether known or unknown. Thus, when it sold its claims, the lender had failed to retain any consolation claim that might arise in its favor if it later were required to return to the debtor any avoidable payment.

What's a lender to do?

When selling a bankruptcy claim, a lender should bear in mind the need to document the transfer carefully so as to protect itself in case it is later found to have received an avoidable transfer.

For more information on these or other legal issues, please contact Andrew Gold at 212-592-1459 or [email protected], or Scott Tross at 973-274-2030 at [email protected].

Copyright © 2003 Herrick, Feinstein LLP. Lender's Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.