a Practical Platform to Sell Trade Claims
Claims Market  is a market for trade claims that solves the three biggest issues in trade claims: helping sellers get the best price, providing transparent closing documents, and a structuring predictable closing process. “Trade claim” is a catch-all term for claims in a bankruptcy case that are not debts for money borrowed. In most bankruptcy cases, the largest amount of claims are for money borrowed by the bankrupt debtor, such as bonds evidenced by a bond indenture, or loans evidenced by a credit agreement.
The underlying basis of a trade claim is usually the extension of credit by a supplier or a service provider. After goods are sold or services are rendered, the vendor requests payment, typically in 30 to 60 days. The documents evidencing an extension of credit in the case of goods, typically include a purchase order, invoice, and a bill of lading. In some cases, there may be a formal contract. The amount of a claim may also be based on contractual damages. If a contract is rejected by the debtor as part of its bankruptcy case, the vendor will have a claim for the difference between the contract price, and the market price the vendor was able to obtain from a third party, over the term of the contract. Market prices can be based on actual prices the vendor was able to obtain or published quotes from a reliable source.
There is no centralized market for trade claims. It is a classic over-the-counter voice market where sellers and buyers negotiate and settle transactions telephonically and by emailing documents. Claims trade either directly from a seller to a buyer, or indirectly from a seller through a broker to a buyer. The trade claims market is imbalanced. There can be hundreds, and often thousands of vendors in a bankruptcy case. Those large number of sellers are doing business with a small number of buyers. In most bankruptcy cases there are fewer than ten buyers of trade claims. Many trade creditors are inexperienced and have never sold a claim. Some vendors might have sold a claim before, but the people who worked on that prior sale, might not work on a subsequent sale. Thus, there is limited institutional knowledge of the selling process. The disparity in transactional experience is one reason misunderstandings can arise between sellers and buyers.
Hybridization of Voice Markets
The traditional definition of a hybrid market is a securities exchange that offers trading through an automated system and a floor brokerage. We expand the hybrid definition to include over-the-counter voice and partially automated systems. Many over-the-counter financial markets have been evolving from pure voice to hybrid forms of voice/electronic markets. Foreign exchange used to be a pure voice market with constant voice updates of prices. The noise was constant and stressful. Foreign exchange has evolved into hybrid market using software such as FENICS. It must be more bearable to trade foreign exchange now. The corporate bond market has several hybrid platforms such as MarketAxess and Tradeweb. Bank of America has created Instinct Loans, a marketplace that matches buyers and sellers of syndicated loans. IHS Markit offers a digital trade settlement platform for syndicated loans. IHS Markit automates workflows that improve efficiency. That platform is not a marketplace. It is used for post-trade settlement that gives structure to a complex, historically customized process. Voice communication is not required to settle loan transactions, but is still frequently used. Cryptocurrency market maker Cumberland (a unit of financial trading giant DRW) is modernizing the way it handles over-the-counter cryptocurrency trades with clients. Cumberland announced a “single-dealer platform” called Marea, allowing institutional investors to interact with Cumberland through a screen-based interface, rather than by negotiating trades telephonically.
Hybrid trading can cover a broad range of functionality. It goes beyond merely avoiding a voice conversation through email or chat. It involves at least some type of enabling software to define a market structure and transactional process. Think of web portals with defined work flows according to the rules of a marketplace. eBay is a good example. Sellers need to upload photos of the product they wish to sell and write a description in pre-defined fields.
A hybrid market’s best application is using software tools to partially automate trading and to provide visible structure to markets. Prior to hybridization, the structure of a financial market was stored in the minds of experienced traders and sales people. Knowing that market structure, these people use email, chat and voice communication to share market information and negotiate deals. One source of inefficiency that affects these experienced people is complex illiquid assets. For example, many loan traders will also occasionally trade vendor claims. The market for trade claims is highly cyclical. This cyclicality results in infrequent trading that makes it difficult for experienced loan traders to master the intricacies of claims trading. Because of this infrequency, it is difficult for them to develop expertise in trade claim specific issues, such as precisely defining a seller’s obligation to repay a buyer if the claim is objected to.
In theory, lack of standardization should not be a barrier to automation. With sufficient time and resources, any rules-based process can be expressed through software. However, creating a market structure that takes into account every possibility can result in a cumbersome user experience. This is particularly an issue for less liquid markets, where unlike eBay, there already exists an established voice marketplace. A voice conversation can appear to be the most time efficient way to occasionally trade non-standardized thinly traded assets. Why should a trader go through a complex interface when she only needs to transact a few times each year ? It’s easier to continue working through traditional voice conversations. The problem is that voice conversations are inefficient. Although picking up the phone is initially easy, that process can create an inefficient path to negotiating and closing deals. Experienced loan traders have standards and processes for getting deals done, that might not be suitable for trade claims. We believe that there is a latent demand for a hybrid market that focuses on trade claims that are easy to validate through due diligence.
Due Diligence and Marketability
As we pointed out above, “trade claim” is a catch-all that includes any claim in a bankruptcy case that is not for borrowed money. “Trade claims” can include claims of vendors, lessors, employees, personal injury and property damage plaintiffs. Despite this wide array, there are some common elements that allow for standardization of trade claim due diligence.
Bankruptcy law requires that a chapter 11 debtor publicly file a schedule of its creditors. This schedule is typically filed several months after the initial chapter 11 petition is filed. First Energy filed its schedules about two and a half months after its chapter 11 petition date. Sears filed its schedules about three months after its chapter 11 petition date. The schedules usually show the names of each creditor as well as the amount of their claim that is recognized as a valid payable by the debtor as of the chapter 11 petition date. In addition, schedules may classify the claim as either “contingent,” “unliquidated,” or “disputed.” “Contingent” means that something has to occur before the claim is allowed. “Unliquidated” means that the exact amount of the claim as not been determined yet. “Disputed” means that the debtor does not agree with the creditor on the amount of the claim.
Notable exceptions include Lehman where most claims resulted from financial swap terminations. Lehman’s schedules were filed nine months after the chapter 11 petition date. Because financial markets were dislocated in September 2008, it was unclear what market prices should have been used to calculate swap termination damages. As a result, most Lehman swap termination claims did not have amounts listed on the schedules.  Asbestos cases such as Owens Corning and Armstrong had large amounts of asbestos personal injury claims that were never listed on the schedules as a result of the disputed nature of those claims.
Schedules may be inaccurate. Information used to create schedules is often taken directly from a debtor’s accounts payable ledger as of the chapter 11 petition date. Amounts owed to creditors are often understated as a result of timing delays. For example, a debtor may have issued a paper check to one of its creditors that reduced the payable on the debtor’s books. However, the funds may never have cleared because of the bankruptcy. The creditor deposited the check, but it bounced and funds were never deposited into the creditor’s account. In this case there will be a mismatch between the schedules (e.g., $100,000) which reflect the issuance of a check (e.g., $20,000) prior to the petition date. The creditor’s records will correctly show what amount the debtor owes (e.g., $120,000). The creditor will typically file a proof of claim in the case for the higher amount.
A claim should be acknowledged by the debtor to be marketable. The debtor acknowledges claims by listing them on its schedules. General unsecured claims that are listed on a debtor’s schedules, and are not classified as “contingent,” “unliquidated,” or “disputed,” are accepted by investors as marketable claims. I estimate that approximately two-thirds of vendor claims in most chapter 11 bankruptcies fall into this category.
Figure 1: Illustrative Example of Claims in a Typical Bankruptcy Case:
Claims that are not marketable can often be corrected through reconciliation with the debtor. When the reconciliation process is completed, the creditor and debtor will often both sign an agreement that states the reconciled amount of the claim. This agreement is called a stipulation. Stipulated claims are preferred by investors because there is minimal risk that the face amount will change. Due diligence can be limited to a review of the language of the stipulation.
The limiting factors to pure electronic markets are complex non-standardized assets. We have seen curated marketplaces emerge in other specialized assets that address the problem of complexity by focusing on a narrow range of products. Swappa operates a marketplace for used smartphones and other consumer electronics. They focus mostly on used iPhones. Swappa curates its site by not allowing obsolete, or non-working phones to be listed on the main part of their website. As a result, they are able to offer fields and descriptions that are better suited to their product niche than a generic site like eBay. Similarly, the trade claims market needs a curated site where sellers of scheduled marketable claims can broadcast their offering to multiple qualified buyers.
Let’s review the current structure of the trade claims market in Figure 2 below. The price communication runs predominately from buyers to seller.
Figure 2: Current Market Structure
As you can see, in the current market structure, a claim seller does not have a clear view of the market and is not visible to all potential buyers. Sellers typically respond to individual buyer bids. In this type of bilateral market, a seller will typically sell to the buyer who contacts the seller first with an acceptable price. The problem with this structure is that sellers are selling too cheaply and leaving value on the table. It is very difficult for an episodic seller to find the best buyer in the current market structure.
Figure 3: Claims Market Structure
Claims Market optimizes the market structure for the benefit of sellers. It allows sellers to broadcast their claim offering instantly to multiple buyers. The price communication runs predominantly from seller to buyers.
In the Claims Market structure, a seller offers their claim through the website to all registered buyers. All buyers see the offer to sell. Buyers know they are competing with each other and will increase their prices accordingly. This change in market structure also shifts the advantage away from the buyer who is best at reaching a seller, to the buyer with the best price.
We view the market for claims as being two-tiered. The first tier is comprised of scheduled marketable claims that are well suited to Claims Market’s website. The second tier is comprised of claims that are either not vendor claims, or vendor claims that are neither listed on Schedule F, nor stipulated (see Figure 1, above). These claims might be marketable, but they are not suitable for a hybrid market because of the difficulty of performing “on-screen” diligence. There may be extensive information that a buyer needs to review. The seller may require a Non-Disclosure Agreement that needs to be separately negotiated. For complex transactions, where both seller and buyer retain outside counsel, negotiating an assignment of claim can be time consuming. This second tier is best served by the existing over-the-counter trade claims market. Cherokee Debt Acquisition, LLC (the administrator of Claims Market) is a leading buyer of complex claims in the over-the-counter trade claims market.
A Better Closing Process
One of the most frustrating aspects of selling a trade claim is not knowing when the buyer will make payment. There can be many reasons for this uncertainty: complex, unverified claims that require extensive diligence, legal counsel with little experience in selling trade claims, and buyer delays in preparing closing documents. Claims Market’s solution is to only list scheduled marketable claims and to disclose on our site a Simple Assignment of Claim that we encourage both sellers and buyers to use.
By focusing only on marketable claims that are either scheduled or stipulated, we eliminate diligence delays. Encouraging sellers and buyers to use the Simple Assignment of Claim agreement removes the greatest reason for delays. Lawyers are busy (and expensive). Different lawyers experienced in documenting claims transactions each use somewhat different assignment agreements that need to be negotiated. In a traditional transaction, if seller and buyer agree to a transaction on day 1, and the seller asks her lawyer to review the buyer’s assignment the same day, the seller’s lawyer might not start reviewing the assignment until day 2. The review might be completed on day 3. The buyer’s lawyer might start reviewing the seller lawyer’s changes on day 4. The buyer’s lawyer might need to consult their client. The client (buyer) might be busy and not be available until day 6. The seller’s lawyer might not receive the revised assignment until day 8. The revised assignment might not be signed by both parties until day 9. The buyer will then wire transfer funds to the seller on day 10. This timeline assumes neither lawyer needs to be in court on other matters, and there are no other unforeseen delays. As you can see, it does not take much to turn a 10 day illustrative closing process into a 15 to 20 day closing process. Diligence standards and transaction closing times can vary, leading to misunderstandings.
There is a better way. Claim Market’s Buyer’s Agreement (available on our website) obligates the buyer to close in 2 business days after confirming a transaction. How can a trade claim settle as fast as a stock ? The reason is that all the buyer’s diligence is completed before a transaction is confirmed. The greatest barriers to a hybrid market for claims is the difficulty buyers face with “on-screen” diligence and the friction of dealing with non-standard assignment agreements. The best way to resolve the “on-screen” diligence issue is to only list those claims that are acknowledged by a debtor as a result of being listed on the debtor’s schedules or by a stipulation with the debtor. Since each listed claim’s diligence information (schedule and proof of claim) is displayed on the site, a buyer can perform “on-screen” diligence before making a buy decision. If a seller agrees to use the Simple Assignment of Claim, the buyer does not need to review any transactional documents. At this point, the buyer has all the information she needs to make a decision to buy. If a seller has requested red-line changes to the Simple Assignment of Claim, the buyer only needs to focus on the red-lined changes.
Simple Assignment of Claim
Claims Market offers two straightforward document innovations. First, we created a “middle of the road” assignment called the Simple Assignment of Claim that fairly balances the interests of sellers and buyers. The Simple Assignment of Claim includes widely accepted provisions for dealing with the risk of claim disallowance and excess claim payments to sellers. We noticed that many claims buyers start with a buyer-friendly assignment, and sellers often request seller-friendly provisions to be included. After days (sometimes weeks) of back-and-forth negotiations, the parties typically end up with an assignment acceptable to both seller and buyer. Why not start with a fairly balanced assignment in the first place ? We developed the Simple Assignment of Claim to bypass the inefficiencies of the negotiating process and start with an assignment that will be acceptable to both parties. Other industries have also simplified previously arcane documents.
Second, we put the Simple Assignment of Claim on our website, so everyone can see it. This seems like common sense to us, but no one else does it. Many direct claims buyers don’t want sellers to see the fine print. They want to rush sellers into an agreement on price and then show them the assignment later. We think being transparent and open is a better way to do business.
Claims Market Economics
The market structure of Claims Market is designed for claim sellers. After a seller’s price is accepted by a buyer and a transaction is confirmed, the seller and buyer are introduced to each other. The key is that the closing occurs directly between seller and buyer. Claims Market is paid an administrative fee by the buyer. The seller pays no fees. There is no hidden spread. All parties to the transaction see what is being paid and who is paying. A lack of transparency leads to high transaction costs that result in less efficient markets and lower volumes. Market participants that might transact, choose not to because of the cost and difficulty of negotiating and closing deals. Transparent markets encourage lower transaction costs. We believe that lower transaction costs and higher volumes are better for all parties.
Building a Brand
The structure of the market for trade claims is highly concentrated. There are a large number of episodic sellers transacting with a small number of professional buyers. Because of this dispersion of sellers, it is rare for a seller and a buyer to transact more than once. Therefore it is difficult for buyers to build a favorable reputation. Without a favorable reputation, it is difficult for sellers to know much about who they are transacting with. We believe that the currently unstructured trade claims market has a latent need for a specialized marketplace that lists marketable claims offered to multiple buyers using a simplified assignment. In a market where sellers transact episodically with unfamiliar buyers, branding and reputation are critical.
Claims Market’s approach is to list only marketable claims that can be diligenced on-screen by viewing the debtor’s schedule and a proof of claim. By only listing marketable claims, we greatly reduce the diligence that a buyer needs to perform. Encouraging sellers to use the Simple Assignment of Claim and showing a red-line of changes to the Simple Assignment of Claim if requested by a seller, reduces the time a buyer needs to review the assignment. These two innovations allow buyers to agree contractually (by signing the Buyer’s Agreement) to pay the seller by wire transfer within two business days. We believe the transparency of documents and clear path to closing a sale will establish trust in the Claims Market brand.
 BGC Partners, Inc. 4Q2018 Investor Presentation, page 13
 eBay — how to sell https://pages.ebay.com/seller-center/get-started/selling-basics.html