Traders in claims of bankruptcy debtors should take note of a recent Delaware Bankruptcy Court decision that prevents the transfer of claims when the underlying debt instrument prohibited the transfer without the borrower’s consent. In In re Woodbridge Group of Companies, LLC, et al. No. 17-12560 (KJC), (Bankr. Del. June 20, 2018) (http://www.deb.uscourts.gov/sites/default/files/opinions/judge-kevin-j-carey/woodbridge-contrarian-opinion-and-order.pdf), the court held that an anti-assignment provision in a group of promissory notes was enforceable, and Contrarian, the purchaser of the notes, could not file a proof of claim as holder of the notes. While the decision focused, in part, on the specific anti-assignment language in the notes, it has broader applicability, and traders should make sure to do careful legal due diligence when buying claims.
The facts of Woodbridge are straightforward. Prior to the bankruptcy, one of the debtors issued three notes to Elissa and Joseph Berlinger. Each of the notes had an anti-assignment clause, which provided that the notes were not assignable “without the Borrower’s written consent and any such attempted assignment without such consent shall be null and void.” In addition, the loan agreement referenced in the Notes similarly provided that “Lender shall not assign, voluntarily, by operation of law or otherwise, any of its rights hereunder without the prior written consent of Woodbridge and any such attempted assignment without such consent shall be null and void.”
The Woodbridge debtors filed for chapter 11 bankruptcy protection on December 4, 2017. Two months later, the Berlingers entered into an agreement under which the Berlingers would “sell, convey, transfer and assign” the notes and the rights thereunder to Contrarian. On March 1, 2018, Contrarian filed proofs of claim in the debtors’ cases, asserting a secured claim based on the notes. The debtors objected, arguing that the assignment violated the terms of the notes and loan agreement and Contrarian had no right to file a proof of claim. The bankruptcy court upheld the debtors’ objection and ruled that (i) the transfer of the notes was void and (ii) that Contrarian was not entitled to file a proof of claim.
The Woodbridge Court went through a three-part analysis in reaching its decision. First, the court noted that Delaware law generally favors assignability and therefore narrowly construes anti-assignment provisions. But the court also explained that narrow construction is not the same as “wholesale obliteration” of all transfer restrictions, and Delaware law looks to whether what is prohibited is the right or the power to assign without consent. As a result, the court focused on the distinction between (i) contractual language that merely makes a prohibited transfer a breach and (ii) language that voids any prohibited transfer ab initio. In the Woodbridge case, the notes and loan agreement expressly provided that a transfer without the borrower’s consent was not just prohibited but also void. In re Woodbridge, at 2. Second, the Woodbridge Court rejected the argument that the debtors’ breach of the notes, e.g., the filing of bankruptcy and the non-payment, eviscerated the anti-assignment provisions of the notes. The Woodbridge Court found that the debtor’s breach did not make the other provisions of the note, including the anti-assignment provisions, unenforceable and that “a non-breaching party may not emerge post-breach with more rights than it had pre-breach.” In re Woodbridge, at 7. In other words, Contrarian could not both seek payment on the notes and ignore the anti-assignment provisions, just because the debtors had defaulted under the notes. Finally, the Woodbridge Court dispatched Contrarian’s UCC-based arguments as inapplicable. As a result, the transfer was voided and Contrarian was left with no right to file a claim.
The Woodbridge Court was unconcerned that its decision might cause disruption in the market for the trading of bankruptcy claims. As the Court noted, traders are sophisticated and fully capable of performing their own due diligence. The Woodbridge Court’s advice should be taken seriously: market participants need to conduct careful legal due diligence before buying a claim. While most sophisticated loan agreements strip away the borrower’s rights to block a transfer once the borrower has defaulted, that provision is less common in bespoke transactions and one-off loan agreements. Moreover, anti-assignment provisions differ in whether they treat a violation as a mere breach or as void and ineffective and so must be carefully scrutinized. In addition, claims purchasers should make sure they (and any predecessor buyers) have strictly complied with the transfer provisions and restrictions of the underlying agreements which can vary widely. For all these reasons legal due diligence should be done as early as possible. Finally, but not least importantly, traders should ensure their documentation allows them to elect to treat the transaction as a participation – something the Woodbridge court did not address or prohibit – rather than as an assignment and to instruct the seller to file a proof of claim for the benefit of the buyer if necessary. In short, post-Woodbridge, claims traders must be even more attentive to their legal due diligence, compliance with the terms of the underlying instruments and trade documentation.
 In a subsequent ruling, the Woodbridge Court granted the Berlingers leave to file their own proofs of claim (subject to the debtors rights to object).