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November 12, 2019 Practice Points

Tales from the Front: the Perils of Claims Trading

Cautionary tales from two recent cases.

By Andrew M. Toft

In the rush to close a transaction, particularly a small one, critical terms of pertinent documents are sometimes not read and analyzed as closely as they should be. The September 11, 2019 opinion from the U.S. District Court for the District of Delaware—and the Bankruptcy Court decision it affirms—provides a cautionary tale about the risks of failing to read and analyze the anti-assignment clauses of promissory notes before buying those notes. Contrarian Funds, LLC v Woodbridge Group of Companies, LLC, et al., Civ. No. 18-996-LPS (D.Del. September 11, 2019), affirming In re Woodbridge Group of Companies, LLC, 590 B.R. 99 (Bankr. D.Del. 2018)

In this case, one of the Woodbridge debtors issued three promissory notes to the Berlingers. All three notes had broad anti-assignment clauses. The anti-assignment clauses required the prior written consent of the maker Woodbridge for a transfer to occur. The clauses specifically stated that any attempted assignment without consent “shall be null and void.” Post-petition, the Berlingers sold, transferred and assigned all of their right, title and interest in the three promissory notes to Contrarian. This was done without obtaining Woodbridge’s consent. Believing it had a claim, Contrarian filed a proof of claim. The debtors objected. Ultimately, the debtors’ objection was sustained in the bankruptcy court and that decision was affirmed on appeal, with the district court relying to a great extent on Bankruptcy Judge Carey’s opinion.

Contrarian presented three main arguments to defend their claim—all of which failed to persuade:

  1. Contrarian argued anti-assignment provisions are unenforceable under Delaware law. Both the District Court and the Bankruptcy Court, however, found that Delaware law allowed for the enforcement of anti-assignment clauses, though such clauses had to be express and would be narrowly construed. In the face of the clear and unambiguous language of the promissory notes, the courts found Contrarian’s arguments that it was merely being assigned “claims” or “causes of action” to be without merit.
  2. Contrarian argued the debtors’ breach by failing to pay the notes barred the debtors from enforcing the anti-assignment clauses, an argument both judicial opinions disposed of fairly quickly, finding it “axiomatic” that a party does not pick up more rights post-breach that it had before any breach occurred.
  3. Contrarian argued that Section 9-408 of the Uniform Commercial Code invalidated the anti-assignment clauses because the consent of the maker of the notes was required for assignment. This argument failed because 9-408 deals with restrictions on security interests in promissory notes, not the notes themselves. Further, Contrarian’s argument would render 9-406 superfluous, thus violating a rule of statutory construction. While 9-406 does prohibit restrictions on assignment in promissory notes, such prohibitions did not apply, as was relevant here, to the sale of a promissory note.

What We Can Learn

  • From the creditors’ or claims purchasers’ perspective: Even though it seems obvious: Read the terms of the documents being sold/purchased. An hour reviewing and analyzing the anti-assignment clause would clearly have been less expensive than the subsequent drafting of bankruptcy court pleadings and briefs in the district court. If a client knowingly accepts a risk of not conducting that review, that is the client’s decision. But if not, the client may be very unhappy.
  • From the debtor’s perspective: This case is also a lesson for those who draft promissory notes and do not want them to be assignable. The two opinions provide a roadmap for drafting anti-assignment clauses so they will be deemed effective in later litigation.

Andrew M. Toft is an attorney in Denver, Colorado.

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