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Longacre v. ATS: Reservation of Right to Object Sufficient for Claim Impairment
Practical Law Legal Update 3-521-6423 (Approx. 4 pages)
Longacre v. ATS: Reservation of Right to Object Sufficient for Claim Impairment
by PLC Finance and Practical Law Bankruptcy & Restructuring
| Published on 04 Oct 2012 • USA (National/Federal) |
The US Court of Appeals for the Second Circuit found in Longacre v. ATS that a claim was impaired within the meaning of the claim purchase agreement, even though the debtor only reserved its right to object to the claim.
On September 14, 2012, the US Court of Appeals for the Second Circuit, in Longacre Master Fund, Ltd. v. ATS Automation Tooling Systems Inc., held that a bankruptcy claim was sufficiently impaired within the meaning of the claim purchase agreement under which it was sold by seller ATS Automation Tooling Systems Inc. (ATS) to buyer Longacre Capital Partners (QP) L.P. (Longacre), even though the debtor, Delphi Automotive Systems (Delphi), only reserved its right to object to the claim in the applicable omnibus claims objection.
Background
The claim purchase agreement required Longacre to refund the purchase amount to ATS, with interest, if:
- Any objections to the claim were filed that amounted to an impairment or possible impairment.
- Those objections were not resolved within:
- 180 days of the date the objection was filed; or
- a reasonable time thereafter.
This is a common risk allocation provision in bankruptcy claims purchase documents because unresolved objections hinder the ability to transfer or obtain payment on a claim.
Longacre alleged that:
- Delphi's objection constituted an impairment under the purchase agreement, which occurred "when all or any part of the Claim is objected to in whole or in part for any reason whatsoever, pursuant to an order of the Bankruptcy Court."
- ATS breached its warranty under the purchase agreement that, to the best of its knowledge, the claim was not subject to any defense, claim or right of setoff, reduction, impairment, avoidance, disallowance, subordination or preference action.
Longacre sought indemnification from ATS under the claim purchase agreement based on the above alleged breaches.
Key Litigated Issues
The issues considered by the Second Circuit were whether:
- ATS's obligations to refund the purchase price were triggered by an objection that constituted a reservation of rights.
- ATS breached its representations and warranties concerning its knowledge of potential preference actions related to the claim.
Outcome
District Court
The US District Court for the Southern District of New York granted ATS's motion for summary judgment, reasoning that Delphi's objection did not constitute an impairment or possible impairment because the omnibus claims objection only preserved Delphi's right to object to the claim under section 502(d) of the Bankruptcy Code. Therefore, the objection did not attach to or encumber the claim itself. Section 502(d), among other things, permits an objection to claims held by creditors who have received voidable preference payments.
The District Court also found that there was no material issue of fact on whether ATS had knowledge of a possible preference action. It reasoned that because the preference action and related objections were not meritorious, ATS had no reason to believe that the claim would become impaired.
Therefore, the District Court found that the indemnification clause in the claim purchase agreement was not triggered because ATS had not breached its obligations under the agreement.
Second Circuit
The Second Circuit vacated the District Court's holdings, finding that Delphi's reservation of its right to object to the claim in the omnibus objection constituted an impairment as defined by the plain language of the claim purchase agreement. It also held that repurchase provisions of the agreement did not require the objection to be meritorious for the claim to be impaired. Therefore, when Delphi filed its omnibus claims objection and the bankruptcy court issued an order stating that the objection was preserved, ATS's obligations to refund the purchase price to Longacre under the purchase agreement were triggered.
The Second Circuit also found that the District Court erred in finding that there were no material issues of fact regarding ATS's alleged breach of warranty. Delphi had made a $17.3 million payment to ATS within the 90-day period before its bankruptcy filing. Therefore, the possibility existed that a preference action may impair the claim that was sold to Longacre.
The Second Circuit remanded the case to the District Court to determine whether the objection to the claim had been resolved within a reasonable amount of time after the 180-day period had passed. If so, the claim cannot be impaired under the terms of the claim purchase agreement and the repurchase obligation cannot be triggered.
Practical Implications
The Second Circuit's broad reading of the repurchase provisions of the claim purchase agreement reaffirms the bankruptcy claim market's expectations that contractual risk allocation provisions in bankruptcy claims purchase documents are enforceable.
However, to avoid the expense of litigation, both the purchaser and seller should take extra care when drafting the purchase agreement to ensure that the allocation of risk is clear. For instance, the contract language in this case could have more explicitly included in the definition of impairment any reservation of rights to object. Generally buyers should ensure that risk allocation provisions are broad enough to cover any existing or possible impairments that may affect their right to receive a timely distribution on the claim. They should also ensure that the seller's representations and warranties clearly guarantee the validity of the face amount of the claim both on and after the effective date of the claim purchase.