What is 'claims trading' in the context of bankruptcy, and when did it start?

Claims trading refers to the buying and selling of claims against bankrupt companies in a secondary market. This practice emerged after the Bankruptcy Act of 1978, allowing creditors to sell their rights to investors who then participate in negotiations. While some view claims trading as a way to streamline bankruptcy proceedings, others worry it introduces instability and conflict due to the involvement of activist investors.

What are the main concerns of those who oppose claims trading in bankruptcy cases?

Critics of claims trading argue that it can destabilize the bankruptcy negotiation process. They are concerned that the entry of new creditors, especially activist investors, can disrupt ongoing negotiations and potentially lead to increased litigation. These critics often advocate for increased disclosure requirements for claims traders to mitigate these potential negative impacts on Chapter 11 bankruptcy cases.

What arguments do proponents of claims trading use to defend the practice?

Proponents of claims trading suggest that it can enhance bargaining efficiency by consolidating smaller claims into larger holdings, enabling activist investors to participate in the firm's capital structure. This perspective views the increased transparency and disclosure requested by critics as potentially detrimental, as it could chill the market for distressed debt and reduce the benefits derived from claims trading.

What does empirical data reveal about the actual impact of claims trading on bankruptcy cases?

Empirical data suggests that while heavy claims trading is common in large Chapter 11 cases, its negative impact on bankruptcy governance might be overstated. Activist groups often acquire a significant portion of the bond issue early in the bankruptcy process and remain relatively stable throughout. However, the data also indicates that claims trading is linked to a higher likelihood of litigation, particularly at the beginning of bankruptcy proceedings.

Is claims trading truly disruptive to bankruptcy proceedings, or is its impact more nuanced than commonly believed?

The impact of claims trading can vary depending on the specific circumstances of a bankruptcy case. While it can complicate negotiations by introducing new parties and potentially increasing litigation, it can also facilitate the process by consolidating claims and bringing in investors with expertise in distressed debt. Observed activist entry isn't a perfect indicator of changes in the creditor body, and important changes may be missed. The findings should satisfy neither critics nor proponents of bankruptcy claims trading fully, indicating a nuanced relationship between claims trading and bankruptcy outcomes.

Chessboard with financial documents and distressed investors as pawns

Bankruptcy Claims Trading: Is It Really Disruptive?

Mira Elwood in Law & Justice June 2025 • 4 min read.

"Unpacking the truth behind claims trading in bankruptcy cases: Does it help or hinder the process?"

The buying and selling of bankruptcy claims has been a hot topic among legal experts and scholars for over two decades. It all started with the Bankruptcy Act of 1978, which set up a system where creditors and shareholders could hash out financial problems with company management. But then, in the late 20th century, a new market emerged: a secondary market for claims against bankrupt companies. This allowed creditors to bow out of negotiations and sell their claims to investors who would then take their place at the bargaining table.

This development, as described by Levitin (2010), has been a game-changer since the original Bankruptcy Code. However, it's sparked controversy. Many worry that this trading makes Chapter 11 bankruptcies more challenging, as managers find themselves dealing with a constantly changing group of investors. In fact, the American Bankruptcy Institute even debated whether new regulations were needed to address these concerns.

In this article, we'll explore the role of claims trading in bankruptcy cases, providing an empirical study of trading in the financial claims. While the debate among academics and lawyers is well-known, there's a lack of solid data to bring claims trading into focus. The results show that claims trading is indeed a significant part of most large bankruptcy cases, but its impact may not be as negative as some critics fear.

Decoding Claims Trading: Facts, Fears, and Market Realities

Chessboard with financial documents and distressed investors as pawns

Critics are concerned that claims trading could destabilize the bankruptcy negotiation process. Bankruptcy law relies on difficult negotiations to reorganize a company. A new creditor can restart negotiations, leading to more conflict and potential litigation. The worry here is activist investors influencing the bankruptcy case. These critics want Congress to increase disclosure requirements for claims traders.

On the other hand, some argue that claims trading makes bargaining more efficient. They say it consolidates smaller claims into larger holdings and allows activist investors to enter the firm's capital structure, benefiting the process. Increased transparency and disclosure might chill the market for distressed debt, reducing the benefits of claims trading.

Heavy claims trading is common in large Chapter 11 cases.
Activist groups tend to appear early in bankruptcy cases and remain stable.
Cases with late activist appearances often show the most improvement in industry conditions.
Claims trading is linked to higher litigation likelihood, especially at the start of bankruptcy.

The data indicates that fears about claims trading's impact on bankruptcy governance might be overblown, especially in the average case. When activist investors are involved, they often own most of the bond issue, likely acquired before or early in the bankruptcy. These groups remain fairly stable throughout the process.

Final Thoughts: Navigating the Nuances of Claims Trading

The findings should satisfy neither critics nor proponents of bankruptcy claims trading fully. Both sides have valid points, and claims trading can complicate or facilitate bankruptcy depending on the circumstances. However, the evidence suggests that the negative impacts of claims trading on bankruptcy outcomes may be overstated. Observed activist entry isn't a perfect indicator of changes in the creditor body, and important changes may be missed. Claim trading is a pervasive feature of Chapter 11.