On September 11, 2019, the Delaware district court affirmed the bankruptcy court's decision to expunge a proof of claim filed by a claims trader in the Woodbridge Group of Companies, LLC bankruptcy case. The court's holding was based on three primary legal conclusions: (1) the anti assignment provisions in the underlying loan agreements and promissory notes were enforceable under Delaware law; (2) the debtors' pre-petition breach of the loan agreements did not bar the debtors from relying on the anti-assignment provisions; and (3) the Uniform Commercial Code ("UCC") did not render the anti-assignment provisions unenforceable. This decision could have a major impact on the claims trading business and should be closely examined and analyzed by claims traders.

I. Background

Prior to the petition date, the debtors executed three promissory notes and loan agreements in favor of Elissa and Joseph Berlinger, each of which contained anti-assignment provisions. Specifically, the provisions held that none of the documents could be assigned without the debtors' written consent and that any assignment without the debtors' consent would be null and void. Approximately two months after the debtors filed their voluntary petitions, Contrarian Funds, LLC ("Contrarian") purchased the notes and loan agreements, executed a transfer of claim agreement and filed a transfer notice in the bankruptcy cases. Approximately two weeks later, Contrarian filed a proof of claim in the amount of the outstanding notes. Soon thereafter, the debtors filed an objection to Contrarian's claim, which was sustained by the bankruptcy court without prejudice to the right of the Berlingers to file a proof of claim related to the notes. Contrarian timely appealed the decision to the district court.

II. Enforceability of Anti-Assignment Provisions

Contrarian first argued that Rule 3001(e) of the Federal Rules of Bankruptcy Procedure set out a "policy of free assignability" and that this policy gave Contrarian the right to file a claim based on the notes and loan agreements. The district court rejected the implicit argument that Rule 3001(e) precluded the court from determining whether applicable non-bankruptcy law restricted the transfer of claims. Instead, the court held that Rule 3001(e) merely recognizes that claims trading occurs and provides procedures for such transfers.

The court continued by comparing the difference of a counterparty's power to assign versus their right to assign. Although Delaware courts construe anti-assignment provisions narrowly in order to foster the tenet of free assignability, "[w]hen a provision restricts a party's power to assign, it renders any assignment void." A clause prohibits the power to assign when there is express language that any subsequent assignment will be void or invalid. The court held that "[w]ithout such express language, the contract merely restricts the right to assign," making the assignment valid and generating a breach of contract action against the party that assigned their interest. Because the notes and agreements here contained express language prohibiting assignment without the debtors' consent and stated that any assignment without the debtors' consent would be null and void, the court held that the assignment was void and invalid.

Contrarian also argued that according to Section 322(1) of the Restatement (Second) of Contracts, the anti-assignment provisions in the notes and agreements only prohibited assigning the contracts themselves, not claims arising from such contracts. However, relying on the Comment to Section 322(2), the court explained that the debtors and Berlingers intended for the anti-assignment provisions to forbid assigning both the contracts and any claims related thereto.

III. Impact of Debtors' Breach on Anti-Assignment Provisions

Although the debtors failed pre-petition to pay principal and interest due on the promissory notes, thus breaching the agreements, the court held that such breach did not mean that the debtors had waived, and could not enforce, the anti-assignment provisions.

IV. UCC and Anti-Assignment Provisions

Finally, the district court rejected Contrarian's argument that Section 9-408(a) of the UCC renders the anti-assignment provisions unenforceable. First, the court held that Section 9-408(a) applies only to the transfer of a security interest arising out of a sale of a promissory note, not the sale of a note. Second, the court rejected Contrarian's argument that the purchase of a promissory note is always a "security interest," holding that because Contrarian did not lend money to the Berringers for which the repayment obligation is secured by the Berlingers' interest in the promissory notes, Contrarian did not hold any security interest. Third, the court looked to Section 9-406 of the UCC which permits anti-assignment provisions when enforced in the context of a promissory note sale. In short, Section 9-408 applies only to transfers of a security interest in a promissory note, not an outright sale of a promissory note, as was the case here.

V. Takeaways

Courts have long held that under Delaware law a party may not purchase and file a claim where the transferor's contract with the debtor restricts the transferor's power to assign. Claim purchasers should take heed and carefully review the underlying contracts they are purchasing for such anti-assignment provisions. At a minimum, transferors must have the power to assign the contracts, and thereby the claims, to the claims trader. Yet, if a purchaser realizes after the sale that their contract has an anti assignment provision, courts have kept the door open for claim traders to enter into agreements with the original creditor whereby the creditor will file their own proof of claim and thereafter remit any recovery to the claims trader. Moving forward, claims traders should diligently review the documents underlying a creditor's claim to ensure that no anti assignment provisions bar the claims trader's attempt to purchase a claim.

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