ABC's - An Alternative to Bankruptcy Liquidations
April 27, 2023
ASSIGNMENTS FOR THE BENEFIT OF CREDITORS
An Alternative to Chapter 11 and Chapter 7 Liquidations
Distressed companies faced with unlikely prospects for reorganization often take advantage of the liquidation option via bankruptcy, where the debtor’s assets can be sold free and clear of all liens, claims, and encumbrances.
In a Chapter 7 bankruptcy liquidation, a trustee is appointed to liquidate assets, taking a commission. In a Chapter 11 liquidation, ownership or management typically continues operating the business throughout the bankruptcy process, whether in a reorganization or liquidation.
A state-law alternative to a federal bankruptcy liquidation, known as an assignment for the benefit of creditors (ABC), can facilitate a business liquidation without many of the time-consuming delays, complications, or added costs associated with the federal bankruptcy process. In Colorado, for example, ABCs have few formal requirements, which allows for a quick sale process.
What is and is not an ABC?
An ABC is not an appropriate vehicle for a company looking to reorganize. By contrast to a bankruptcy case, no automatic stay is imposed to limit creditor action upon the commencement of an ABC.
An ABC also will not discharge any debt or liability that is not repaid in full. What the ABC can do for the debtor and insiders, if properly managed by the assignee, is diminish creditors’ concerns that the board or management is standing in the way of recovering value for creditors, while the assignee sets about doing just that. Additionally, an ABC is often a good option for distressed companies with debt that is largely unsecured.
ABC’s have long existed in law and are usually addressed in state statutes. A simple and accurate way to think of an ABC is as a trust agreement whereby the owner of a distressed company irrevocably transfers title, custody, and control of its assets to an impartial third party, the assignee. The assignee is entrusted with the assets and has duties to liquidate the assets in an efficient, orderly manner and distribute net proceeds to creditors on a pro rata basis, subject to court approval. The court approval process can vary greatly from state to state.
When might an ABC make more sense that a liquidating bankruptcy?
An ABC is a liquidation vehicle. It is not a process by which a company can reorganize, obtain a discharge, or otherwise emerge from insolvency. Thus, the company’s board of directors, officers, and investors need to accept that their control over the company and its assets will cease following commencement of an ABC. In addition, shareholder equity will have no value unless there is money left to distribute after the costs of the ABC are funded and all creditors have been paid in full.
Factors that drive a company to consider an ABC typically include:
Negative cash burn coupled with an inability to raise additional debt financing or equity investment.
An unwillingness by current lenders to extend loan/forbearance periods and confirmation that no further loan advances will be made.
Increasing risk for board members and officers that cash will be insufficient to handle key fiduciary items at wind down (e.g., accrued payroll, vacation, taxes, etc.).
A more realistic assessment of the lack of value of the company and/or its assets, particularly relative to its debt or ability to continue to function as an operating entity (i.e., an unsuccessful M&A process has occurred)
Benefits and Limitations
While every situation must be evaluated independently, an ABC offers many strategic benefits to companies, boards, and other stakeholders. It allows the company to select an assignee with appropriate industry expertise to conduct the liquidation process, resulting in a greater opportunity to maximize the value of the assets.
Second, the assignee is responsible for the sales process and any risks associated with it. Board members and officers are not parties to the sale of the assets from an ABC. Any such sale or liquidation is conducted by the assignee, an independent fiduciary for the benefit of creditors who takes no direction from the assignor’s board or officers. Therefore, any attempted attack or claim by a creditor of the assignor or other interested stakeholder concerning the process or ultimate terms should lack merit and be dismissed by the court.
Third, ABCs tend to have lower administrative costs than Chapter 11 filings due to less extensive court filings (or no filings, depending on the jurisdiction) and the lack of a creditors’ committee.
Fourth, certain investor groups or board members may prefer an ABC to a federal bankruptcy filing due to the lower visibility of an ABC.
Finally, secured creditors generally support an ABC if they believe that the budget for the process is reasonable and that the assignee will return proceeds in a timely manner post-ABC after investigating and validating the creditors’ secured position.
An ABC does have challenges and limitations that should be understood by the board of directors and officers of a company as they consider the most appropriate insolvency process to undertake. While ABC law varies from state to state, there are a few common limitations.
First, an assignee cannot use the collateral of secured creditors without their consent. Therefore, secured creditors have significant leverage in an ABC in regards to the budgeting process. While the budgeting process may be similar to a Chapter 11 cash collateral process, there may be no judge to hear disputes in an ABC. Therefore, the assignee may be more accommodating to secured creditors in an ABC than a debtor might be in a Chapter 11.
Second, a buyer cannot assume any of the secured debt in an ABC sale without the consent of the secured creditor. Similarly, there is no cramdown opportunity (or forced loan extension) of secured debt in an ABC, as is possible in a confirmed plan of reorganization or liquidation in Chapter 11.
Third, with limited exceptions, there is no automatic stay in an ABC. While the ABC transfers the assets out of the assignor and therefore post-ABC judgments may have no practical value or impact, litigation can continue against the assignor, and the assignee typically has neither the funding nor the economic motivation to defend the assignor against any litigation. In addition, hostile creditors may decide to shift their focus to other stakeholders (i.e., board members or officers in their capacity as guarantors or fiduciaries) if they believe there will likely be no return for them from the ABC estate.
Fourth, an assignee has no rights to assign executory contracts or leases beyond those granted by the contract terms, as is possible in bankruptcy, and seeking consents of counterparties to assign contracts or leases to a buyer of assets from an ABC estate can be a laborious process. If such contracts are numerous or favorable to the assignor, the assignee may be unable to obtain the required consents. That, in turn, may reduce the purchase price or prevent a sale from closing because an ABC does not provide a mechanism to capture the above-market value of any executory contract or lease for the benefit of creditors, absent consent of the counterparties, as Chapter 11 does.
Finally, assignees in most states, including Colorado, cannot provide free-and-clear sale orders. What a buyer of assets in an ABC typically obtains, along with the sale documents, is a bill of sale from the assignee. A bill of sale, particularly from an assignee who is a well-known and well-regarded fiduciary, is a very powerful document from the perspective of creditor protection, successor liability, etc., but it does not have the same force and effect as a free-and-clear sale order from a bankruptcy court.
To authorize an ABC properly, the debtor must abide by the requirements of its corporate documents (an LLC operating agreement articles of incorporation, etc.), as well as applicable state law.
Before accepting the assignment, the prospective assignee will typically review certain aspects of the debtor, including:
The accuracy and completeness of the debtor’s information to be used to document the inventory of assets and liabilities, and analysis of viability, liquidity, and prospects for recovery of value under various scenarios;
Potential environmental risks, if real estate assets are involved;
A determination of whether the assignee will need specific approvals or licenses to operate the business or liquidate its assets; and
The existence of liens and the status of their perfection. If one or more properly perfected liens on the substantial assets of the debtor are found, the prospective assignee will likely agree to become the assignee only with approval of secured creditors.
The choice of assignee is not subject to approval by creditors, but the creditors may be able to challenge the choice if the assignee fails to properly fulfill its fiduciary duties to creditors. ABCs generally commence at the time of the assignee’s acceptance of the debtor’s assignment of its distressed assets, which must be evidenced by a written agreement, typically in the form of a trust or similar arrangement.
The assignee is required to give notice of the assignment to all of the debtor-assignee’s creditors, equity holders, and other parties of interest, such as taxing authorities. The ABC trust is legally distinct from the pre-assignment debtor. Therefore, judgments or garnishments obtained or liens filed against the debtor-assignor after the assignment has occurred generally do not attach to the assets held in trust by the assignee.
To maximize the value of assets distributed to creditors, the assignee may operate the business (if it remains in business) for a period of time prior to selling the assets. Operating the business makes sense if the expected increase in recovery outweighs the additional costs of operating the business; however this option is subject to the availability of sufficient liquidity. An “operating” ABC can make sense where, for example, there is:
A need to complete work in process or confirmed customer orders;
An ability to hold going-out-of-business sales, as is often the case with retailers; or
A serious buyer looking to purchase a going concern.
When operations have ceased before the assignment is made, or they are stopped by the assignee, assets can be liquidated through various means, including an auction or a negotiated sale. If the assignee decides to hold an auction, the assignee must provide notice of the auction to creditors and other parties in interest. Potential buyers will typically buy only if they can do so “free and clear” of liens on the assets being bought. For this reason, an assignment for the benefit of creditors is often done in compliance with personal property foreclosure procedures set forth in Article 9 of the Uniform Commercial Code.
Distribution of sale proceeds and administrative duties
The goal of every ABC process is to maximize distributions to creditors. An assignee handles the administrative tasks associated with:
Noticing creditors of the commencement of the ABC and the deadline for filing claims against the ABC estate.
Distributing funds to creditors.
Winding down the assignor.
Shortly after the commencement of the ABC, the assignee sends a notice of the ABC to all creditors, shareholders, and other interested parties, accompanied by a proof of claim form that allows any person or entity to submit a claim to the assignee. The assignee is responsible for reviewing submitted claims and verifying their validity, and may also object to unsupported claims.
If funds are available for distribution to creditors, the assignee is required to distribute them in accordance with the priority schedule established under applicable state law, which is a similar concept to the creditor priorities in a bankruptcy proceeding. If disputes arise between two creditor classes or within a single creditor class, then the assignee attempts to resolve them in a manner that is cost efficient for the ABC or through a declaratory relief lawsuit in state court. Certain state laws may impact the distribution priority scheme and should be reviewed as part of the distribution process.
The assignee generally handles wind down tasks, such as retention of accountants to prepare final tax returns of the assignor, closing 401(k) plans, storage of books and records, cleanup and return of facilities to landlords, and return of leased equipment. These are tasks that the company’s officers and board are often not well-suited to handle. After payment of claims and any open issues concerning the ABC are resolved, the ABC and associated trust are terminated.