An assignment for the benefit of creditors (ABC) is a business liquidation device available to an insolvent debtor as an alternative to formal bankruptcy proceedings. In many instances, an ABC can be the most advantageous and graceful exit strategy. This is especially true where the goals are (1) to transfer the assets of the troubled business to an acquiring entity free of the unsecured debt incurred by the transferor and (2) to wind down the company in a manner designed to minimize negative publicity and potential liability for directors and management.
The option of making an ABC is available on a state-by-state basis. During the meltdown suffered in the dot-com and technology business sectors in the early 2000s, California became the capital of ABCs. In discussing assignments for the benefit of creditors, this article will focus primarily on California ABC law.
The process of an ABC is initiated by the distressed entity (assignor) entering an agreement with the party which will be responsible for conducting the wind-down and/or liquidation or going concern sale (assignee) in a fiduciary capacity for the benefit of the assignor’s creditors. The assignment agreement is a contract under which the assignor transfers all of its right, title, interest in, and custody and control of its property to the third-party assignee in trust. The assignee liquidates the property and distributes the proceeds to the assignor’s creditors.
In order to commence the ABC process, a distressed corporation will generally need to obtain both board of director authorization and shareholder approval. While this requirement is dictated by applicable state law, the ABC constitutes a transfer of all of the assignor’s assets to the assignee, and the law of many states provides that the transfer of all of a corporation’s assets is subject to shareholder approval. In contrast, shareholder approval is not required in order for a corporation to file a petition commencing a federal bankruptcy case. In some instances, the shareholder approval requirement for an ABC can be an impediment to the quick action ordinarily available in the context of an ABC, especially when a public company is involved as the assignor.
The board of directors of an insolvent company (a company with debt exceeding the value of its assets) should be particularly attentive to avoiding harm to the value of the enterprise and the interests of creditors. Under Delaware law, for example, the obligation is to maximize the value of the enterprise, which should result in protecting the interests of creditors.
It is not unusual for the board of a troubled company to determine that a going concern sale of the company’s business is in the best interests of the company and its creditors. However, generally the purchaser will not acquire the business if the assumption of the company’s unsecured debt is involved. Further, often the situation is deteriorating rapidly. The company may be burning through its cash reserves and in danger of losing key employees who are aware of its financial difficulties, and creditors of the company are pressing for payment. Under these circumstances, the company’s board may conclude than an ABC is the most appropriate course of action.
The Alternative of Voluntary Federal Bankruptcy Cases
Chapter 7 bankruptcy provides a procedure for the orderly liquidation of the assets of the debtor and the ultimate payment of creditors in the order of priority set forth in the U.S. Bankruptcy Code. Upon the filing of a Chapter 7 petition, a trustee is appointed who is charged with marshaling all of the assets of the debtor, liquidating the assets, and eventually distributing the proceeds of the liquidation to the debtor’s creditors. The process can take many months or even years and is governed by detailed statutory requirements.
Chapter 11 of the Bankruptcy Code provides a framework for a formal, court-supervised business reorganization. While the primary goals of Chapter 11 are rehabilitation of the debtor, equality of treatment of creditors holding claims of the same priority, and maximization of the value of the bankruptcy estate, Chapter 11 can be used to implement a liquidation of the debtor. Unlike the traditional common law assignment for the benefit of creditors (assignments are governed by state law and may differ from state to state), Chapter 7 and Chapter 11 bankruptcy cases are presided over by a federal bankruptcy judge and are governed by a detailed federal statute.
Advantages of an ABC
The common law assignment by simple transfer in trust, in many cases, is a superior liquidation mechanism when compared to using the more cumbersome statutory procedures governing a formal Chapter 7 bankruptcy liquidation case or a liquidating Chapter 11 case. Compared to bankruptcy liquidation, assignments may involve less administrative expense and are a substantially faster and more flexible liquidation process. In addition, unlike a Chapter 7 liquidation, where generally an unknown trustee will be appointed to administer the liquidation process, in an ABC the assignor can select an assignee with appropriate experience and expertise to conduct the wind-down of its business and liquidation of its assets. In prepackaged ABCs, where an immediate going concern sale will be implemented, the assignee will be involved prior to the ABC going effective. Further, in states that have adopted the common law ABC process, court procedures, requirements, and oversight are not involved. In contrast, in bankruptcy cases, the judicial process is invoked and brings with it additional uncertainty and complications, including players whose identity is unknown at the time the bankruptcy petition is filed, expense, and likely delay.
In situations where a company is burdened with debt that makes a merger or acquisition infeasible, an ABC can be the most efficient, effective, and desirable means of effectuating a favorable transaction and addressing the debt. The assignment process enables the assignee to sell the assignor’s assets free of the unsecured debt that burdened the company. Unlike bankruptcy, where the publicity for the company and its officers and directors will be negative, in an assignment, the press generally reads “assets of Oldco acquired by Newco,” instead of “Oldco files bankruptcy” or “Oldco shuts its doors.” Moreover, the assignment process removes from the board of directors and management of the troubled company the responsibility for and burden of winding down the business and disposing of the assets.
From a buyer’s perspective, acquiring a going concern business or the specific assets of a distressed entity from an Assignee in an ABC sale transaction provides some important advantages. Most sophisticated buyers will not acquire an ongoing business or substantial assets from a financially distressed entity with outstanding unsecured debt, unless the assets are cleansed either through an ABC or bankruptcy process. Such buyers are generally unwilling to subject themselves to potential contentions that the assets were acquired as part of a fraudulent transfer and/or that they are a successor to or subject to successor liability for claims against the distressed entity. Buying a going concern or specified assets from an assignee allows the purchaser to avoid these types of contentions and issues and to obtain the assets free of the assignor’s unsecured debt. Creditors of the assignor simply must submit proofs of claim to the assignee and will ultimately receive payment by the assignee from the proceeds of the assignment estate. Moreover, compared to a bankruptcy case, where numerous unknown parties (e.g., the bankruptcy trustee, the bankruptcy judge, the U.S. trustee, an unsecured creditors’ committee, and possibly others) will become part of the process and where court procedures and legal requirements come into play, a common law ABC allows for flexibility and quick action.
From the perspective of a secured creditor, in certain circumstances, instead of being responsible for conducting a foreclosure proceeding, the secured creditor may prefer to have an independent, objective third party with expertise and experience liquidating businesses of the type of the distressed entity act as an assignee. There is nothing wrong with an assignee entering into appropriate subordination agreements with the secured creditor and liquidating the assignor’s assets and turning the proceeds over to the secured creditor to the extent that the secured creditor holds valid, perfected liens on the assets that are sold.
As a common law liquidation vehicle that has been around for a very long time, ABCs have been used over the years for all different types of businesses. In the early 2000s, in particular, ABCs became an especially popular method for liquidating troubled dot-com, technology, and health-care companies. In large part, this was simply a reflection of the distressed nature of those industries. At the same time, ABCs allow for quick and flexible action that frequently is necessary in order to maximize the value that might be obtained for a business that is largely dependent on the know-how and expertise of key personnel. An ABC may provide a vehicle for the implementation of a quick transaction which can be implemented before key employees jump from the sinking ship.
The liquidation process in an ABC can take many different forms. In some instances, negotiations between the buyer and the assignee commence before the assignment is made and a prepackaged transaction is agreed on and implemented contemporaneously with the execution of the assignment. This type of turnkey sale can effectively allow the purchaser of a business to acquire the business without assuming the former owner’s unsecured debt in a manner where the business operations continue uninterrupted.
In certain instances, the assignee may operate the assignor’s business post-ABC with the intent of selling the business as a going concern even if an agreement has not been reached with a purchaser. However, the assignee must weigh the risks and costs of continuing to operate the business against the anticipated benefits to be received from a going concern sale.
In many cases, the distressed enterprise has already ceased operations prior to making the assignment or will cease its business operations at the time the ABC is entered. In these cases, the assignee may be selling the assets in bulk or may sell or license certain key assets and liquidate the other assets through auctions or other private or public liquidation sale methods. At all times, the assignee is guided by its responsibility to act in a reasonable manner designed to maximize value obtained for the assets and ultimate creditor recovery under the circumstances.