A bad season can leave a store with unsold stock, a loan payment it cannot make and vendors who want their money. When that happens, the first word many owners hear is bankruptcy. It is true that a retail company in Chapter 11 may use the bankruptcy process to restructure its debts or to sell its assets and there may be advantages to liquidating its assets through bankruptcy rather than by other means of sale. A Chapter 11 bankruptcy case, though, can be expensive. Moreover, sometimes bankruptcy is too slow, or there are reasons that another process will work just as well in a shorter time or for less money. Some creditors would prefer that the debtor not file at all, and instead try to enforce their collection rights without a bankruptcy proceeding. In those situations, the debtor and/or the creditors look to other ways to liquidate the debtor’s assets or restructure. The main ways to do this, without filing bankruptcy, are UCC foreclosure, assignments for the benefit of creditors, receiverships, and creditor’s composition agreements. Each one works differently, and each one fits a different kind of trouble.
Almost every state has adopted the Uniform Commercial Code, or the UCC. The UCC says that a debtor can give a lender an interest in personal property by a contract that allows the lender to put a lien on the property. If the company doesn’t pay its debt on time, then the creditor can take the asset and sell it to recoup some of what’s owed. The creditor has to give notice to the company, its other secured creditors, and anyone who signed a guaranty. It can take and sell the collateral without going to court, so long as it can do it without causing a breach of the peace. If the debtor agrees or doesn’t object, the creditor may retain the collateral in full or partial satisfaction of the debt.
If the bank chooses to sell the collateral, it must do it in a “commercially reasonable” way. If it doesn’t, it can be liable to you, or it may be unable to collect on a deficiency judgment (the difference between the loan amount and the sale price of the collateral), or it may be unable to pursue any guarantors. A UCC sale typically costs much less than bankruptcy, and can be accomplished quickly (the notice can be as short as 10 days). Only personal property subject to a UCC security interest can be sold, however. Real estate must be sold separately, which usually requires a lawsuit. Unsecured creditors have no right to a UCC sale. But the debtor can interrupt the process at any time before it is completed, by filing bankruptcy. Moreover, because there is virtually never a court ruling approving the sale and the price it obtained, collecting the balance from the debtor or the guarantors may involve extensive litigation.
An assignment for the benefit of creditors (ABC) is when the business transfers all of its assets to another person who then acts kind of like a trustee and sells those assets for the benefit of the creditors. There is no discharge for the debtor, so it remains on the hook for the unpaid debts. But by the time a creditor gets a judgment, the assignee has already sold the assets and distributed the proceeds, so the judgment may be for nothing. Some states have very detailed ABC statutes; others are common law. In Indiana there is a pretty detailed statute but ABCs are almost never used; in Illinois it’s all common law, but ABCs are fairly common.
Secured lenders still come first in an ABC. If the value of the liens on all of the debtor’s assets exceeds the value of the assets, there is nothing left for unsecured creditors. The secured creditor gets the proceeds from the sale of its collateral. An assignment for the benefit of creditors is often less expensive and less time consuming than a bankruptcy filing, all creditors in the same class are treated similarly, and the race to the courthouse, in which creditors race to file lawsuits and the last ones get nothing, is less likely. The downside is that it is a liquidation proceeding only, and there is ordinarily no possibility of reorganization. For a retailer that wants to keep its doors open, that settles the question.
A receivership is a process in which the business is taken over by a third party - often someone appointed by a court or a federal agency, who then runs the business and its property. It could be used to try to fix a failing business but more often it is used to wind the business up and sell its assets. The receiver can take any claims that the debtor has against others, including its officers and directors, and distribute the proceeds to the creditors. The receivership usually starts after the debtor defaults on its debts, and how easy one is to get varies a great deal by state. The scope of the receiver’s authority is limited to what the appointing order says.
Unlike a UCC foreclosure sale, a receiver can sell real estate, not just personal property. A federal court can sometimes put a hold on lawsuits against the debtor in several jurisdictions, so that all creditors have to come to the receivership. The receivership can be done without the business’s consent, and it can be initiated by unsecured creditors as well as secured creditors. The court will generally consider someone suggested by the creditor that wants the receivership. A receivership can be time-consuming and expensive because the receiver, and often the receiver’s lawyer, have to be paid out of the assets of the business, and a state court’s receiver might not be able to control property that is located in a different state. In other words, this is often something that happens to an owner rather than something an owner chooses.
A composition agreement is an arrangement between a business and some or all of its creditors. It is designed so that the debtor can either reorganize and keep the business going or liquidate in an orderly fashion. It works best when the debtor has a relatively small number of creditors that will benefit from its continuing success. A composition agreement will typically include an agreement to accept less than the full amount owed and/or an extension of the time to pay, together with an agreement that creditors will not try to collect their debts for a specified time period (a standstill). Since it is a contract, it is very flexible and can be designed to fit the needs of the particular situation. It can be arranged quickly and inexpensively, especially if the debtor has a few larger creditors, and it can be handled confidentially, without the bad press of a bankruptcy filing.
Which Alternative Is the Right One
So which of these works after a bad season? If the goal is to keep the store, a composition agreement is the only one of the four built to do that outside of court. The others are mostly ways to sell what is left. Chapter 11 is a powerful remedy, but it’s also expensive, risky, complex, and can take a long time. Before filing a case, a debtor should always look for a more efficient alternative way to achieve the same goals. Many of these alternatives can also be used by creditors in cases where the debtor refuses to address its financial problems. And each alternative is more complex than can be covered in a summary article. Therefore, it is important that a debtor or creditor find an experienced attorney to determine which alternative is the right one.
