If you’re the owner of a small or mid-sized U.S. business and facing insolvency issues, you may have some significant decisions to make in short order. You are out of money, and you have no hope of raising additional cash from your investors or your lender. Payables are growing older, and creditors are starting to make claims on the debt. Perhaps you have some sale interest. You may be able to investigate Chapter 11, Chapter 7, corporate dissolution, or the assignment for the benefit of creditors (“ABC”). This post is a comparison of Chapter 11 and the ABC. Keep in mind that which option is appropriate depends on the facts and circumstances. This is not one of those things that works with a one size fits all approach.
Chapter 11 is designed to help your business stay in business. An ABC is designed to help you exit the business as cleanly as possible. In Chapter 11, you retain control of the business. You remain as the debtor-in-possession (DIP). In an ABC, you are handing control of the business to someone else, an assignee. The assignee — a third party — sells the company’s assets to pay creditors.
Assignment for the Benefit of Creditors
An assignment for the benefit of creditors is another insolvency proceeding, also governed by state law (not federal bankruptcy law), that is available in many states. ABCs have been used for some years in California. The debtor company and the assignee sign a formal “Assignment Agreement.” The company provides the assignee with a list of the company’s creditors, equityholders and other interested parties, with their names, addresses and the amount of their claims, signed under penalty of perjury. Within 30 days after the assignment is accepted by the assignee, the assignee notifies the creditors in writing. The notice establishes a bar date for filing claims against the company, 150 to 180 days from the date of the notice (five to six months from the date of the notice). The California procedure does not require any court filing. (Some other states do require a court filing.)
Many states have statutes for ABC’s, and they are utilized to varying degrees by companies. California ABCs are more prevalent than they are on the East Coast, with some exceptions. Delaware corporations, for example, are generally permitted to employ Delaware’s voluntary assignment statutes. These procedures are similar, in some respects, to the California law, and they differ in others. Georgia and Florida also have ABCs; Florida requires specific statutory procedures. An analysis of how an ABC functions in any given state, and how it would function for a specific company, is a matter for the consultation of insolvency counsel.
In an ABC, the company typically selects the assignee (Chapter 7 appoints a trustee on a random selection basis from a pre-approved list). The assignee, a fiduciary to creditors, is often a professional liquidator. Many assignees charge an up front fee in addition to a percentage of assets liquidated. Most corporations require both board approval and shareholder approval for an ABC because the sale or transfer of substantially all assets requires shareholder approval. This renders ABCs not viable for the majority of publicly held corporations.
Bankruptcy Protection Differs from an ABC
One major way that bankruptcy protection differs from an ABC is the “automatic stay.” In an ABC, the automatic stay does not apply in many states (including California) but the assignee may be able to stop judgment creditors from seizing assets. If the debtor makes an ABC, it is typically a default under a debtor’s contracts. Under an “ipso facto” clause, counterparties can terminate contracts. As in bankruptcy, creditors file a proof of claim with the assignee by a certain bar date. Employee wage priority and other priority debts in an ABC are determined under state law and are not necessarily the same as the priorities under the Bankruptcy Code.
Under Section 503(b)(9) of the Bankruptcy Code, a vendor that has sold goods to the debtor in the ordinary course during the twenty-day period before the filing of a bankruptcy case may assert an administrative priority claim. The typical ABC statute does not have an equivalent provision; thus, the general vendors may receive less in the ABC than in bankruptcy, subject to their reclamation rights. Under the Code, there is a cap on a landlord’s claim for breach of a real property lease. There is generally no cap in an ABC. Most states allow assignees to maintain actions for preferences and fraudulent transfers. The Ninth Circuit Court of Appeals held that the Bankruptcy Code pre-empts California’s preference law, but California state courts have not adopted the Ninth Circuit Court of Appeals ruling and have thus allowed assignees to pursue preference actions in state court. In February 2008, a Delaware state court agreed with the California state courts.
Why Not Simply File Chapter 11
So why not simply file Chapter 11? Chapter 11 may be difficult for a company with no cash to fund its operating expenses and no significant sources of revenue. You would need DIP financing, and it is unlikely that you would be able to secure DIP financing unless the buyer itself would make the loan. Moreover, many boards are reluctant to enter Chapter 7, fearing that the bankruptcy trustee – who is unfamiliar with the company’s technology or business – may not maximize the recovery for creditors.
For all the ABC advantages listed above, the buyer’s perspective is important. Some buyers will not buy assets outside of Chapter 11 or Chapter 7. Other buyers might prefer the ABC route. They’re under the impression that a sale in an ABC case offers more protection against fraudulent transfer claims than buying directly from the insolvent business. In some states, like California, where no court approval of the sale is required, an ABC sale can close extremely quickly — even within a day or two of the ABC, once the assignee has completed the due diligence process with respect to the sale and the alternatives. A court-approval of a Section 363 sale, on the other hand, usually takes 30 to 60 days. This means that an ABC sale can give you the opportunity to sell the business as a going concern.
Then there is your lease. Note that if the lease has only a few months left (say 9), the bankruptcy cap on the landlord’s claim will not help you much. However, if years remain on the lease and the landlord will not consent to termination on terms favorable to you (close to the cap amount), a large uncapped landlord claim in your ABC can be dilutive to your other unsecured creditors. That can be a reason to file bankruptcy instead. In the event the buyer backs out, the assignee then decides whether a sale of all or part of the assets is still possible. If not, the assignee liquidates the assets to the maximum extent feasible and distributes the proceeds to the creditors according to priority, going through the claims process.
For some owners, an ABC makes sense depending on the buyer’s assessment of the business, the value a sale would bring to creditors and other parties, and a clear-eyed view of other available options. Other options should be considered. Business leaders and the board of directors should be advised by counsel and other insolvency professionals as early as possible. In popular memory, the song “ABC” reminds us that ABC is “easy as 1-2-3.” In truth, however, selecting between ABC and Chapter 11 raises numerous intricate issues.
