How does an assignment for the benefit of creditors compare to bankruptcy for a distressed business?

Ask ChatGPT and you’ll learn that “ABC” stands for… well, an awful lot of things (you could end up with a whole new alphabet). In this case, ABC stands for Assignment for the Benefit of Creditors, a form of U.S. business liquidation process governed by state law. Traditionally a go-to alternative to Chapter 7 liquidation, the ABC process has been around for over 100 years, but is now getting renewed attention as a faster, more flexible and cost-effective alternative to bankruptcy. Like bankruptcy, the ABC process involves a winding down of the business, but is based in state law instead of proceeding in federal bankruptcy court.

There are certain times when it makes sense for a purchaser (and a seller) to pursue an ABC. But caution is warranted in terms of purchasing directly from an insolvent company (a company whose liabilities exceed its assets) as doing so may invite other interested parties to argue the purchase price was below fair value and may attempt to unwind the transaction or assert successor liability or fraudulent conveyance claims. This risk can be alleviated, though, by purchasing assets from an independent fiduciary in the course of a sanctioned procedure, making such claims less likely and the transaction safer for buyers. In addition, the distressed seller does not need to engage in a time-consuming and costly federal bankruptcy process.

Four Main Steps

The ABC process is a bit different in different states, but generally involves four main steps.

Step one: The board (and, if necessary, shareholders) authorize an ABC process, and the company selects an assignee, an independent fiduciary akin to a bankruptcy trustee, who will normally have insolvency and/or industry experience. In states like California, Texas and Illinois, the ABC process usually does not involve the court much at all. The courts in Delaware and New York play a greater role, but to a far lesser extent than in a bankruptcy. Once the board selects the assignee, the board no longer plays a role in the process.

Step two: The assignee notifies creditors and parties in interest and requests the submission of their claims within a set period. While the timelines for California are set by statute, the assignee will look to local practice or custom in places like Delaware and Illinois.

Step three: The assignee then takes steps to liquidate company assets in a manner that maximizes value. Depending on the circumstances, this could involve a going-concern sale soon after the assignment begins, based on a set of pre-negotiated documents with the buyer. Alternatively, the assignee may sell key assets in bulk, with the rest sold by auction or another type of private or public sale.

Step four: Finally, the assignee distributes the net proceeds of the sale to creditors according to priority under applicable law.

A buyer may engage directly with the company before the ABC assignment process, or with the assignee after that. In either case, the ABC assignment can function like a Section 363 bankruptcy sale with a potentially shorter due diligence process and risk of losing key staff. There are several key differences from a bankruptcy, however.

Does Not Provide the Same Protections Afforded in Bankruptcy

For example, there is no automatic stay on debt collection or enforcement of legal rights, creditors can still try to force the company into bankruptcy, and contracts will have the same force and effect as before, including any clause allowing termination or modification.

Also, liens will remain in place after an assignment, unlike a Section 363 sale. Typically, the assignee will not have the ability to sell the company’s assets free and clear of liens and security interests, which means that the secured creditor must be paid in full or must agree to release its lien. ABCs in Florida and Minnesota, which allow court approval of the sales, may be able to obtain relief similar to a free-and-clear order.