An alternative to selling through bankruptcy court
If you sell your business to a buyer with experience in company failures, it’s common for the agreement to provide that the assets be “sold free and clear of all liens and encumbrances.”
Assignment for the Benefit of Creditors
A “363 sale” in a Chapter 11 bankruptcy case is a well-known mechanism for selling an ailing business. There is a non-bankruptcy option, an “assignment for the benefit of creditors” or ABC, that has similar advantages for both buyers and sellers. It can be faster, cheaper and more flexible. The procedure is less familiar, and in certain cases less appropriate. But anyone selling or buying a distressed company should give it a serious look before defaulting to a 363 sale.
An ABC is a creature of state law, not federal bankruptcy. It has no tie to a bankruptcy filing.
General assignments began in the common law and are still governed in some states purely by case law. Many states, though, have passed statutes covering ABCs in whole or part. The rules differ in important ways, depending on where the company is located. By some accounts California’s ABC law has been used more often than any other state’s over the last twenty years. This article focuses on California law.
In practice, an ABC is a tool for selling or closing a business and liquidating its assets in an orderly way. As a liquidation tool, it works in much the same way as a Chapter 7 bankruptcy.
Not all ABCs end in liquidation, though. An ABC can also be used in many cases for a going-concern sale to an outside buyer. A 363 sale will do the same. But when rehabilitating the business is a goal, an ABC won’t do the job at all.
The basic idea behind an ABC is simple. The company chooses an “assignee,” who must be independent of the company. All its assets pass to the assignee. The assignee is a fiduciary for the creditors as a group.
The assignee’s job is to sell or liquidate the business assets, and apply the money to outstanding claims. The unsecured creditors can’t go after the assets of the assignee directly, just as they can’t pursue the debtor’s assets once a Chapter 11 case begins.
A creditor who wants to be paid must send in a proof of claim. A “proof of claim” is a way for a creditor to request payment of its claim against the business. The cash gets paid out to creditors under priorities set by state law.
Where an ABC Comes Out Ahead
Where an ABC comes out ahead
The major advantage an ABC has over a bankruptcy sale is that it is non-judicial. In California and many other states, it doesn’t need a court filing or hearing or bankruptcy judge’s approval. For distressed M&A, that makes it the better tool to get a deal done in an orderly way in an uncertain time.
Speed is one big difference between an ABC sale and a 363. A 363 sale can take weeks of careful planning beforehand to get ready to file, and then more weeks or months after the bankruptcy case is open to get approved by the judge. By comparison, an assignee can do a prepackaged ABC sale in weeks after the parties agree on the basic terms.
Speed matters both to seller and buyer, too. If the company is insolvent, the seller may have no other choice. And a deal can fall apart before it closes. If the time to closing is short, there is less of a chance key people will resign, or be poached, or customers or suppliers will find new partners.
The assignee doesn’t always need to shop the deal and hold an auction or marketing process beforehand. It is up to the assignee to decide whether to sell the company assets at auction, or to a prequalified buyer. The better assignees will test the market and decide whether to go with the sale lined up beforehand.
For the M&A buyer, a prearranged ABC can give it certainty of getting to closing after spending time and money on a deal.
An ABC keeps the liquidation private. Because the sale goes through without a bankruptcy filing, there’s no court notice to the world. If the seller wants to start another business, it won’t be tagged a failure in the public view. And the company won’t leave behind a long trail of bankruptcy pleadings in federal court.
The company’s announcement can be just a friendly notice that it has sold its business to a good new partner.
In a Chapter 7 case, the trustee is picked at random from a list of preapproved professionals. With an ABC, the company is in charge of choosing the assignee.
For companies domiciled in California, the state has a long list of reputable, experienced assignees, with some that specialize in certain industries. An assignee who knows your business knows how to make it work.
Experienced assignees can operate the business themselves until it is sold. They can step into the shoes of the owner and often the manager. If the owner has handed over control to the assignee for an orderly transition, the owner can walk away.
Where an ABC Falls Short
Where an ABC falls short
The ABC option often has advantages over a 363 sale. But not always. Every deal has its quirks.
An ABC is a tool for selling a failed business, not fixing it. It has no provisions for rehabilitating a distressed company like those in a Chapter 11 case. So if the plan is for the business to carry on under a restructured debt load, an ABC won’t work at all.
An ABC also doesn’t halt collection lawsuits or other claims by creditors against the company. Like any other lawsuit, a creditor suit or debt-collection action can keep going after the assignment.
An ABC will often trigger what’s called an “insolvency clause.” That is a clause in contracts that lets the other side terminate if the business goes bust. Under federal bankruptcy law, certain clauses triggered by insolvency can’t be enforced. An ABC has no such protection, so some contracts that are crucial to the business might have to be rebuilt from scratch.
A 363 sale can shift lease contracts and some other “executory” contracts over to the buyer without the consent of the other party. That’s not so with an ABC. The buyer must negotiate new terms, adding risk that the old contracts will be lost, one by one.
It can be hard to get shareholders to agree to a corporate ABC. Disposing of essentially all assets is a fundamental change in the company, so stockholder approval is needed. A debtor that files a Chapter 11 case doesn’t need to get stockholder consent beforehand. If that vote would be tough, an ABC may not work.
The laws governing an ABC change by state. That can matter. The ABC shield may only protect assets located in the state of the assignment. And it can make sense to not use an ABC at all if the assets are scattered around.
Other states may not respect the transfer of the business assets. Some buyers may prefer the stability of federal law in a bankruptcy sale over the state law of an assignment.
Whether a Chapter 11 case or ABC is the better option for distressed M&A will come down to the details. It may be tempting for a company in financial trouble to opt for an ABC because it can be faster and cheaper. That’s not always the best answer. Take on the ABC analysis early on, rather than assuming a Chapter 11 filing is the only alternative.
Seven states, New York, Florida, Wisconsin, Ohio, Michigan, Pennsylvania and New Jersey, will require a court filing or other court supervision for an ABC.
The ABC may have to be set up in the state where the company is incorporated or headquartered.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
