More and more firms are winding down in orderly fashion via so-called “ABCs” or “assignments for the benefit of creditors.”
An ABC is an attractive choice for a company and its directors and officers. They have many reasons to choose this form of wind-down.
The first advantage to an ABC is that it is much less expensive than a Chapter 11. It can be put in place quickly.
The second advantage: Directors and officers usually get to resign at the start of an ABC. The assignee runs the wind-down from then on, freeing them for new jobs.
A third advantage to an ABC: press coverage. Bankruptcy filings often turn up on the front page of the newspaper, and the publicity is generally bad. ABCs, on the other hand, usually do not appear in the paper at all.
The fourth benefit of an ABC to a company: control. Top people can be afraid of a hostile court-appointed Chapter 7 trustee coming into the company and suing them to fund the case; but in an ABC, they pick the assignee and work with that person beforehand.
The general ins and outs and advantages and disadvantages of an ABC are discussed elsewhere. This piece focuses on key issues which directors and officers should think about before taking this step.
Fiduciary Duties
Delaware law imposes fiduciary duties on the directors and officers of a corporation, including a duty of care and a duty of loyalty.
In practice, this means their decisions must be made in good faith, after due diligence; and they must be in the interest of the company, not the personal interest of the directors and officers.
When the company is solvent, the directors’ and officers’ duties run to the company and its shareholders. When the company becomes insolvent, those duties extend to all residual claimants, and that includes creditors.
Among the ways a board can meet its legal duties to the creditors is to opt for the ABC, since in that case the assets are sold and the proceeds are used to pay the creditors in order of their legal priority; and the assignee acts as fiduciary to the creditors.
But an ABC is not automatically the right step. Which path is right very much depends on the specific situation. The board of directors must first consider all possible options and weigh them on the specific facts of the case.
Too many companies hang on too long without bringing in insolvency counsel to get them through wind-down. At the end they don’t have the time or money to figure out whether an ABC is best for them.
The board should be working with a financial advisor on the 13-week cash flow forecast, and should understand how much cash is available to meet payables. Knowing how much money you have now and being able to cover the required payments are critical.
The company board needs to decide in good faith which option is best for the creditors. The company board and its officers should have no conflicts of interest in selecting the option, otherwise there is a risk of self-dealing which might taint the result.
Directors’ actions will be judged with the benefit of hindsight. It is vital to be diligent when keeping meeting minutes, especially the reasons the board acts and the way it goes about it.
When the board’s decisions are second-guessed later, the minutes can be strong proof of its diligence.
Picking Which State
ABCs are based on state law, and vary a lot from state to state. The parties often adopt Bankruptcy Code venue tests (like the company’s state of incorporation, or state of principal place of business) as a way to decide which state they will be in.
Some assignees argue venue is proper if the assignee is incorporated or based in that state.
In some states, like Delaware, Florida, and New Jersey, the ABC is done in court, under court supervision. In other states, like California, it’s outside court.
You might want to pick a court-supervised ABC if you anticipate legal resistance from unsecured creditors or other stakeholders, because then you have a court as umpire.
If a prospective buyer of your assets wants the comfort of a court sale order, then you need to pick a state that requires court supervision of the ABC.
The ability of an assignee to claw back payments to creditors which were made pre-ABC varies from state to state. Some states have a statutory claw back rule, such as New Jersey does; others do not, such as Delaware.
If you made major payments to creditors just before the ABC, then the possibility of claw backs becomes a factor in picking which state.
The clawback issue comes up most often in cases where there is no secured creditor, and a higher expected recovery for general unsecured creditors. The purpose of a clawback is to promote the equal treatment of general unsecured creditors.
Before You Go Ahead with an ABC
Directors and officers of the company should make sure the company pays all trust fund taxes before the ABC. Trust fund taxes are monies the company collects from others, and then holds in trust for the government, until they are paid to the government.
Trust fund taxes include sales taxes, excise taxes, and some payroll taxes. If you are a responsible person for a business and willfully fail to pay them, then you could be personally, and sometimes criminally, liable for the whole amount.
A federal statute, 31 U.S.C. 3713, says that if you are a company that is insolvent but not in bankruptcy, then you will have to pay the federal government creditors first in full, before paying any unsecured creditors. Officers and directors of the insolvent company can be personally liable for the shortfall.
Confirm that you’ve paid all wages owed to employees in full, before you file your ABC. Unpaid wages can expose the directors and officers of a business to personal, and sometimes criminal, liability.
Due diligence should include any and all documents regarding what is owed to the employees of the company: employment agreements, severance agreements, bonus plans, employee handbooks.
Make sure you know what constitutes wages in your state. In some states severance bonuses are considered wages.
ABC firings can trigger the federal WARN Act or similar state law. The federal WARN Act requires employers of a certain size to give at least 60 days’ notice before mass layoffs or the closing of a facility. Make sure you know the rules before you do anything.
A D&O tail policy is important to get before you go ahead with an ABC, in order to protect yourself going forward.
A “tail policy” extends the life of a policy so that claims made after it expires can still be filed. It covers directors and officers for claims that arise before termination.
The tail premium will be due and payable the day you purchase it. Keep that cost in mind as you prepare your 13-week cash flow.
When you enter into an ABC the assignee will choose a bar date, a deadline for all creditors to file their claims.
If the creditors don’t make the deadline, they can get nothing, and their claims are discharged. That’s why you need to come up with a detailed list of the creditors and possible creditors of the company so that none are missed.
A good list for the creditors would include:
- customers;
- vendors;
- contract and lease counterparties;
- litigants;
- employees;
- consultants;
- and professionals, among others.
Also include the local, state and federal tax authorities, as well as any regulators.
In summary, the ABC can be the right solution for a wind down.
But the decision to pick it depends on a number of factors and the board of directors has to take key steps before making that call. They will help your board discharge its legal responsibilities, protect your interests, and insure the success of the ABC.
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.
