What should I expect as a creditor when a customer makes an assignment for the benefit of creditors?

A legal procedure called an “assignment for the benefit of creditors” or “ABC” works like this. A hopelessly indebted customer, the assignor, transfers assets to an assignee, usually to liquidate a business, wind it down or occasionally for sale as a going concern. It avoids the expense and uncertainty of a bankruptcy liquidation.

An ABC has no federal law provision behind it as a bankruptcy has. It follows state law where it was initiated. ABCs are an important alternative to Chapter 7 that more credit managers should become familiar with. That familiarity should include the peculiarities of the process and how it varies by state.

Bruce Nathan is a partner at New York-based Lowenstein Sandler. He explains that an ABC is usually a wind-down of a company. Once the process begins, the company doesn’t exist anymore under the same ownership. The assignee gets the keys to the entire business.

In an ABC, the assignee receives legal and equitable ownership of property and the power to sell and pay creditors. Every bankruptcy is court supervised, while an ABC isn’t in every state. The downside of the ABC is that in some states, without a court overseeing it, creditors have less visibility of what the assignee is doing and can find it harder to monitor things.

The duties of the assignee are defined by statute in each state or, in states with no statute, by common law. The debtor selects the assignee, but in some instances the selection of an assignee can depend on approval by the secured lender.

Michael Papandrea, a partner at Lowenstein Sandler in Roseland, NJ, says that in an ABC, the assignee takes control over the assets, just as in Chapter 7 the trustee does. The claims and distributions process is similar to Chapter 7. The Chapter 7 process is federal, and so it’s more uniform. The ABC process varies from state to state in terms of whether it’s a court process, whether you have to give clear notice, and whether a court has to approve anything.

Once appointed the assignee is a fiduciary for all creditors. A Chapter 7 trustee, by contrast, is picked off a roster. By allowing the debtor to pick the assignee the company can try to find someone with specific expertise in liquidations or its specific industry, and can negotiate the cost. Prior to assigning, the debtor and prospective assignee can discuss the assignment and the assignment’s likely expense and determine whether it is worth doing or not.

The upside is that the parties can negotiate what might happen in an ABC before it starts. The downside for creditors is that the debtor could potentially pick someone who is too friendly to the secured lender or the owners.

Costs Associated with an ABC

ABCs are generally faster and much less costly than bankruptcy. That means that after paying priority claims under the laws of the state where the ABC took place, there may be more money left over to pay the unsecured creditors. Assignments are also extremely flexible.

There are still costs associated with an ABC, despite it being cheaper than a bankruptcy. Here are some of them:

The first cost is the administrative rent. This is when the assignee stays in the debtor’s previous premises. In cases where the landlord is the principal or a related party, the assignee can negotiate rent down, or have it waived entirely.

The second cost is the assignee’s fee. This is the fee that the assignee charges for handling the assignment. It can be a negotiated percentage of proceeds or a fixed amount, and the assignment contract usually fixes it. If there is no money to pay it, a deal with the secured lender is needed to get started. In states where the court monitors the ABC the court needs to approve the fees.

No Automatic Stay

Unlike a bankruptcy, an ABC has no automatic stay. So creditors can still sue and get a judgment, but when they come to collect they find the assets are no longer with the debtor but are in the hands of the assignee. A secured lender can still foreclose, so it is crucial to get the secured lender’s consent.

Usually the assignee sends a notice to all creditors, and explains how distributions will work. They will also send out a claim form as part of the process, let creditors know if they’ve got problems with their claim amount, and will then pay claims in priority (according to claim type).

The order of priority for claim payment is governed by state law and may vary by jurisdiction. Generally, secured claims that are properly perfected must be paid out prior to unsecured trade creditors claims.

Depending on the State in Which It Is Filed

Many ABC basics are similar across most states, but the role of the court, the priority of claims, who designates the assignee, and when creditors need to file claims all depend on the state where the ABC is filed. The ABC process will be more or less costly, and more or less efficient, depending on the state in which it is filed. If a customer of yours decides to take the ABC route, the first step in any analysis is to find out which state it is filing in and how the ABC will work there.