Companies in financial trouble are often forced to liquidate their assets to pay creditors. While a Chapter 11 bankruptcy sometimes makes the most sense, other times a Chapter 7 bankruptcy is required, and in still other situations a corporate dissolution may be best. This post examines another of the options, the assignment for the benefit of creditors, commonly known as an "ABC."
A Few Caveats. It’s important to remember that determining which path an insolvent company should take depends on the specific facts and circumstances involved. As in many areas of the law, one size most definitely does not fit all for financially troubled companies. With those caveats in mind, let’s consider one scenario sometimes seen when a venture-backed or other investor-funded company runs out of money.
One Scenario. After a number of rounds of investment, the investors of a privately held corporation have decided not to put in more money to fund the company’s operations. The company will be out of cash within a few months and borrowing from the company’s lender is no longer an option. The accounts payable list is growing (and aging) and some creditors have started to demand payment. A sale of the business may be possible, however, and a term sheet from a potential buyer is anticipated soon. The company’s real property lease will expire in nine months, but it’s possible that a buyer might want to take over the lease.
- A Chapter 11 bankruptcy filing is problematic because there is insufficient cash to fund operations going forward, no significant revenues are being generated, and debtor in possession financing seems highly unlikely unless the buyer itself would make a loan.
- The board prefers to avoid a Chapter 7 bankruptcy because it’s concerned that a bankruptcy trustee, unfamiliar with the company’s technology, would not be able to generate the best recovery for creditors.
The ABC Option. In many states, another option that may be available to companies in financial trouble is an assignment for the benefit of creditors (or "general assignment for the benefit of creditors" as it is sometimes called). The ABC is an insolvency proceeding governed by state law rather than federal bankruptcy law.
California ABCs. In California, where ABCs have been done for years, the primary governing law is found in California Code of Civil Procedure sections 493.010 to 493.060 and sections 1800 to 1802, among other provisions of California law. California Code of Civil Procedure section 1802 sets forth, in remarkably brief terms, the main procedural requirements for a company (or individual) making, and an assignee accepting, a general assignment for the benefit of creditors:
1802. (a) In any general assignment for the benefit of creditors, as defined in Section 493.010, the assignee shall, within 30 days after the assignment has been accepted in writing, give written notice of the assignment to the assignor’s creditors, equityholders, and other parties in interest as set forth on the list provided by the assignor pursuant to subdivision (c).
(b) In the notice given pursuant to subdivision (a), the assignee shall establish a date by which creditors must file their claims to be able to share in the distribution of proceeds of the liquidation of the assignor’s assets. That date shall be not less than 150 days and not greater than 180 days after the date of the first giving of the written notice to creditors and parties in interest.
(c) The assignor shall provide to the assignee at the time of the making of the assignment a list of creditors, equityholders, and other parties in interest, signed under penalty of perjury, which shall include the names, addresses, cities, states, and ZIP Codes for each person together with the amount of that person’s anticipated claim in the assignment proceedings.
In California, the company and the assignee enter into a formal "Assignment Agreement." The company must also provide the assignee with a list of creditors, equityholders, and other interested parties (names, addresses, and claim amounts). The assignee is required to give notice to creditors of the assignment, setting a bar date for filing claims with the assignee that is between five to six months later.
ABCs In Other States. Many other states have ABC statutes although in practice they have been used to varying degrees. For example, ABCs have been more common in California than in states on the East Coast, but important exceptions exist. Delaware corporations can generally avail themselves of Delaware’s voluntary assignment statutes, and its procedures have both similarities and important differences from the approach taken in California. Scott Riddle of the Georgia Bankruptcy Law Blog has an interesting post discussing ABC’s under Georgia law. Florida is another state in which ABCs are done under specific statutory procedures. For an excellent book that has information on how ABCs are conducted in various states, see Geoffrey Berman’sGeneral Assignments for the Benefit of Creditors: The ABCs of ABCs, published by the American Bankruptcy Institute.
Important Features Of ABCs. A full analysis of how ABCs function in a particular state and how one might affect a specific company requires legal advice from insolvency counsel. The following highlights some (but by no means all) of the key features of ABCs:
- Court Filing Issue. In California, making an ABC does not require a public court filing. Some other states, however, do require a court filing to initiate or complete an ABC.
- Select The Assignee. Unlike a Chapter 7 bankruptcy trustee, who is randomly appointed from those on an approved panel, a corporation making an assignment is generally able to choose the assignee.
- Shareholder Approval. Most corporations require both board and shareholder approval for an ABC because it involves the transfer to the assignee of substantially all of the corporation’s assets. This makes ABCs impractical for most publicly held corporations.
- Liquidator As Fiduciary. The assignee is a fiduciary to the creditors and is typically a professional liquidator.
- Assignee Fees. The fees charged by assignees often involve an upfront payment and a percentage based on the assets liquidated.
- No Automatic Stay. In many states, including California, an ABC does not give rise to an automatic stay like bankruptcy, although an assignee can often block judgment creditors from attaching assets.
- Event Of Default. The making of a general assignment for the benefit of creditors is typically a default under most contracts. As a result, contracts may be terminated upon the assignment under an ipsofacto clause.
- Proof Of Claim. For creditors, an ABC process generally involves the submission to the assignee of a proof of claim by a stated deadline or bar date, similar to bankruptcy. (Click on the link for an example of an ABC proof of claim form.)
- Employee Priority. Employee and other claim priorities are governed by state law and may involve different amounts than apply under the Bankruptcy Code. In California, for example, the employee wage and salary priority is $4,300, not the $10,950 amount currently in force under the Bankruptcy Code.
- 20 Day Goods. Generally, ABC statutes do not have a provision similar to that under Bankruptcy Code Section 503(b)(9), which gives an administrative claim priority to vendors who sold goods in the ordinary course of business to a debtor during the 20 days before a bankruptcy filing. As a result, these vendors may recover less in an ABC than in a bankruptcy case, subject to assertion of their reclamation rights.
- Landlord Claim. Unlike bankruptcy, there generally is no cap imposed on a landlord’s claim for breach of a real property lease in an ABC.
- Sale Of Assets. In many states, including California, sales by the assignee of the company’s assets are completed as a private transaction without approval of a court. However, unlike a bankruptcy Section 363 sale, there is usually no ability to sell assets "free and clear" of liens and security interests without the consent or full payoff of lienholders. Likewise, leases or executory contracts cannot be assigned without required consents from the other contracting party.
- Avoidance Actions. Most states allow assignees to pursue preferences and fraudulent transfers. However, the U.S. Court of Appeals for the Ninth Circuit has held that the Bankruptcy Code pre-empts California’s preference statute, California Code of Civil Procedure section 1800. Nevertheless, to date the California state courts have refused to follow the Ninth Circuit’s decision and still permit assignees to sue for preferences in California state court. In February 2008, a Delaware state court followed the California state court decisions, refusing either to follow the Ninth Circuit position or to hold that the California preference statute was pre-empted by the Bankruptcy Code. The Delaware court was required to apply California’s ABC preference statute because the avoidance action arose out of an earlier California ABC.
The Scenario Revisited. With this overview in mind, let’s return to our company in distress.
- The prospect of a term sheet from a potential buyer may influence whether our hypothetical company should choose an ABC or another approach. Some buyers will refuse to purchase assets outside of a Chapter 11 bankruptcy or a Chapter 7 case. Others are comfortable with the ABC process and believe it provides an added level of protection from fraudulent transfer claims compared to purchasing the assets directly from the insolvent company. Depending on the value to be generated by a sale, these considerations may lead the company to select one approach over the other available options.
- In states like California where no court approval is required for a sale, the ABC can also mean a much faster closing — often within a day or two of the ABC itself provided that the assignee has had time to perform due diligence on the sale and any alternatives — instead of the more typical 30-60 days required for bankruptcy court approval of a Section 363 sale. Given the speed at which they can be done, in the right situation an ABC can permit a "going concern" sale to be achieved.
- Secured creditors with liens against the assets to be sold will either need to be paid off through the sale or will have to consent to release their liens; forced "free and clear" sales generally are not possible in an ABC.
- If the buyer decides to take the real property lease, the landlord will need to consent to the lease assignment. Unlike bankruptcy, the ABC process generally cannot force a landlord or other third party to accept assignment of a lease or executory contract.
- If the buyer decides not to take the lease, or no sale occurs, the fact that only nine months remains on the lease means that this company would not benefit from bankruptcy’s cap on landlord claims. If the company’s lease had years remaining, and if the landlord were unwilling to agree to a lease termination approximating the result under bankruptcy’s landlord claim cap, the company would need to consider whether a bankruptcy filing was necessary to avoid substantial dilution to other unsecured creditor claims that a large, uncapped landlord claim would produce in an ABC.
- If the potential buyer walks away, the assignee would be responsible for determining whether a sale of all or a part of the assets was still possible. In any event, assets would be liquidated by the assignee to the extent feasible and any proceeds would be distributed to creditors in order of their priority through the ABC’s claims process.
- While other options are available and should be explored, an ABC may make sense for this company depending upon the buyer’s views, the value to creditors and other constituencies that a sale would produce, and a clear-eyed assessment of alternative insolvency methods.
Conclusion. When weighing all of the relevant issues, an insolvent company’s management and board would be well-served to seek the advice of counsel and other insolvency professionals as early as possible in the process. The old song may say that ABC is as "easy as 1-2-3," but assessing whether an assignment for the benefit of creditors is best for an insolvent company involves the analysis of a myriad of complex factors.
Assignments for the benefit of creditors are a terrific tool to facilitate the liquidation of assets of a failing enterprise. In this article, my partner, Ben Young, explains why a recent opinion from the California Fourth District Court of Appeal missed the point and why ABCs remain a powerful tool available to get the bank paid.
GIVE NOTICE TO CREDITORS BEFORE SELLING THE ASSIGNOR’S ASSETS?
by Bennett G. Young
Assignments for the benefit of creditors (ABC’s as they are called) are known for their speed and flexibility. In California, the practice of an ABC occurring followed seconds later by a sale of the assignor’s assets is well established. The buyer’s ability to take over the failing business quickly in a seamless transition is a principal benefit of the ABC process. The speed and the seamless transition help preserve going concern values for the benefit of creditors.
A recent unpublished decision of a California appellate court appears to question this practice. El Saad v. Tarakji, No. G044716, 2011 WL 5910059 (Cal. Ct. App. Nov. 28, 2011). In Tarakji, Callcom obtained a fraud judgment against West Coast Distributors. One month later, West Coast made an assignment for the benefit of creditors and three days later the assignee sold all of West Coast’s assets to Platinum Touch, a newly formed entity owned by West Coast’s insiders, for $20,000 cash and the assumption of $4.7 million in purported secured debt.
Callcom challenged the sale to Platinum Touch as a fraudulent transfer. In the course of agreeing with Callcom, the Court included some inaccurate and misleading language regarding an assignee’s obligation to give notice of a sale:
Civil Code section 1802 is designed to ensure that the assignee gives notice to all identified creditors before proceeding with the disposition of the debtor’s property. … In other words, the assignee for the benefit of creditors is obligated to follow formal procedures, and consider the interests and claims of all creditors before disposing of the debtor’s property. Clearly this means that the assignee cannot simply make a deal in advance of the general assignment, to dispose of the debtor’s property to a designated third party – even if that third party were chosen by the debtor’s primary creditor – without providing notice to anyone else, as occurred in this case.
El Saad v. Tarakji, 2011 WL 5910059, at *5 n. 3.
The Court went on to state:
It is practically inconceivable that an actual assignee for the benefit of creditors would agree, in advance of the assignment, to transfer the entirety of a debtor’s assets to a third party – for nominal consideration – without ever notifying those creditors or giving them an opportunity to question the debtor’s own negative characterization of its net value, or its chosen buyer. But if appellants are to be believed, that’s exactly what [assignee] agreed to do here.
Id., at *5 n. 4.
The Court’s analysis of section 1802 is incorrect. Indeed, the Court read a requirement into the statute that simply is not there. The statute does not mention sales and does not include an express requirement that the assignee give notice of a sale. Instead, Civil Code section 1802 merely directs an assignee to fix a bar date for the filing of claims and to give notice of the assignment and of the bar date to creditors. Further evidence that notice of an assignee’s sale is not required is found in the California Commercial Code, which expressly excepts ABC’s and sales by the assignee from the notice and other requirements of the bulk sales law. Cal. Com. Code § 6103(c)(6).
The Court’s construction of section 1802 to require notice of a sale creates a host of other problems. Among the more obvious is the amount of notice to give. The statute does not state how many days notice should be given. Nor does the statute provide any procedure to address any objections to the sale or comments that creditors might have.
The holding in El Saad may be a reflection of its egregious facts. The case involved a sale to insiders for a nominal amount immediately after a fraud judgment had been entered against the assignor. The principal consideration for the sale was the buyer’s assumption of secured debt, but there was no evidence that this debt was valid. Nor was there any evidence that the assignee had done anything to market the assets prior to the sale to the insider. Instead, the entire transaction appeared to be a sham.
Some comfort can be taken in the fact the El Saad opinion is unpublished. Because the opinion is unpublished, it has no precedential value and cannot be cited. According to the California Rules of Court, an unpublished opinion “must not be cited or relied on by a court or a party in any other action.” Cal. Rules of Court 8.1115(a). Nonetheless, although the opinion cannot be cited, it is out there, as evidence of how one court read section 1802.
As Ben notes, the lesson here is to carefully consider the rights of all creditors who are affected by the liquidation of a troubled company. By properly structuring the sale of the borrower’s assets, it is usually possible to get the bank paid while avoiding costly bankruptcy and litigation. ABCs are just one of the many approaches that the JMBM Special Assets Team might recommend to our bank clients in working with them to realize on their collateral while it still has sufficient value.
This is Dick Rogan, bank lawyer and author of www.SpecialAssetsLawyer.com, signing off for now. Join us again soon to check out what’s new in the World of Workouts.
Ben Young is partner at Jeffer Mangels Butler & Mitchell LLP and represents parties in insolvency matters. He has extensive experience in workouts, restructurings, bankruptcies, and assignments for the benefit of creditors. His clients include lenders, financial institutions, secured and unsecured creditors, distressed investment funds, businesses, receivers, special servicers, and creditors’ committees. Contact him at BYoung@jmbm.com or 415.984.9626.
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Richard A. Rogan is Chair of the JMBM Special Assets Team™. He also serves as the co-managing partner of JMBM’s San Francisco office and co-chair of its Bankruptcy Practice Group.
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