Assignment For The Benefit Of Creditors Process Analysis

An assignment for the benefit of creditors (ABC) is a business liquidation device available to an insolvent debtor as an alternative to formal bankruptcy proceedings. In many instances, an ABC can be the most advantageous and graceful exit strategy. This is especially true where the goals are (1) to transfer the assets of the troubled business to an acquiring entity free of the unsecured debt incurred by the transferor and (2) to wind down the company in a manner designed to minimize negative publicity and potential liability for directors and management.

The option of making an ABC is available on a state-by-state basis. During the meltdown suffered in the dot-com and technology business sectors in the early 2000s, California became the capital of ABCs. In discussing assignments for the benefit of creditors, this article will focus primarily on California ABC law.

Assignment Process

The process of an ABC is initiated by the distressed entity (assignor) entering an agreement with the party which will be responsible for conducting the wind-down and/or liquidation or going concern sale (assignee) in a fiduciary capacity for the benefit of the assignor’s creditors. The assignment agreement is a contract under which the assignor transfers all of its right, title, interest in, and custody and control of its property to the third-party assignee in trust. The assignee liquidates the property and distributes the proceeds to the assignor’s creditors.

In order to commence the ABC process, a distressed corporation will generally need to obtain both board of director authorization and shareholder approval. While this requirement is dictated by applicable state law, the ABC constitutes a transfer of all of the assignor’s assets to the assignee, and the law of many states provides that the transfer of all of a corporation’s assets is subject to shareholder approval. In contrast, shareholder approval is not required in order for a corporation to file a petition commencing a federal bankruptcy case. In some instances, the shareholder approval requirement for an ABC can be an impediment to the quick action ordinarily available in the context of an ABC, especially when a public company is involved as the assignor.

The board of directors of an insolvent company (a company with debt exceeding the value of its assets) should be particularly attentive to avoiding harm to the value of the enterprise and the interests of creditors. Under Delaware law, for example, the obligation is to maximize the value of the enterprise, which should result in protecting the interests of creditors.

It is not unusual for the board of a troubled company to determine that a going concern sale of the company’s business is in the best interests of the company and its creditors. However, generally the purchaser will not acquire the business if the assumption of the company’s unsecured debt is involved. Further, often the situation is deteriorating rapidly. The company may be burning through its cash reserves and in danger of losing key employees who are aware of its financial difficulties, and creditors of the company are pressing for payment. Under these circumstances, the company’s board may conclude than an ABC is the most appropriate course of action.

The Alternative of Voluntary Federal Bankruptcy Cases

Chapter 7 bankruptcy provides a procedure for the orderly liquidation of the assets of the debtor and the ultimate payment of creditors in the order of priority set forth in the U.S. Bankruptcy Code. Upon the filing of a Chapter 7 petition, a trustee is appointed who is charged with marshaling all of the assets of the debtor, liquidating the assets, and eventually distributing the proceeds of the liquidation to the debtor’s creditors. The process can take many months or even years and is governed by detailed statutory requirements.

Chapter 11 of the Bankruptcy Code provides a framework for a formal, court-supervised business reorganization. While the primary goals of Chapter 11 are rehabilitation of the debtor, equality of treatment of creditors holding claims of the same priority, and maximization of the value of the bankruptcy estate, Chapter 11 can be used to implement a liquidation of the debtor. Unlike the traditional common law assignment for the benefit of creditors (assignments are governed by state law and may differ from state to state), Chapter 7 and Chapter 11 bankruptcy cases are presided over by a federal bankruptcy judge and are governed by a detailed federal statute.

Advantages of an ABC

The common law assignment by simple transfer in trust, in many cases, is a superior liquidation mechanism when compared to using the more cumbersome statutory procedures governing a formal Chapter 7 bankruptcy liquidation case or a liquidating Chapter 11 case. Compared to bankruptcy liquidation, assignments may involve less administrative expense and are a substantially faster and more flexible liquidation process. In addition, unlike a Chapter 7 liquidation, where generally an unknown trustee will be appointed to administer the liquidation process, in an ABC the assignor can select an assignee with appropriate experience and expertise to conduct the wind-down of its business and liquidation of its assets. In prepackaged ABCs, where an immediate going concern sale will be implemented, the assignee will be involved prior to the ABC going effective. Further, in states that have adopted the common law ABC process, court procedures, requirements, and oversight are not involved. In contrast, in bankruptcy cases, the judicial process is invoked and brings with it additional uncertainty and complications, including players whose identity is unknown at the time the bankruptcy petition is filed, expense, and likely delay.

In situations where a company is burdened with debt that makes a merger or acquisition infeasible, an ABC can be the most efficient, effective, and desirable means of effectuating a favorable transaction and addressing the debt. The assignment process enables the assignee to sell the assignor’s assets free of the unsecured debt that burdened the company. Unlike bankruptcy, where the publicity for the company and its officers and directors will be negative, in an assignment, the press generally reads “assets of Oldco acquired by Newco,” instead of “Oldco files bankruptcy” or “Oldco shuts its doors.” Moreover, the assignment process removes from the board of directors and management of the troubled company the responsibility for and burden of winding down the business and disposing of the assets.

From a buyer’s perspective, acquiring a going concern business or the specific assets of a distressed entity from an Assignee in an ABC sale transaction provides some important advantages. Most sophisticated buyers will not acquire an ongoing business or substantial assets from a financially distressed entity with outstanding unsecured debt, unless the assets are cleansed either through an ABC or bankruptcy process. Such buyers are generally unwilling to subject themselves to potential contentions that the assets were acquired as part of a fraudulent transfer and/or that they are a successor to or subject to successor liability for claims against the distressed entity. Buying a going concern or specified assets from an assignee allows the purchaser to avoid these types of contentions and issues and to obtain the assets free of the assignor’s unsecured debt. Creditors of the assignor simply must submit proofs of claim to the assignee and will ultimately receive payment by the assignee from the proceeds of the assignment estate. Moreover, compared to a bankruptcy case, where numerous unknown parties (e.g., the bankruptcy trustee, the bankruptcy judge, the U.S. trustee, an unsecured creditors’ committee, and possibly others) will become part of the process and where court procedures and legal requirements come into play, a common law ABC allows for flexibility and quick action.

From the perspective of a secured creditor, in certain circumstances, instead of being responsible for conducting a foreclosure proceeding, the secured creditor may prefer to have an independent, objective third party with expertise and experience liquidating businesses of the type of the distressed entity act as an assignee. There is nothing wrong with an assignee entering into appropriate subordination agreements with the secured creditor and liquidating the assignor’s assets and turning the proceeds over to the secured creditor to the extent that the secured creditor holds valid, perfected liens on the assets that are sold.

As a common law liquidation vehicle that has been around for a very long time, ABCs have been used over the years for all different types of businesses. In the early 2000s, in particular, ABCs became an especially popular method for liquidating troubled dot-com, technology, and health-care companies. In large part, this was simply a reflection of the distressed nature of those industries. At the same time, ABCs allow for quick and flexible action that frequently is necessary in order to maximize the value that might be obtained for a business that is largely dependent on the know-how and expertise of key personnel. An ABC may provide a vehicle for the implementation of a quick transaction which can be implemented before key employees jump from the sinking ship.

The liquidation process in an ABC can take many different forms. In some instances, negotiations between the buyer and the assignee commence before the assignment is made and a prepackaged transaction is agreed on and implemented contemporaneously with the execution of the assignment. This type of turnkey sale can effectively allow the purchaser of a business to acquire the business without assuming the former owner’s unsecured debt in a manner where the business operations continue uninterrupted.

In certain instances, the assignee may operate the assignor’s business post-ABC with the intent of selling the business as a going concern even if an agreement has not been reached with a purchaser. However, the assignee must weigh the risks and costs of continuing to operate the business against the anticipated benefits to be received from a going concern sale.

In many cases, the distressed enterprise has already ceased operations prior to making the assignment or will cease its business operations at the time the ABC is entered. In these cases, the assignee may be selling the assets in bulk or may sell or license certain key assets and liquidate the other assets through auctions or other private or public liquidation sale methods. At all times, the assignee is guided by its responsibility to act in a reasonable manner designed to maximize value obtained for the assets and ultimate creditor recovery under the circumstances.

Disadvantages of an ABC

As discussed above, an ABC can be an advantageous means for a buyer to acquire assets and/or a business in financial distress. However, unlike in a bankruptcy case, because the ABC process in California is nonjudicial, there is no court order approving the sale transaction. As a result, a buyer who requires the clarity of an actual court order approving the sale will not be able to satisfy that desire through an ABC transaction. That being said, the assignee is an independent, third-party fiduciary who must agree to the transaction and is responsible for the ABC process. The buyer in an ABC transaction will have an asset purchase agreement and other appropriate ancillary documents that have been executed by the assignee.

Unlike in a formal federal bankruptcy case, executory contracts and leases cannot be assigned in an ABC without the consent of the counter party to the contract. Accordingly, if the assignment of executory contracts and/or leases is a necessary part of the transaction and, if the consent of the counter parties to the contracts and leases cannot be obtained, an ABC transaction may not be the appropriate approach. Further, ipso facto default provisions (allowing for termination, forfeiture, or modification of contract rights) based on insolvency or the commencement of the ABC are not unenforceable as they are in a federal bankruptcy case.

Secured creditor consent is generally required in the context of an ABC. There is no ability to sell free and clear of liens, as there is in some circumstances in a federal bankruptcy case, without secured creditor consent (unless the secured creditor will be paid in full from sale proceeds). Moreover, there is no automatic stay to prevent secured creditors from foreclosing on their collateral if they are not in support of the ABC. The lack of an automatic stay is generally not significant with respect to unsecured creditors since assets have been transferred to the assignee and unsecured creditors claims are against the assignor.

While there is a risk of an involuntary bankruptcy petition being filed against the assignor, experience has shown that this risk should be relatively small. Further, when an involuntary bankruptcy petition is filed, it is generally dismissed by the bankruptcy court because an alternative insolvency process (the ABC) is already underway. In the context of an out-of-court workout or liquidation, there is always the risk that an involuntary bankruptcy petition may be filed against the debtor. Such a risk is substantially less, however, in connection with an assignment for the benefit of creditors because the bankruptcy court is likely to abstain when a process (the assignment) is already in place to facilitate liquidation of the debtor’s assets and distribution to creditors. A policy is in place that favors allowing general assignments for the benefit of creditors to stand.

Distribution Scheme in ABCs

ABCs in California are governed by common law and are subject to various specific statutory provisions. In states like California, where common law (with specific statutory supplements) governs the ABC process, the process is nonjudicial. An assignee in an assignment for the benefit of creditors serves in a capacity that is analogous to a bankruptcy trustee and is responsible for liquidating the assets of the assignment estate and distributing the net proceeds, if any, to the assignor’s creditors.

Under California law, an assignee for the benefit of creditors must set a deadline for the submission of claims. Notice of the deadline must be disseminated within 30 days of the commencement of the assignment and must provide not less than 150 and not more than 180 days’ notice of the bar date. Once the assignee has liquidated the assets, evaluated the claims submitted, resolved any pending litigation to the extent necessary prior to making distribution, and is otherwise ready to make distribution to creditors, pertinent statutory provisions must be followed in the distribution process. Generally, California law ensures that taxes (both state and municipal), certain unpaid wages and other employee benefits, and customer deposits are paid before general unsecured claims.

Particular care must be taken by assignees in dealing with claims of the federal government. These claims are entitled to priority by reason of a catchall-type statute which entitles any agency of the federal government to enjoy a priority status for its claims over the claims of general unsecured creditors. In fact, the federal statute provides that an assignee paying any part of a debt of the person or estate before paying a claim of the government is liable to the extent of the payment for unpaid claims of the government.As a practical result, these payments must be prioritized above those owed to all state and local taxing agencies.

In California, there is no comprehensive priority scheme for distributions from an assignment estate like the priority scheme in bankruptcy or priority schemes under assignment laws in certain other states. Instead, California has various statutes which provide that certain claims should receive priority status over general unsecured claims, such as taxes, priority labor wages, lease deposits, etc. However, the order of priority among the various priority claims is not clear. Of course, determining the order of priority among priority claims becomes merely an academic exercise if there are sufficient funds to pay all priority claims. Secured creditors retain their liens on the collateral and are entitled to receive the proceeds from the sale of their collateral up to the extent of the amount of their claim. Thereafter, distribution in California ABCs is made in priority claims, including administrative expenses, obligations owing to the federal government, priority wage and benefit claims, state tax claims, including interest and penalties for sales and use taxes, income taxes and bank and corporate taxes, security deposits up to $900 for the lease or rental of property, or purchase of services not provided, unpaid unemployment insurance contribution, including interest and penalties, and general unsecured claims. Interest is paid on general unsecured claims only after the principal is paid for all unsecured claims submitted and allowed and only to the extent that a particular creditor is entitled under contract or judgment to assert such claim for interest.

If there are insufficient funds to pay the unsecured claims in full, then these claims will be paid pro rata. If unsecured claims are paid in full, equity holders will receive distribution in accordance with their liquidation rights. No distribution to general unsecured creditors should take place until the assignee is satisfied that all priority claims have been paid in full.

Conclusion

Assignments for the benefit of creditors are an alternative to the formal burial process of a Chapter 7 bankruptcy. Moreover, ABCs can be particularly useful when fast action and distressed transaction and/or industry expertise is needed in order to capture value from the liquidation of the assets of a troubled enterprise. The ABC process may allow the parties to avoid the delay and uncertainty of formal federal bankruptcy court proceedings. In many instances involving deteriorating businesses, management engages in last-ditch efforts to sell the business in the face of mounting debt. However, frequently the value of the business is diminishing rapidly as, among other things, key employees leave. Moreover, the parties interested in acquiring the business and/or assets will move forward only under circumstances where they will not be taking on the unsecured debt of the distressed entity along with its assets. In such instances, especially when the expense of a Chapter 11 bankruptcy case may be unsustainable, an assignment for the benefit of creditors can be a viable solution.

A general assignment or assignment is a concept in bankruptcy law that has a similar meaning, due to common law ancestry, in different jurisdictions, but wide dispersion in practical application. The "assignment for the benefit of creditors", also known as an ABC or AFBC is an alternative to bankruptcy, which is a "general assignment"/"assignment" concept.

The United States[edit]

In the United states, a general assignment or an assignment for the benefit of creditors is simply a contract whereby the insolvent entity ("Assignor") transfers legal and equitable title, as well as custody and control of its property, to a third party ("Assignee") in trust, to apply the proceeds of sale to the assignor's creditors in accord with priorities established by law.[citation needed]

An assignment for the benefit of creditors is a relatively well-established common law tool and is one alternative to a bankruptcy. An assignment for the benefit of creditors is designed to save time and expense by concluding the affairs of a bankrupt company. The assignment for the benefit of creditors is a state form of bankruptcy action versus a federal form of bankruptcy action. The assignment for the benefit of creditor’s process is similar in character to a Chapter 7 bankruptcy and parallels some of the same procedures, but is not an actual "bankruptcy" in the form the word is used in the United States.[citation needed]

Mechanism[edit]

The assignment for the benefit of creditors is a common law contract between the board of directors and the assignee in which the board "assigns" the assets and liabilities of the company to the assignee, a third party. The assignment for the benefit of creditors contract is usually recorded the public record at a town, a city, a county or a state level. Each state will differ on recording requirements for the assignment for the benefit of creditors contract.[citation needed]

The physical filing of the assignment usually occurs after: the board of directors has spoken with local insolvency counsel; a board of directors authorization of some nature has been enacted; an appropriate assignee chosen; and the contract has been written. The assignee's primary goal is to try to make the creditors whole. The assignee performs duties similar to a trustee under federal bankruptcy. The assignee has a similar, if not equivalent, fiduciary role as the bankruptcy trustee. The assignee has the primary responsibility to: liquidate the assets of the company; vette creditor claims; and issue a dividend to the creditors. The creditors are the assignee's top priority, not shareholders. Shareholders by definition have a residual claim on assets once all creditors are satisfied.[citation needed]

The assignee, once the assignment process is completed, issues a dividend. The dividend is derived from the sale of assets, collection of receivables, recovery of the bankrupt company’s assets and cash. Certain creditors may or may not receive a dividend. The assignee's hope is to provide a one-to-one redemption of the creditor’s claims; however, this depends on the amount of cash an assignee can marshal in the liquidation process.[citation needed]

The claims process is similar to a standard bankruptcy action in which creditors submit claims to the assignee for review and acceptance. The acceptance and vetting of claims is an important process to ensure that no one creditor has overstated their claim. There are rare occasions in which an assignee may issue a non-cash dividend as part of the overall dividend to creditors on their claims, but a dividend of this type is not common. If all the creditors are made whole, shareholders would then have a claim on the remainder of the dividend. This holds true only if there are no other classes of equity that have priority senior to the shareholders.[citation needed]

The order of creditor’s claims usually follows the normal bankruptcy order prescribed in a Chapter 7 bankruptcy, generally secured, and unsecured in descending order. The assignee, depending on the specific state law may use Chapter 7, Title 11, United States Code as needed. Neither the federal bankruptcy court nor a state court usually oversee this process, however the assignee is subject in most cases to a look back provision within the state the assignment took place.[citation needed]

A Federal Bankruptcy Court judge in a Chapter 7 bankruptcy must approve the sale of the bankrupt company's assets, thus adding time and expense on to the entire liquidation process. The assets sold in an assignment for the benefit of creditor process do not usually require a judge's intervention. It is this removal of the court from the liquidation process which increases the speed of the assets sold in an assignment process. This is one substantial difference from a regular bankruptcy.[citation needed]

Creditors[edit]

Secured and unsecured creditors constitute the creditor body. Both secured and unsecured creditors are ahead of shareholders as noted earlier. A secured creditor is a creditor, who has a priority claim on an asset or assets of a company. A lien on the specific asset or assets places the secured creditor's claim ahead of the unsecured creditor. Once a secured creditor is satisfied, the unsecured creditor is then the next priority. This is again the normal order of priority in a bankruptcy.[citation needed]

Secured creditor influence[edit]

If there has been a determination by company management and interested parties such as a secured creditor that even after restructuring, a "going concern" may still not viable. A secured creditor or group of secured creditors frequently may encourage the company's senior management to pursue this liquidation mechanism. Secured creditor(s) may encourage this type of action to relieve themselves of the legal costs and risks associated with the foreclosure and sale of its collateral. One specific risk a secured creditor wants to avoid is preference or the perception of preference in the liquidation process (see fraudulent transfer).[citation needed]

In situations where the liquidation value of the assets exceeds a secured creditor's lien, the assignee is not normally required to obtain the consent of a secured creditor or any other creditor prior to the assignment process. Cooperation of the secured creditor may however affect the assignee's ability to liquidate an asset. An assignee in practice may obtain the consent of the secured creditors in advance of the assignment to ensure that the assignee can liquidate the asset or assets in a timely manner without a secured party stopping or holding up the assignment process. Secured party consent in this case is optional, not necessary.[citation needed]

In situations where the liquidation value of the assets is less than a secured creditor's lien, the assignment process can be done, however a vast number of legal questions need to be reconciled before the assignment process can possibly be initiated. There unfortunately is no concise answer in this particular situation.[citation needed]

Secured creditors may in certain instances assume the senior management roles within the bankrupt company, however noted earlier this situation occurs when the secured creditor(s) have foreclosed on their lien. Large secured creditors again may influence the decision making process, but that secured creditor can not enter into that contract on behalf of the bankrupt company. Only the bankrupt company's senior management and/or board of directors have the power to do an assignment.[citation needed]

Dividend[edit]

The dividend is hopefully the payout that the assignee issues, once all creditors' claims have been vetted and all the assets have been sold. The assignee hopes to generate enough cash to provide a one for one redemption of a creditor's claims. This is the hope the reality varies vastly, depending on the price the assets fetched when sold. Most dividends are in the form of cash back to the creditor, but not necessarily all. There may not even be a dividend in certain instance, thus no creditor receives any payment. There is no way to determine the cash value of an asset in the assignment process, regardless of past estimates. Tangible assets cash value can usually, but not always, be reasonably estimated. Intangible assets such as intellectual property or processes are much more difficult to evaluate.[citation needed]

Key attributes of the process[edit]

Noted earlier this is a state form of bankruptcy, not federal form. The assignment process or any bankruptcy process for that matter is a legal matter. The state attributes of an assignment process may be understood by any attorney however a local/regional bankruptcy attorney in the specific state usually is best equipped to handle the legal end of the process for the company making the assignment. This is not asserted to diminish an attorney’s capabilities, but to stress the legal niche that this legal instrument falls within, bankruptcy. Non legal staff familiar with bankruptcy and the assignment process can also affect the speed validity of the process.[citation needed]

General assignment attributes[edit]

The general rule is that any debtor may make an assignment. This would include any individual, partnership, corporation or limited liability company that owes anything to anyone. Any debtor owning property has the common law right to make an assignment.[citation needed]

Other common law countries[edit]

In other common law countries, general assignments usually refer to any general assignment of existing or future book debts by a natural person (including, in some cases, partnerships). A general assignment made by a natural person who is subsequently adjudged bankrupt is void against the trustee in bankruptcy as regards any book debts which have not been paid prior to the presentation of the bankruptcy petition.[citation needed]

The definition of book debts includes "debts which in the ordinary course of business would be entered in a well-kept trade book",[1] future debts and future rents under a hire purchase agreement. Bills of exchange also fall within the definition of book debts,[2] but a bank balance does not.[3]

Under (for example) English law, any general assignment, either absolute or by way of security, of book debts is void unless registered under the Bills of Sale Act 1878. A trustee would not be able to attack an assignment under this section which relates to debts due from specified debtors or debts becoming due under specified contracts or where the debts were assigned as part of a bona fide transfer of a business or the assignment is for the benefit of creditors generally.[citation needed]

References[edit]

  1. ^Re Shipley v Marshall [1863] 4 C.B. 566
  2. ^Re Siebe Gorman v Barclays Bank Plc [1979] 2 Lloyds Rep 142
  3. ^Re Brightlife Ltd [1987] 1 Ch 200

0 Replies to “Assignment For The Benefit Of Creditors Process Analysis”

Lascia un Commento

L'indirizzo email non verrà pubblicato. I campi obbligatori sono contrassegnati *