The Road to an Assignment for the Benefit of Creditors (ABC): A Case Study

How Does a Company Decide to Enter an Assignment for the Benefit of Creditors?

This is how a troubled company considered its duties and options before executing a strategy using an assignment for the benefit of creditors (ABC). They successfully mitigated potential losses. The guarantor’s liability was minimized, the bank and going-concern buyer got what they wanted, and the enterprise continued. This story puts meat onto skeletal discussions of ABC rules and how they compare with competing resolution structures under the Bankruptcy Code and Uniform Commercial Code (UCC).

Background

A family-owned business in Illinois had lost large amounts of money for 3 years. Trade creditors had been stretched, and some were cutting the company off. Several breach of contract lawsuits were working their way through the courts, but no judgments had been entered. Some trade creditors received payments to induce them to continue shipping. The company had only paid some of their federal and state withholding taxes. It struggled to keep current on debt obligations to the bank, which had good liens on inventory, accounts receivable, and equipment, as well as a mortgage on the company’s real estate. Following difficult discussions with the bank, the board of directors and the majority shareholder/CEO — who had guaranteed the company’s debt to the bank — concluded that the company should sell or liquidate its assets. The board and shareholder agreed that a sale of the company as a going concern would generate more proceeds than would a liquidation. A sale would further pay down the bank loan and diminish the shareholder’s liability on his personal guarantee.

The shareholder had been quietly marketing the company for several months and was negotiating a letter of intent with a strategic buyer to purchase the assets of the business. The asset the buyer most desired was the company’s large but perishable customer base. The buyer believed it could retain that customer base if the sale closed quickly. The buyer also agreed to purchase the inventory and equipment but did not want the accounts receivable or environmentally challenged real estate. The buyer offered to purchase the inventory at 50% of book value and the equipment at 80% of orderly liquidation value. As part of the deal, the buyer would assist the company in collecting on accounts receivable for a period of time. The company and shareholder estimated that the purchase price, plus proceeds from the liquidation of the accounts receivable and real estate, could potentially yield net proceeds exceeding the debt to the bank.

The buyer planned to retain the shareholder/CEO for his strong relationships with a number of large customers. The buyer intended to move the business to an out-of-state facility, which meant termination of employment for most of the company’s 100 workers. The buyer would offer permanent future employment to a few employees, but most would be needed only for a limited post-sale transition period to ensure continuous operation.

The bank was willing — if such a sale would get the debt paid. Importantly, the shareholder, concerned for his reputation, wanted to keep financial issues as quiet as possible. He thought it better to sell assets on the “down low,” as it were.

Examining Options

After consulting insolvency counsel, the board recognized that insolvency gave the board fiduciary obligations to the creditors. The board had to preserve the assets and sell them for the highest value possible. The shareholder was anxious to address guarantee and federal withholding tax issues with net proceeds remaining after payment to the bank. They considered the following options.

Chapter 11 Bankruptcy

The company could operate in chapter 11 as a debtor-in-possession. As such, the automatic stay would bar progress in the trade creditor suits. Company assets could be sold to the highest bidder through a sale under section 363 of the Bankruptcy Code. Such a sale could get the buyer title to the assets, free and clear of liens, claims, and encumbrances, which might result in a better price. However, the chapter 11 process through sale would take no less than 60 to 90 days. It would be a very public, court-supervised process that might involve a contentious creditors’ committee populated by those stretched and restive creditors. Each aspect of this process would increase expenses, and it was not clear that the bank would fund operations or expenses. It appeared that the buyer, having performed due diligence, would be willing to purchase the assets through a faster process, even with less protection for the title.

Chapter 7 Bankruptcy

Under a chapter 7 bankruptcy case, a chapter 7 trustee would be appointed by the U.S. Trustee and would immediately displace company management. It is unlikely  that a trustee would operate in a chapter 7 or secure bank financing to make that possible. The resulting liquidation would destroy going-concern value. The customer base would dissipate. The realization on inventory and receivables would diminish in liquidation. Even if the trustee received an Asset Purchase Agreement at the outset of the case and was willing to operate the business, the public and court-supervised process would still take at least 60 to 90 days at considerable cost.

Foreclosure and Sale Under Article 9 of the UCC

The board was willing to conduct a foreclosure sale of the company’s personal property assets, subject to the bank’s senior lien. An Article 9 foreclosure sale does not require court involvement. It can be concluded in 10 to 20 days, radically lowering the cost compared to sales in bankruptcy. The bank’s attorney, however, believed that, if an involuntary bankruptcy were filed, the company had to shut down for 20 days prior to a sale to diminish the potential effect of section 503(b)(9) claims by creditors. Shutting down the business for 20 days would destroy the value of the customer base to the buyer.

Assignment for the Benefit of Creditors

An assignment for the benefit of creditors is a well-established out-of-court process under Illinois common law. Other states, such as Massachusetts and Missouri, also have non-judicial common law ABC processes. In some states, the ABC process may be statutory and court-supervised.

When an assignment is made, all company’s assets are transferred to a trust administered by the assignee. The company, or the assignor, is allowed to select its own assignee to administer the assets. The U.S. Trustee’s office does not randomly select an assignee as is the case in a Chapter 7. There is no automatic stay in an ABC. However, it creates a similar effect because the assignee is accorded lien creditor rights as of the date of the assignment and thus stands ahead of all unsecured creditors and later-perfected secured creditors. Most creditors stop pursuing collection lawsuits against an assignor after an ABC begins because

(1) the defendant assignor no longer has any assets, and

(2) even if the plaintiff creditor adds the assignee as defendant, the assignee’s rights are prior to the creditor’s judgment and to any judgment lien the creditor might then file.

The ABC process is typically faster and less expensive than a chapter 7 or chapter 11 bankruptcy case. A sale of assets can be done in as few as 10 business days and can be done in conjunction with an Article 9 foreclosure. A buyer purchasing from an assignee receives the right, title, and interest in the company’s assets that was transferred to the assignee when the assignment was made.

[Editors’ Note: ABC may not be available in receiverships. To learn more, please see 90 Second Lesson: Receivership vs Bankruptcy.]

Proposing an Assignment for the Benefit of Creditors

The buyer was willing to take some title risk to get the deal done quickly and to preserve the customer base. The bank recognized that the assignment for the benefit of creditors was its best option to maximize value from inventory and receivables. The bank agreed to support the ABC, lend funds to the proposed assignee, and pay the administrative costs of the trust estate. The buyer agreed to lease the company’s real property during the transition period following the sale date and to reimburse the trust for payroll costs and certain operating expenses.

[Editors’ Note: For more information on what a secured lender can do when its borrower is in trouble, please see What Secured Lenders Should Know If Their Borrower Files for Bankruptcy.]

Principal Issues and Arrangements

Prior to formal acceptance of the assignment, the assignee and their attorney needed to work through substantive issues, including:

• Negotiating the Asset Purchase Agreement — The completed Asset Purchase Agreement and Operating Agreement would trigger the ABC. Because of the assignee’s fiduciary duty to get the highest and best price possible, and because a public sale of the assets was feasible, the buyer had to agree to marketing and sale of the assets by public auction. The agreements provided that the auction would be 20 days into the assignment, giving the assignee time to reach out to other potential buyers. The sale would be advertised in the auction section of the Chicago Tribune for 2 consecutive weekends. The buyer’s deposit of 10% of the purchase price, and potential bidders had to post that amount before bidding. The agreements also afforded the buyer bid protection — new bids had to exceed the current bid by a set increment, and the prevailing bidder was obligated to close.
• Environmental Issues with the Real Estate — The Buyer did not want the real estate since it had potential environmental issues. The company agreed to place the real property into an LLC owned by the company. The company’s LLC member interest would be transferred to the assignee as part of the assignment. The assignee would sell the real estate in a separate transaction.
• Employee Layoffs and Terminations – The company had more than 100 employees and the buyer would not retain most of them. The company was subject to the federal WARN Act and its state law counterpart, so it made sense to complete the appropriate notice to state and local officials and employees before the assignment was accepted. Therefore, the WARN liability would be a pre-assignment liability, not an administrative cost of the estate. The WARN liability would be paid from proceeds left over after the bank was paid in full, rather than being paid ahead of the bank. Key employees agreed to stay with the business for a certain time with some stay-bonus arrangements.
• Funding Agreement with the Bank — The assignee prepared a liquidation expense budget for the bank. The bank agreed to fund the budget and provide cash advances to the assignee.

Once these issues were resolved, the assignee accepted the ABC, and all company’s assets were moved into the agreed upon trust per the trust agreement. Immediately following the acceptance of the ABC, the assignee sent a notice to creditors

• informing them that the assignment had taken place,
• informing them of the sale and auction,
• providing a schedule of assets and liabilities,
• providing a claim form for the creditor to complete and return to the assignee, and
• disclosing the buyer’s plan to retain the shareholder/CEO after the sale

Such a notice initiates clear and reliable communication with creditors, which is critical to the success of an ABC. It reassures creditors that the assignee will honor its duties rather than balking and stretching as a company does when it’s in distress. Some creditors who received extra payments prior to the ABC inquired as to preference issues. However, in Illinois, an assignee has no power to avoid and recover preferential payments made by a company. Such creditors may be relieved that no bankruptcy case was filed, whereupon they would be exposed to such potential liability.

The assignee received responses to the auction marketing. Several parties performed due diligence on the assets, and one showed up to the auction and bid. The buyer prevailed at the auction, and the closing occurred 2 days later.

Following the closing:

• The assignee and the buyer operated the facility for a short period of time while the buyer transitioned customers, inventory, and equipment to its other facility.
• The buyer helped collect accounts receivable for approximately four months.
• WARN claimants with pre-assignment unsecured claims, were entitled to no more than the dividend other unsecured claimants were entitled to.
• The shareholder/CEO retained liability for federal tax liabilities.
• The real estate was listed with a broker for later sale by the assignee.
• The assignee sent 2 additional notices to creditors reporting the progress of the liquidation and their prospects for a dividend.
• The bank and shareholder/CEO negotiated the latter’s liability related to his guarantee of the company’s obligations.

Conclusions

This tale illustrates how an assignment for the benefit of creditors might mitigate loss and preserve going-concern value. There are certain practical considerations when navigating an ABC:

• Before deciding on an ABC, a distressed company, and its secured lender, must weigh the pros and cons of each bankruptcy option and sale options to determine the best fit.
• Before an assignee formally accepts an ABC, he should consider situational factors and potential complications. These might include personnel issues like WARN Act rules and liability, financial and tax responsibilities, real estate issues like repair costs and environmental concerns, and packaging assets for maximum realization. Package them with the real estate or separate from the real estate? Exclude certain asset classes?
• The assignee must work closely with the secured lender to ensure funding for the administration of the ABC.
• The assignee should ensure good communication with employees, creditors, and other stakeholders.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each includes a comprehensive customer PowerPoint about the topic):

• Bankruptcy Intersections 
• Chapter 11 Potpourri 
• The Nuts & Bolts of a Chapter 11 Plan 

This is an updated version of an article originally published in December 2013; it was previously updated on April 25, 2019 and was most recently edited by Nora Willi]

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