This detailed story illustrates how a troubled company considered its duties and its options, then executed a strategy using an Assignment for the Benefit of Creditors (“ABC”) to mitigate successfully its potential losses.  This story puts meat onto more skeletal discussions of ABC rules and how they compare with competing resolution structures under the Bankruptcy Code and Uniform Commercial Code (“UCC”).  In this story, through an ABC, the guarantor’s liability was minimized, the Bank and going-concern Buyer got what they wanted, and the enterprise continued.

Background

A family-owned business in Illinois (the “Company”) had lost large amounts of money for three years.  Trade creditors had been stretched and some were cutting off the company.  Several breach of contract lawsuits were working their way through the courts (but no judgments had been entered).  Some trade creditors had received additional payments to induce them to continue shipping.  Some federal and state withholding taxes had not been paid over to the taxing authorities.

The Company 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 several difficult discussions with Bank regarding the prospects of the business, the board of directors and the majority shareholder/CEO of the Company (who had guaranteed the Company’s debt to Bank) concluded that the Company should sell or liquidate its assets.  Board and shareholder agreed that a sale of the company as a going concern would generate more proceeds than would a liquidation, and thus go further toward paying down the Bank loan and diminishing 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 most desired by the Buyer was the Company’s large but perishable customer base.  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 real estate, which had environmental challenges. The Buyer offered to purchase the inventory at 50% of book value (subject to a physical count) and the equipment at 80% of orderly liquidation value. As part of the deal, the Buyer would assist the Company in collecting the 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 Bank.

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

The Bank was willing, if such a sale would get the debt paid.  Importantly, the shareholder was greatly concerned for his reputation and wanted to keep all financial issues as quiet as possible – it would be better to sell the assets on the “down low,” as it were.

Examining Options

Advised now by insolvency counsel, the board recognized that the Company’s insolvency meant that the board held fiduciary obligations to the creditors 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 of the Bank.  The options considered were:

• Chapter 11 Bankruptcy– Company could operate in chapter 11 as debtor-in-possession, where the automatic stay would bar any progress in the trade creditor suits, and the assets of the Company could be sold to Buyer (or higher bidder) through a sale under section 363 of the Bankruptcy Code.  Such a sale could get Buyer title to the assets, free and clear of liens, claims, and encumbrances, and such title support might arouse a better price.  However, the chapter 11 process through sale would take no less than 60-to-90 days, through a very public court-supervised process, which may involve a contentious creditors committee (populated by those stretched and restive creditors).  Each aspect of this process raised expenses, and it was not clear that the Bank would fund operations or expenses.  It appeared that the Buyer, having performed extensive due diligence, would be willing to purchase the assets through a faster process, even with less protection for 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 management of the Company.  It is unlikely (though not impossible) that a trustee would operate in a chapter 7 or secure Bank financing to make that possible.  The resulting liquidation under chapter 7 would destroy any going-concern value.  The customer base would dissipate.  The realization on inventory and receivables would diminish in liquidation.  Even if the trustee were presented with an Asset Purchase Agreement at the outset of the case and were willing to operate the business, the public and court-supervised process would still take at least 60 to 90 days, presenting considerable cost.
• Foreclosure and Sale Under Article 9 Sale of the UCC – The Board was willing to conduct a foreclosure sale – under Article 9 of the UCC — of the Company’s personal property assets subject to the Bank’s senior lien.  No court need be involved in an Article 9 foreclosure sale, and it can be concluded in 10 to 20 days, which radically lowers costs compared to sales in bankruptcy.  The Bank’s attorney, however, believed that 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 if an involuntary bankruptcy was filed.  Shutting down the business for 20 days would also 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. [i] When an Assignment is made, all of the Company’s assets are transferred to a trust administered by the Assignee.  The Company (the Assignor) is allowed to select its own Assignee to administer the assets (as distinct from the random selection of a chapter 7 trustee by the US Trustee’s office in a chapter 7 case). There is no automatic stay in an ABC.  However, a similar effect is created 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 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 could be done in as few as 10 business days (and can be done in conjunction with an Article 9 foreclosure).  A Buyer 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.

The Company proposed an ABC to Buyer and Bank.

The Buyer was indeed willing to take some title risk to get the deal done quickly and to preserve the customer base.  The Bank recognized that the ABC was its best option to maximize value from inventory and receivables.  The Bank agreed to support the ABC and lend funds to the proposed Assignee and to pay for the administration 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 costs incurred for payroll and certain operating expenses.

Principal Issues and Arrangements Made

Prior to formal acceptance of the Assignment, the Assignee (and his attorney) needed to work through a number of substantive issues, including:

• Negotiating the Asset Purchase Agreement – The ABC would be entered into when the Asset Purchase Agreement and Operating Agreement were ready.  Because the Assignee had a 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 held 20 days into the Assignment, to give the Assignee time to reach out to other potential buyers, and the sale would be advertised in the Auction Section of the Chicago Tribune for two consecutive weekends.  The Buyer put up a deposit of 10 percent of the purchase price, and potential bidders had to post that amount in order to bid.  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 real estate was not wanted by Buyer and had potential environmental issues to boot.  The Company agreed to place the real property into a limited liability company owned by the Company.  The Company’s member interest to that LLC would be transferred to the Assignee as part of the Assignment.  The real estate would thus be sold by Assignee in a transaction totally separate from the asset sale to Buyer or higher bidder.
• Employee Layoffs and Terminations – The Company had more than 100 employees.  Most would not be offered jobs by Buyer.  Because the Company was subject to both the federal WARN Act and its state law counterpart, it made sense to complete appropriate notice to state and local officials and employees before the Assignment was accepted.  Thus the WARN liability would be a pre-assignment liability and not an administrative cost of the estate.  So, WARN liability would be paid from proceeds left over after Bank was paid in full rather than being paid in full ahead of Bank.  Arrangements were made with key employees to stay with the business for a certain time, and some stay bonus arrangements were made.
• 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 of the Company’s assets were moved into the trust created by the Trust Agreement.

Immediately following the acceptance of the ABC, the Assignee sent a Notice to Creditors which: informed them that the Assignment had taken place; informed them of the sale and auction; provided a schedule of assets and liabilities; and attached a Claim Form to be completed and returned to the Assignee. The Notice also disclosed Buyer’s plan to retain the shareholder/CEO after the sale.

Notice like that provided by the Assignee initiates clear and reliable communication with creditors that is critical to the success of an ABC.  Creditors can thus become re-assured that the Assignee will honor its duties to creditors (by contrast to the balking and stretching Company in its distress).  Some creditors that had 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 two days later.

Following the closing:

• The Assignee and the Buyer operated the facility for a short period of time while the Buyer transitioned the customers, inventory, and equipment to its other facility;
• The Buyer helped collect accounts receivable for approximately four months;
• WARN claimants, having pre-Assignment unsecured claims, became entitled to no more than the same dividend to which other unsecured claimants were to be entitled;
• 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 two additional Notices to Creditors that reported on the progress of the liquidation and their prospects for a dividend;
• The Bank and shareholder/CEO commenced negotiations on the latter’s liability to Bank on his guarantee of Company’s obligations.

Conclusions

This tale illustrates both how an ABC might mitigate loss and preserve going-concern value and certain practical considerations regarding 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 option, in order to determine the best fit the company’s situation;
• Before an Assignee formally accepts an ABC, he should identify and take into consideration the factors and potential complications related to the specific situation, such as personnel issues like WARN Act rules and liability, financial and tax responsibilities, potential real estate issues like repair costs and environmental issues, and how to package the assets (together with the real estate? Separate from the real estate? excluding certain asset classes?) for maximum realization;
• The Assignee must work closely with the secured lender to ensure funding for the administration of the ABC;
• The Assignee should be a good communicator with employees, creditors, and other stakeholders.

Editor’s Note: For a great discussion of options available to struggling businesses, we recommend this webinar.

[i] Some states, such as Massachusetts and Missouri, also have non-judicial common law ABC processes.  In other states, the ABC process may be statutory and court supervised.