There is an alternative to a Chapter 7 or Chapter 11 bankruptcy filing: an Assignment for Benefit of Creditors. In fact, an ABC can be a better vehicle to maximize the value of a debtor’s assets on behalf of creditors.

When cash flow slows to a crawl, and creditors begin pressing for payment, many lawyers immediately recommend filing a Chapter 11 or even a Chapter 7 bankruptcy petition. But an ABC may present a better alternative—by treating the company’s creditors fairly, creating the best chance for maximizing the value of the company assets, and giving company management a way to more gracefully exit a difficult and unpleasant situation.

The unavoidable truth is that in a recession, the bankruptcy system becomes overloaded. Bankruptcy trustees are extremely busy. They have neither the time nor the resources to operate a company in Chapter 7. Assets must be disposed of quickly and frequently without the assistance of former management. The bankruptcy forum, especially in Chapter 11, is fraught with administrative costs and complications, such as required operating statements, payments to the United States Trustee, preparation of a comprehensive plan of reorganization and formal court approval for the disposition of assets, and other actions. Much of this requires substantial legal expense and extensive court involvement.

The ABC concept is quite simple: all of the assets of the company are assigned to a fiduciary (the "Assignee"), whose function is to maximize the liquidation value of the assets and prorate payment among the provable claims. In many states the whole process is accomplished non-judicially, thus removing many costs and impediments, and increasing the Assignee’s maneuvering room to come up with innovative ways to maximize value. Even where judicially supervised, it is usually much less complicated than bankruptcy.

An Assignee with a good network of connections often can sell a company’s assets for far more than would be achieved in a bankruptcy auction.

The Legalese Behind an ABC

An ABC is the establishment of a trust for the benefit of all of a debtor’s creditors, vested in a fiduciary and funded with most, if not all, of the property of the debtor. ABCs usually are governed by state common law, but statutory schemes also exist in many states. Little if any court attention is paid to ABCs; they are not "managed" by courts in the same sense as a bankruptcy case. Courts have jurisdiction to handle specific disputes, but the ABC process is designed to, and takes place, largely outside a court’s purview.

The absence of a comprehensive statute and minimal court involvement allows ABC arrangements to solve debtor insolvency problems privately.

ABC Assignors

Anyone can make an ABC, provided they own sufficient property to justify the cost of liquidating it for the benefit of creditors; and have existing obligations, contingent or not; or may reasonably be expected to become liable to another. Generally assignors will be corporations, LLCs, or other business entities. Individuals acting as sole proprietors also can make an ABC, but rarely do because the ABC process has few benefits for an individual.

Because an ABC assigns all of a business’s assets, individuals executing an ABC on behalf of a legal entity such as a corporation or partnership must make sure that the governing board or membership of the organization has properly authorized the action. Moreover, because the ABC represents a permanent transfer of all of an entity’s assets, the Assignee must pay diligent attention to the prerequisites of asset transfer, whether under the applicable state Corporations Code or specific requirements of governing corporate documents such as the bylaws.

Most individuals will not want to make an ABC unless they have significant business debt to deal with because an ABC does not provide an individual with subsequent protection from creditors. Assignors are not discharged in the same sense as individual debtors in bankruptcy. Creditors who formally assent to an assignment that expressly absolves the Assignor from personal liability are deemed to have released the individual debtor, but not otherwise. Liquidation of assets with payment prorated to creditors reduces an individual’s obligations but does not completely eliminate them unless all the creditors enter into a formal compromise with the debtor. Thus, ABCs are more frequently executed by legal entities, which simply cease to exist after the assignment.

Assigning Property Through ABCs

An ABC can cover all types of property owned and transferred by the debtor, such as real estate (including leases), computers and communications gear (including leased equipment), contracts to sell its products, receivables, software, intellectual property licenses, patents, patent applications, and trademarks. Any property that can be lawfully sold or conveyed, or which can be taken from the debtor through execution on a judgment, can be assigned. The property can be real or personal, tangible or not. Because legal entities such as corporations do not have exemptions from execution, a general assignment by a legal entity transfers all of its interests in its property to the Assignee.

Close attention should be paid to the proper form of assignment needed to protect the effectiveness of the ABC. A properly acknowledged assignment with a notary’s jurat can be recorded to transfer any real property such as a lease, but only if the assignment includes an adequate legal description of the property so that the recording is public notice of the transfer. Similarly, transfers of intellectual property such as patents, patent applications, copyrights and trademarks must be accomplished in a way that will satisfy the agencies with which the transfer documents are filed. Since the executives of the assigning usually will move quickly on to other jobs following the ABC, a prudent Assignee will obtain all appropriate specific transfer documents contemporaneously with the making of the ABC itself.

If any of the property assigned is subject to an enforceable security interest such as a deed of trust or a financing statement, the Assignee takes that property subject to those liens. (See below for a further discussion of litigation liens such as attachment and execution liens.)

To preserve the opportunity for an Assignee to realize upon the value of any lease which is part of the ABC and to avoid administrative hassles, some states have enacted laws that allow the Assignee to occupy any leased real property for a period following the ABC so long as the rent is timely paid—even if the lease provides that it terminates upon an assignment. A more difficult problem still unaddressed by statutory enactments is how to protect the value of assigned intellectual property licenses that purport to terminate upon assignment.

ABC Assignees

Since ABCs are almost universally made in circumstances where a business is insolvent and its managers owe fiduciary duties to both creditors and equity holders, the chosen Assignee should be a prudent individual with all the talents necessary to realize the full value of the assigned assets.

While any person or legal entity that can legally own property can serve as an Assignee, ABCs are made almost exclusively to professional fiduciaries or the legal entities that employ them. Sometimes they double as bankruptcy trustees, but more frequently they also serve as receivers, workout specialists and/or troubled asset managers. The Assignor, with the advice of its lawyer, chooses the Assignee, and, while on rare occasion an Assignee is removed for incompetence or self dealing, most Assignees see the problem through to the end.

Assignees are not required to carry a fiduciary’s bond, but most do. And most try to insure themselves to the highest degree possible. Their obligations to the creditors are similar to those of any other fiduciary—exercise of sound business judgment, avoidance of personal interest in the matter, and application of careful diligence in the pursuit of their duties. An Assignee’s compensation usually is determined by the specific terms of the assignment documentation. Even if not addressed in the document, an Assignee likely will be entitled to some compensation, because courts usually have the power to award reasonable compensation for these services. Prudent Assignees will negotiate a specific agreement for hourly compensation covering themselves and others working with them, or a commission based on the dollar volume of the assets that flow through the assignment estate, as well as reimbursement of their expenses. Assignees are almost always entitled to legal counsel at the expense of the assignment estate should legal assistance be necessary.

Assignee’s Role

The primary job of an Assignee is to fulfill the responsibilities of a prudent fiduciary. In addition to the generally expected duties of any fiduciary, the assignment instrument or agreement frequently specifies particular duties for the Assignee. The almost universal components of an Assignee’s activities are to:

• Secure and protect the property

• Convert the estate to cash by selling the property

• Take legal action to recover on causes of action which are part of the assignment estate, including receivables, fraudulent transfers and preferential transfers

• Determine which creditors have valid and enforceable claims

• Consider and deal with any tax issues incident to the administration of the estate

• Distribute the cash first to priority creditors in the order mandated by statutory or common law and then pro rata among the remaining creditors

In some states, statutes give Assignees many of the same powers that bankruptcy trustees have, including the right to recover a preferential transfer; and to avoid as a preference not only the payment of money but also the transfer of property or interests in property, such as the granting of a lien.

The Assignee also may pursue actions under the Uniform Fraudulent Transfer Act or other fraudulent transfer statutes in the same way that a creditor could. Suits to recover fraudulent transfers must be filed within the time limits allowed by the applicable statute of limitations, and suits to recover preferential transfers, if provided for, must be filed within the time allowed by
statute.

Why ABCs Work

Assignors may be concerned that the lack of court supervision may lead creditors to file lawsuits against the Assignor to try to obtain payment in preference to other creditors, or involuntary bankruptcy petitions in the hopes of being "bought off."

But if the Assignee is a professional fiduciary, the liquidation of an Assignor’s assets often is regarded by the creditors as more of a blessing than a curse. A professional approach, periodic reporting and an evident expertise in obtaining the highest value for the assets will instill creditor confidence in the process. Creditors with a high degree of confidence that they will receive their equitable share of the largest reasonably achievable pot will allow that process to go forward without interference. These characteristics usually make the ABC a successful non-judicial liquidation process.

However, some unsecured creditors will remain skeptical of even the best efforts by an Assignee, who lacks the imprimatur of a court. But creditors may find it difficult to attack an ABC. Creditors who file an involuntary bankruptcy case after the ABC usually are faced with a motion by the Assignee or other interested parties to dismiss or abstain from the bankruptcy case on the grounds that the pending ABC is a more than adequate substitute for an involuntary bankruptcy case. Replacing one professional fiduciary with another generally is considered by the courts to be a waste of resources and time, and most such actions are dismissed, or the bankruptcy court abstains in deference to the existing ABC.

Creditors need to be aware that obtaining writs of attachment or judgments after an ABC becomes effective will have nothing to which to attach the lien. After the ABC is signed, all the Assignor’s property belongs to the assignment estate. There is nothing to attach or execute on. Creditors may even lack the right to attack the ABC itself as a fraudulent transfer to the Assignee. Even though the Assignee does not pay for the assignment and the debtor is almost always insolvent when it is made, case law and statutes in some states frequently exempt a general assignment for the benefit of creditors from the effects of the fraudulent transfer statute in order to prevent needless litigation. Also any act of acquiescence in the assignment by a creditor, such as filing a claim with the Assignee or accepting a dividend, is an estoppel that prevents it from challenging the ABC as a fraudulent transfer.

Property subject to a valid lien that is not avoidable remains subject to that lien in the Assignee’s hands, and the secured creditors’ rights are preserved as in a bankruptcy case. Thus, with their liens preserved, secured creditors rarely have issues with the concept of an ABC. Many tend to prefer the ABC over a bankruptcy filing because they can enforce their collection rights without first being forced to go to court for relief from the automatic stay to foreclose on their collateral. Moreover, they frequently prefer working with the less formal ABC process.

Creditors in litigation with the debtor at the time the ABC is signed may have valid and indefeasible attachment or execution liens. But in some states attachment and execution liens obtained within a statutory period (sometimes 90 days) before the effective date of the ABC are automatically released, as they are in bankruptcy.

There also can be some logistical pressure on creditors to voluntarily accede to the ABC process. Creditors who file claims with the Assignee pursuant to any notice given are deemed to have assented to the process and are estopped from denying the validity of the ABC. In most states, creditors are presumed to accept the ABC because it naturally benefits them. Even creditors who affirmatively reject the ABC do not have much power to derail the ABC process as a practical matter.

The "Z" of the ABC

How does an ABC come to conclusion? During the administration of the assignment estate, the Assignee must periodically report to the creditors. As the estate comes to a close, the Assignee will provide an accounting of his financial activities, and an indication of the distribution to be made to creditors at the close of the estate administration. Either before or simultaneous to the distribution, the Assignee will submit his final report.

Before paying out the proceeds of the estate to creditors, the Assignee will retain payment, according to the agreed compensation, as well as reimbursement for expenses. These amounts are included in the accounting. The balance of the assignment estate is distributed first to creditors with a priority right to payment and then to all other creditors pro rata.

Under various statutes, certain unsecured creditors have priority in distribution over other unsecureds. Sums owed the United States come first. In fact, fiduciaries that fail to observe this priority are personally liable for the amount owed. For obvious public policy reasons, claims for wages and benefits are given the highest priority after the United States in most places. Wage and benefit claims are to be paid as soon as cash becomes available and are not delayed until the assignment estate is wound up. Not surprisingly, the state taxing authority is given next priority. In some states, the next in line is the reimbursement of deposits given the Assignor prior to the ABC for the purchase or lease of property or services.

Following all the statutory preferences, the remaining proceeds of the assignment estate are divided among the creditors pro rata according to the total amount of their provable claims, plus accrued interest as of the date of the ABC. The Assignee may challenge claims and there may be litigation over the validity and amount of a claim. If funds are available beyond the full payment of the unsecureds, interest on those claims is paid; and if there is a surplus beyond that, the surplus is returned to the Assignor.

The simplicity of the process, the ability to choose the right professional for the job, the relatively low overhead cost, and the inherent fairness of the process means that Assignments for the Benefit of Creditors have become a common and useful tool for the liquidation and distribution of the assets of failed businesses. ABCs should be considered as an alternative to bankruptcy, whenever a small- to medium-sized business fails.