Assignment for the benefit of creditors: What credit managers need to know

When a customer is too indebted to reorganize and rebuild, they may execute a general assignment for the benefit of creditors (ABC), a mechanism where the customer (the “assignor”) assigns its assets to an assignee, typically for the purpose of liquidating the assignor’s business. This method of liquidating (whether through a wind-down process or, in certain instances, a going-concern sale) avoids the potential unpredictability and cost associated with a bankruptcy filing.

Why it matters: ABCs are governed by state law, not federal law, meaning that the process varies depending on the laws in the state where the ABC is commenced. As ABCs become an attractive alternative to a more traditional Chapter 7 liquidation, it is critical that credit managers familiarize themselves with what the process looks like and how it can vary from state to state.

“An ABC filing is typically a wind-down proceeding,” said Bruce Nathan, Esq., partner at Lowenstein Sandler (New York, NY). “Once a company initiates an assignment for the benefit of creditors, that company, at least under its existing ownership, ceases to exist. That company is assigning an assignee the keys to its entire business and operations.”

An assignment is the transfer of a debtor’s legal and equitable title to property to the assignee, granting the assignee the authority to liquidate the debtor’s assets and distribute the proceeds to creditors. Unlike in bankruptcy (where there is always court oversight), whether there are any formal court proceedings or oversight over an ABC varies by state. This, of course, impacts creditors’ visibility into the happenings of the ABC.

The assignee’s responsibilities depend on state law, with some states not having statutes and rather depending on common law developed over the years. The assignee is chosen by the debtor-assignor, at times needing the approval of the assignor’s secured lender.

“The assignee is charged with liquidating and monetizing the debtor’s business and assets, just like a Chapter 7 trustee would,” said Michael Papandrea, Esq., partner at Lowenstein Sandler (Roseland, NJ). “There will be a process for submitting claims and a process for distributions, similar to a Chapter 7. The big difference is that the Chapter 7 process is relatively consistent across jurisdictions, since it is a matter of federal law. An ABC can vary considerably on a state-by-state basis, for example, with respect to whether there is a court process, whether clear notice must be provided to creditors, and whether the assignee needs court approval to take certain actions.”

Once chosen, the assignee acts as a fiduciary to all of the creditors of the debtor’s company. Where a Chapter 7 trustee is assigned from a panel of trustees in the relevant jurisdiction, an assignee in an ABC is typically chosen by the debtor-assignor. This enables the selection process to consider whether the assignee has relevant expertise, e.g., knowledge on liquidations or the industry of the debtor. With the assignor able to pick the professional assignee, they can discuss the assignment and possible cost to determine whether the making of an assignment is worth pursuing.

One advantage of an ABC compared to a traditional liquidation is that the parties can determine, before executing the assignment documents, what may happen through the ABC. A disadvantage of an ABC (from a creditor’s perspective) is the assignor can pick an assignee overly sympathetic to the assignor’s secured lender or owner(s).

“The advantage of an ABC filing is that it is faster than bankruptcy,” Nathan said. “They’re also usually a lot less expensive, which means there may be more money available for unsecured creditors, assuming the state law priority claims are paid. They’re very flexible.”

While ABCs are often less costly than the alternatives, there are still costs associated with the process, including:

• Administrative rent: The cost of the assignee staying in the premises previously occupied by the debtor. The assignee can negotiate a reduction in rent or a waiver if the premises are leased by the debtor’s principal or another related party.
• Assignee’s fee and other administrative costs: The assignee is paid through a fee negotiated as part of the initial assignment contract. If there is not enough money to cover the cost of the assignee, an ABC cannot be initiated without an agreement with a secured lender. Fees may be a percentage of the amount realized in the liquidation of the process or a fixed, capped amount in the initial contract. Furthermore, in states where court monitoring is required, the court will approve assignee fees.

“One disadvantage of an ABC is there is no automatic stay,” Nathan said. “From a practical standpoint, once creditors get notice of an assignment of the benefit of creditors, if they try to sue and collect a judgment, there are no assets for creditors to collect against because they’ve been transferred to the assignee. There is also no automatic stay that stops a secured lender from foreclosing on their collateral. So, to continue with an ABC, the consent of the lender is crucial.”

Once an assignee is chosen, they will usually notify creditors that the assignment has been made, how the distribution process will be handled and provide them with a form so they can submit a claim. Once claim forms are submitted, the assignee will inform the creditors if there are any issues with the amount of the claim. The assignee will then determine the distribution amounts to each creditor based on the priorities of claim types.

The claims priority scheme of an ABC may vary depending on applicable state law. But, generally, properly perfected secured claims will be paid before other claims (e.g., unsecured trade claims).

The bottom line: While the basics of an ABC filing are somewhat consistent from state to state, the process can vary greatly depending on the state where a customer commences its ABC. The degree of court involvement, priority of claims, assignee designation process and filing deadlines depend on state laws. Therefore, the overall cost and efficiency of an ABC filing are entirely dependent on the state filed in.