By: Donald L Swanson

A sweet-spot for an assignment for benefit of creditors (“ABC”) in today’s world is this:

• a failing business needs to liquidate; and
• bankruptcy laws are inadequate or too expensive.

An ABC fills-in where bankruptcy doesn’t work. In other words, an ABC is a state-law complement to federal bankruptcy laws . . . and not a state-law competitor to federal bankruptcy laws.

What follows is a discussion of some of the ways that ABC laws and bankruptcy laws can complement each other.

Individual with a Sole Proprietorship: Using Both

Commonly, an individual with a sole proprietorship would want to use bankruptcy to liquidate the proprietorship business. 

Here’s why:

• An individual needs the fresh start that bankruptcy provides, through a combination of the discharge of debts, exemptions and reaffirmation agreements; and
• ABCs cannot provide a discharge.[Fn. 1]  

But here’s how a sole proprietor, who qualifies for Chapter 7, might achieve the best of both worlds (ABC and bankruptcy) as complementary processes:

1. liquidate assets of the proprietorship through an ABC; and
2. then, file Chapter 7, after the 120 days of § 543(d)(2) expire, to pursue a discharge of debts and to retain personal assets through exemptions and reaffirmations.

Such a course of action might be useful when:

• the proprietor’s business assets are fully encumbered—which assets a Chapter 7 trustee would simply abandon as burdensome to the bankruptcy estate; and
• both the proprietor and secured creditor want to maximize value of debtor’s assets through liquidation but have no desire to incur the expense or trouble of a multi-year bankruptcy plan, under any of the reorganization chapters (i.e., chapters 11, 12 or 13).    

Corporations and LLCs: Significance of Subchapter V

The recent addition of Subchapter V has decreased, somewhat, the number of businesses for which bankruptcy laws are inadequate or too expensive.

–Historically: No help for small businesses

Historically, bankruptcy laws have never provided effective help for small businesses.  That’s because the only reorganization chapter historically available to small businesses is Chapter 11.  And standard Chapter 11 (as opposed to Subchapter V) has always been designed for the reorganization of large businesses.  To illustrate:

• standard Chapter 11 has an absolute priority rule [fn. 2]—this rule may make sense for publicly traded companies that have hundreds or thousands of passive shareholders; but
• the absolute priority is typically unworkable when the owners of the business are also the ones who run the business and guarantee its debts—i.e., they are the business.

And it should be no surprise that a law designed for large businesses is unworkable and way too expensive for small businesses that need to liquidate.

–Subchapter V—Designed for Small Businesses

The relatively-new Subchapter V recognizes a new-value exception to the absolute priority rule for small businesses.  This new value exception bites into the ABC sweet-spot described herein.  That’s because Subchapter V is an expedited and relatively-efficient reorganization tool, designed specifically for small businesses, under which “reorganization” includes “liquidation.” 

Yet, Subchapter V is still an in-court process with heavy court-supervision. This fact, alone, creates expenses that can be prohibitive: i.e., a process that is “efficient” and “cost-effective” when compared to standard Chapter 11 . . . is still inefficient and costly when compared to an out-of-court ABC process.

Notably, Subchapter V has many built-in burdens that can be prohibitive for small business debtors that need to liquidate, such as:

• a $1,738 filing fee for a voluntary petition under Subchapter V;
• the Subchapter V trustee gets an hourly fee; 
• Subchapter V is a judicial process with extensive disclosure and administrative obligations and other fee-creating requirements; and
• any bankruptcy filing makes the debtor’s constituents nervous and hesitant: i.e., lenders, venders and creditors, alike!

The harsh reality of Subchapter V is this: it is still a court-supervised process that is still expensive compared to an out-of-court ABC . . . even though Subchapter V can be much less expensive than standard Chapter 11.

–Factors favoring bankruptcy

Factors that argue against an ABC liquidation and in favor of a bankruptcy liquidation, in certain small business situations, include the following.

• Distribution scheme.  When substantial equity exists in debtor’s assets over and above liens, bankruptcy offers a sophisticated / court-supervised distribution scheme that cannot be replicated under ABC laws.
• Automatic stay. Sometimes, an automatic stay is needed to assure that a liquidation of debtor’s assets can be accomplished in an orderly fashion and without disruption from creditors bent on racing to the courthouse, and only the Bankruptcy Code can provide such a stay (ABC laws cannot);
• Sales free-and-clear.  Sales under the Bankruptcy Code (e.g., under § 363 or a confirmed plan) can be free and clear of liens, with those liens attaching to proceeds of sale in the order of their relative priorities.  Such a sale power is useful when:  
  • a junior, but out-of-the-money, lienholder won’t cooperate in an ABC liquidation, and the debtor and the senior lienholder prefer an assignor-led liquidation over foreclosure; and
  • a buyer is concerned about getting clear title and wants the added free-and-clear protections that the Bankruptcy Code can provide.

Accordingly, the ABC sweet spot discussed in this article may be a little smaller than before enactment of Subchapter V. But that sweet spot is still broad and significant and will apply to many small businesses that need to liquidate in a reasonable and credible manner.

Conclusion

What the foregoing demonstrates is this: ABC is a highly-specialized tool for liquidating the assets of a failing businesses that is complementary to (and not in competition with) remedies available under the Bankruptcy Code. 

Post Script

A Drafting Committee of the Uniform Law Commission is preparing a uniform law on assignments for benefit of creditors.  

My view is that such a uniform law should focus on making ABCs a complementary process to bankruptcy and not on making it a competitor to bankruptcy laws.

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Footnote 1.  See  “The Effect of a National Bankruptcy Law upon State Laws,” by Samuel Williston, published in 1909 by Harvard Law Review, on the first page and in its footnote 3. 

Footnote 2.  The absolute priority rule is a plan confirmation requirement in regular Chapter 11.  It requires that debtor’s owners receive “nothing” under the plan, unless unsecured creditors are either paid in full or agree to something less.  The words “absolute priority” are not found in the Bankruptcy Code, but the absolute priority rule is ensconced in § 1129(b)(2)(B).

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