The United States Bankruptcy Court for the District of New York (the “Bankruptcy Court”) recently ruled In re Scandia Seafood (New York), Inc.[1] that an involuntary chapter 7 bankruptcy case filed against Scandia Seafood (New York), Inc. (“Scandia”) should proceed, notwithstanding the fact that Scandia had previously assigned its assets to an assignee pursuant to an assignment for the benefit of creditors (“ABC”) effectuated under governing state law. The Bankruptcy Court ruling was premised on strong evidence that the assignee failed to comply with his fiduciary duties, focusing more on his own financial gain in prosecuting preference actions as opposed to ensuring a proper valuation of Scandia’s assets and that the value of the assets inured to Scandia’s creditors and not the company’s prior owners. This case is a strong reminder that a fiduciary must always uphold his obligations to the parties he is meant to protect as well as a reminder of the consequences that may follow when this does not occur.
General Background
On November 29, 2016, Scandia executed a deed of assignment and filed it in the New Jersey court, thereby commencing the ABC. Scandia selected Donald F. Campbell (“Campbell”) to serve as the assignee for the benefit of Scandia’s creditors. On March 28, 2017, a group of petitioning creditors filed an involuntary chapter 7 bankruptcy petition against Scandia. Campbell moved to dismiss the involuntary petition on the grounds that the Bankruptcy Court should abstain from hearing the case pursuant to section 305 of the Bankruptcy Code, which allows for dismissal or suspension of a bankruptcy case if the Court finds such action to better serve the interests of the debtor and its creditors.
Prior to selecting Campbell to serve as assignee, and notwithstanding that as assignee Campbell would be a fiduciary for all creditors, Campbell met with the company’s equity owners, Mr. Tucker and Mr. Licht, on numerous occasions to discuss what the equity owners hoped to accomplish through the assignment, including Mr. Tucker’s interest in starting a new business, Seafood Innovations, that would buy the equipment owned by Scandia and would maintain at least part of the business formerly run by Scandia. Moreover, prior to the assignment and with the blessing of Campbell, the owners of Scandia executed a management agreement with Seafood Innovations. The management agreement gave Seafood Innovations the right to manage the business until Campbell could arrange a sale, with Seafood Innovations receiving cost free all inventory on hand and retaining all of the profits from selling the inventory.
After the assignment was effectuated, Campbell negotiated with only Seafood Innovations regarding the sale of Scandia’s assets. Campbell failed to publish notice that the business was for sale and did not retain advisors to conduct the sale process or send notices to other companies in the field. The only work done by Campbell to value the assets was a limited amount of due diligence in the form of an appraisal on the value of the equipment and the terms of the leases (as some equipment was leased). Campbell made no effort to determine whether the leases were on favorable, below-market terms or what the value of the leases might be to the estate. After the woefully deficient sale process, Campbell sold Scandia’s assets to Seafood Innovations for $45,000.
Thereafter, Campbell filed a motion in the New Jersey state court seeking approval of the sale. Notice of the sale was provided to the petitioning creditors who did not oppose the sale or appear at the sale hearing. A few months, later Campbell filed preference actions against the petitioning creditors, pursuant to a New Jersey statute that provides for a 120 day look back period, which caused the petitioning creditors to focus on the assignment. Once they did, the petitioning creditors filed the involuntary bankruptcy petition arguing that (i) the former owners formed Seafood Innovations and bought Scandia’s assets for an inadequate price; (ii) the management agreement was on bad terms; (iii) the sale did not include a valuable trademark that Seafood Innovations was nevertheless using and (iv) the preference actions were being prosecuted for the benefit of Campbell and his lawyers, who stood to recover a majority of the proceeds, and not for the benefit of Scandia’s creditors.
The Bankruptcy’s Court’s Decision
In deciding whether it should abstain from hearing the chapter 7 case, the Bankruptcy Court stated that without “very strong evidence showing that something was amiss”, it was hesitant to allow an involuntary bankruptcy case as a “do over” and as a means to attack matters that might be procedurally immune in the New Jersey court. Based on the record before it, the Bankruptcy Court held that it was not in the best interest of the estate, the debtor or the creditors for it to abstain from hearing the chapter 7 case.
The Bankruptcy Court found that the evidence clearly suggested “an appalling lack of diligence in ensuring that the prior owners paid a fair price for keeping the business and its assets.” Campbell, as a fiduciary, should have acted diligently to maximize value for the creditors. Instead, he did barely anything to protect them. Campbell set out almost immediately to work on potential preference actions against creditors, “while doing almost nothing to ensure that a proper valuation was obtained for the business itself and to ensure that the prior owners were not stealing value that should have belonged to the creditors.”
While the petitioning creditors had some responsibility to pay attention to the assignment proceedings, they also had a right to assume that Campbell, who was appointed as the representative of their interests, would act diligently to protect those interests by making sure the sale, and any dealings with equity owners, were on fair and proper terms. By allowing the involuntary chapter 7 case to proceed, there would be “an independent fiduciary in place who can review what happened and who can take action, if such action is appropriate.”
The Bankruptcy Court did, however, reject the petitioning creditors’ argument that a chapter 7 case was necessary to protect the trademark because Campbell had committed that any transfer of the trademark would be subject to an order of the New Jersey court. With respect to the effect of the preference claims on creditors, the Bankruptcy Court found that Campbell had the better argument since allowing the chapter 7 case might result in the preference actions being nullified because of the look back period under section 547 of the Bankruptcy Code. However, the Bankruptcy Court believed that it was “far more important and potentially more remunerative” for an independent fiduciary to review the pre-assignment dealings between Campbell and Scandia, the management agreement and the sale so that those matters, if appropriate, could be subject to challenge.
There are many advantages to liquidating the assets of a financially troubled company via an ABC including that an ABC is often quicker and less costly than filing a bankruptcy. However, in conducting an ABC, it is critical that proper procedures are implemented that allow the assignee to comply with his fiduciary duties and thereby maximize value for the estate.