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When Business Goes Bad, Know Your ABCs

April 16, 2021, 8:01 AM

We’ve been battling a pandemic for over a year, and are beginning to see daylight. Some businesses have adapted and thrived. Others have not been so fortunate. Some may simply close their doors and walk away. Others will want to give it another shot, and attempt to reorganize through a Chapter 11 bankruptcy reorganization.

Yet others will want to use bankruptcy to liquidate and close out their businesses, or potentially liquidate through a sale of the business. For businesses wanting to liquidate or sell, there is another option, which in some circumstances may prove to be less expensive and more advantageous than the more traditional bankruptcy option—an assignment for the benefit of creditors (also known as an ABC).

Advantages of ABCs

Under an ABC, the troubled business assigns its assets to a trustee or assignee to liquidate them for the benefit of creditors in an effort to pay all or part of their claims. For a straightforward liquidation or sale, an assignment may cost less, be quicker, and have less red tape than a comparable bankruptcy.

It is also less high profile than a bankruptcy and may generate less negative publicity. It is certainly an alternative the distressed business, particularly smaller businesses, should consider with experienced counsel.

Under an ABC, the troubled business chooses the assignee or trustee to liquidate its business, and possibly even operate the business, where doing so will preserve going concern value and maximize return to creditors through a sale of the business.

In comparison, in bankruptcy, the troubled business does not get to select the trustee. Further, bankruptcy trustees are often lawyers and accountants whereas assignees may have more industry specific experience that will help in maximizing the recovery to creditors. Often, the principals of a small business may have guaranteed debts, including loans and leases. Therefore, the more realized from a liquidation or sale to pay creditors, the more the potential exposure under the guaranties may be reduced. This also benefits creditors who may be able to recover more of what they are owed.

Disadvantages Compared to Bankruptcy

Unlike bankruptcy, which has a uniform set of laws, ABCs are subject to the law of each state, and can vary greatly from state to state. Some states have extensive statutory law that mimic or have similar provisions to a number of bankruptcy provisions. In other states, the process is a matter of common law, may have less formality, and may not have as many bankruptcy-like powers.

When considering an ABC as an alternative to bankruptcy, the troubled business will need to consult with counsel to determine the what can and cannot be done in an ABC, as well as the costs, in that particular jurisdiction.

Potential disadvantages could vary depending on the jurisdiction. For example, if a business has assets in different states, a bankruptcy may be better suited to address the situation since a bankruptcy court is a federal court, and jurisdiction can be exercised over assets anywhere in the U.S.

In a bankruptcy, subject to certain delineated defenses, preferential payments to individual non-insider creditors within 90 days of the bankruptcy filing can be recovered for the benefit of the creditor body as a whole. However, in many states, the assignee will not have a similar power. Therefore, where the ability to achieve a significant distribution to creditors depends on recovery of non-insider preferences, bankruptcy will be the superior option.

Even if the bankruptcy option is not selected, creditors could still place the troubled business into involuntary bankruptcy (subject to certain time constraints), provided they meet the requirements. Bankruptcy may also be superior where successor liability of the party acquiring the assets is a significant issue.

Further, bankruptcy often holds out the carrot of a discharge of indebtedness (certain debts are non-dischargeable in bankruptcy), except where corporations are involved, since corporations do not generally receive a discharge in bankruptcy. By contrast, the assignor in an ABC does not receive a discharge. Consequently, where the troubled business is a sole proprietor or partnership, the inability to obtain a discharge will likely weigh against an ABC.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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James D. Silver is a partner at Kelley Kronenberg in Fort Lauderdale, Fla., where he heads the firm’s commercial bankruptcy and creditors rights practice.

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