Even before there was widespread recognition of the economic devastation likely to follow the Covid-19 pandemic, the start-up boom of recent years was on a decline.
An assignment for the benefit of creditors (ABC) may be the exit vehicle of choice for many formerly hot young companies. Further, after many years of steady growth, in what now appears to be an inevitable general economic decline, ABCs are among the legal tools that management, boards, investors and lenders should understand when evaluating options for salvaging or winding down a distressed business across the economy.
The New York Times reported Feb. 24 that “after a decade of prosperity, many [formerly] hot young companies are facing a reckoning.” Layoffs, shutdowns, and uncertainty were already symptoms of this downturn. The Times stated that these start-ups rose through a wave of about $763 billion of funding in the U.S. during the last decade and that, in the four months leading up to publication of the article, start-ups slashed more than 8,000 jobs.
The Times opined that "[t]he pullback will probably not be as severe as the dot-com bust in the early 2000s.” but identified cannabis start-ups as having taken the most drastic negative turn. To even be considering such devastation during a time of perceived relative general economic strength sent a concerning message prior to the impact of the coronavirus crisis.
During the meltdown suffered in the dot-com and technology business sectors in the early 2000s, frequently the exit vehicle of choice was an ABC. An ABC is a business liquidation device available to an insolvent debtor as an alternative to formal federal bankruptcy proceedings (which are unavailable to cannabis businesses because of their illegality under federal law). In many instances, an ABC can be the most advantageous and graceful exit strategy.
This is especially true where the goals are (1) to transfer the assets of the troubled business to an acquiring entity free of the unsecured debt incurred by the transferor and (2) to wind down the company in a manner designed to minimize negative publicity and potential liability for directors and management.
The process of an ABC is commenced by the distressed entity (assignor) entering an agreement with the party which will be responsible for conducting the wind down and/or liquidation or going concern sale (assignee) in a fiduciary capacity for the benefit of the assignor’s creditors.
The assignment agreement is a contract under which the assignor transfers all of its right, title, interest in, and custody and control of its property to the third-party assignee in trust. The assignee liquidates the property and distributes the proceeds to the assignor’s creditors.
It is not unusual for the board of a troubled company to determine that a going concern sale of the company’s business is in the best interests of the company and its creditors. However, frequently the purchaser will not acquire the business if the assumption of the company’s unsecured debt is involved.
Further, often the situation is deteriorating rapidly. The company may be is burning through its cash reserves. The company may be in danger of losing key employees who are aware of its financial difficulties and creditors of the company are pressing for payment. Under these circumstances, the company’s board may conclude than an ABC is the most appropriate course of action.
Advantages of an ABC
Compared to bankruptcy liquidation, assignments may involve less administrative expense and can be a substantially faster and more flexible liquidation process. In addition, unlike Chapter 7 liquidation, where generally an unknown trustee will be appointed to administer the liquidation process, in an ABC the assignor can select an assignee with appropriate experience and expertise to conduct the wind down of its business and liquidation of its assets.
In prepackaged ABCs, where an immediate going concern sale will be implemented, the assignee will be involved prior to the ABC going effective.
The assignment process enables the assignee to sell the assignor’s assets free of the unsecured debt that burdened the company. Unlike bankruptcy, where the publicity for the company and its officers and directors will be negative, in an assignment, the press generally reads “assets of Oldco acquired by Newco,” instead of “Oldco files bankruptcy” or “Oldco shuts its doors.”
Moreover, the assignment process removes from the board of directors and management of the troubled company the responsibility for and burden of winding down the business and disposing of the assets.
From the perspective of a secured creditor, instead of being responsible for conducting a foreclosure, the secured creditor may prefer to have an independent, objective third party with expertise and experience liquidating businesses act as an assignee.
Further, a buyer of assets through an ABC receives the assets cleansed of potential contentions that the assets were acquired as part of a fraudulent transfer and/or that they are a successor to or subject to successor liability for claims against the distressed entity.
The ABC process may allow the parties to avoid the delay and uncertainty of formal federal bankruptcy court proceedings. In many instances involving deteriorating businesses, management engages in last-ditch efforts to sell the business in the face of mounting debt.
However, frequently the value of the business is diminishing rapidly as, among other things, key employees leave. Moreover, the parties interested in acquiring the business and/or assets will only move forward under circumstances where they will not be taking on the unsecured debt of the distressed entity along with its assets.
In such instances or for conducting a wind down, especially when the expense of Chapter 11 may be unsustainable, an assignment for the benefit of creditors can be a viable solution.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
David S. Kupetz is a partner at SulmeyerKupetz. He is an expert in business reorganization, restructuring, bankruptcy, assignments for the benefit of creditors, and other insolvency solutions and related litigation.