• Working with a Financially Distressed Customer: The ABCs of an Assignment for the Benefit of Creditors
  • July 8, 2009 | Author: Kurt M. Carlson
  • Law Firm: Much Shelist Denenberg Ament & Rubenstein, P.C. - Chicago Office
  • When faced with the deteriorating financial condition of a customer or client, there is one simple rule of thumb that every creditor should follow: always participate in the insolvency process. Creditors that stay on the sidelines are doomed to the results others fail to attain.

    I like to play blackjack in Vegas (one of my last remaining vices). Believe it or not, insolvency proceedings and that game of cards are alarmingly similar. First, if you don't have a seat at the table, you will have no chance at getting a distribution. Second, in order to play the game, your seat at the table will cost you money on the front end. Third, if you don't know the rules, you are destined to lose. Finally, if you don't know your odds, you will end up losing far more than you win.

    Clients or customers on the brink of insolvency may introduce you to the phrase "assignment for the benefit of creditors" (ABC). If so, my advice is to take a lesson from blackjack and get your seat at the table. At the very least, explore the insolvency process with them. If it makes sense, you should also participate actively—even if it costs you a little money. To do so, you will first need a working knowledge of the process.

    What Is an Assignment for the Benefit of Creditors?

    An ABC is a voluntary, out-of-court transfer of a debtor's property (of every kind and nature) to a third-party trustee (more commonly known as an assignee). This type of insolvency proceeding is designed to provide a mechanism for liquidating a company's assets in an orderly fashion. In some cases, a buyer will take over the company through an operating assignment, which may allow for the continuation of business for a period of time.

    Because there is no statutory scheme in place for ABCs in Illinois, the process is strictly based on common law. Generally, assignments may not be made in the face of a validly issued and served citation to discover assets, which is a post-judgment recovery process that prohibits the voluntary transfer of property to an assignee. While an ABC does not require approval by the creditors, it helps if they are at least involved in the process. Still better is when one of the primary creditors has a hand in drafting the trust document, which establishes the ABC and lays out the rules of the assignment. Although most assignees have their own standard forms, many are willing to work with creditors to customize several aspects of those documents. As a creditor, your involvement in drafting the trust document could mean the difference between having a budget in place for the assignee or allowing the assignee and legal counsel to operate the business (or wind it down) without any budgetary constraints whatsoever.

    Shieldwipe: A Case Study

    In order to better understand when an ABC is useful, consider the hypothetical example of Shieldwipe, a fictional manufacturer of windshield wipers. Let's say that Shieldwipe, whose primary customers are the Big Three automakers, falls on hard times because wiper sales are dramatically down. Shieldwipe has a credit facility at a regional bank (secured by its assets), and the company's physical plant and fixed assets are all in decent shape. Provided that even one of the Big Three automakers comes out of a bankruptcy reorganization alive, Shieldwipe believes it can win a new contract and continue production at some lesser level. That cost structure, however, would not allow the company to service its current debt. Understandably, the regional bank has no desire to expend significant resources to sue, especially since the bank would only get liquidation value of Shieldwipe's collateral—minus the costs of litigation.

    Faced with insolvency, it appears that Shieldwipe must either reorganize (but cannot bear the expense and burden associated with Chapter 11 filings) or liquidate. A less costly Chapter 7 filing might work for the liquidation option, but payments were previously made to the bank and the owners, which might lead to an unwanted preference action. Furthermore, Shieldwipe's management would rather see its employees keep their jobs and believes there is a business to save. Under the circumstances, is there an alternative? If so, it may well be an assignment for the benefit of creditors.

    Most assuredly, the current ownership will lose all equity and control through the ABC process. Under certain circumstances, however, one or more of the former equity holders may participate in the formation of the new ownership. The secured creditor (or the regional bank in the Shieldwipe example) will need to approve any sale of assets in order to provide its release of liens and mortgage. As such, the secured creditor must work closely with the assignee, and generally is the creditor that must approve budgets throughout the assignment. This is both a cost and a benefit in that it provides oversight and balances the interests of the secured creditor and the assignee, which acts as a fiduciary for all creditors.

    An ABC liquidation, while streamlined in comparison to a Chapter 7 bankruptcy, can take a hybrid form—allowing an assignee to operate the company for a short period of time prior to liquidation (like a Chapter 11 reorganization), with the aid of some current employees and management (as in a Chapter 7 liquidation). This hybrid scenario is particularly beneficial if a new ownership group is waiting in the wings. After completing the sale of the insolvent company's assets, the assignee can ease the transition to the successful buyer. Another benefit (although only to potential recipients of preference payments) is that no preference actions can be brought by the assignee.

    In the Shieldwipe case, the ABC process proves successful. The company that emerges—with its own financing and new mix of ownership—is able to retain many of its best employees and achieve profitability over time.

    In the end, the creditor that gets a seat at the table and actively participates in the insolvency process is the creditor that stands the best chance of obtaining favorable results. In the hypothetical case of Shieldwipe, participating creditors that are also suppliers may very well have parlayed a dying relationship into a new, profitable one by merely staying engaged in the difficult process of an insolvency proceeding.