Comparing and Contrasting Bankruptcy and Assignment for Benefit of Creditors (ABC)
Business observers are familiar with the idea of leveraging Chapter 11 bankruptcy to restructure debts and improve a business’ financial position. Fewer people are familiar with the bankruptcy alternative of an assignment for benefit of creditors.
We recently sat down with Jim Sweet, a partner at the law firm of Steinhilber Swanson LLP, in Madison, to discuss bankruptcy, ABC’s, and how businesses can choose the best path out of financial difficulties. Below are the questions we asked as well as Jim’s responses.
Q: What are the primary differences between Chapter 11 bankruptcy and ABC’s?
A: One of the significant differences is that, unlike Chapter 11, ABC’s take place outside of bankruptcy courts. In some states, there is very little court supervision of ABC’s. Like Chapter 11, ABC’s are a tool for resolving financial issues. Unlike Chapter 11, ABC’s can be less costly for creditors and more expedient than going through the bankruptcy process. But, like any tool, an ABC should be used only for situations that will benefit from its use.
Chapter 11 bankruptcy is structured according to the Bankruptcy Code and the Rules of Bankruptcy Procedure. A formal legal process, the proceedings of Chapter 11 are deliberate and mostly predictable. Chapter 11’s primary benefit to debtors is the automatic stay affecting all creditors, including secured creditors. The stay means that creditors and the debtor must negotiate when the debtor and secured creditor, in particular, are not on the same page.
ABC’s are started via an Order of Appointment, which outlines the custodial responsibilities and obligations of the ABC receiver and the scope of the receivership estate. A properly drafted Order of Appointment should be based on the case’s unique circumstances, providing the receiver with the powers necessary to carry out their obligations. Judges in ABC cases have significant leeway to establish and modify the rules and procedures followed throughout the process.
ABC’s in Wisconsin, under Wis. Stats. Chapter 128, usually arise after the Debtor has assigned for the benefit of its creditors all its right, title, and interest to the receiver. In other words, after the decision has been made that reorganizing under Chapter 11 is not feasible. In practice, the assignment is made voluntarily, with the agreement of the secured creditor, or involuntarily at the insistence of the primary secured lender. In either case, the ABC results in the liquidation of the assets or sometimes a sale of the going concern to a third party.
Q: What are the appointed receiver’s responsibilities during an ABC?
A: The court-appointed receiver is responsible for all management decisions, financial stewardship, and regulatory compliance of the debtor. Everything from decisions over personnel to how to wind up the business falls under the receiver’s responsibilities. Management, board members, and others who remain in place have no power over these decisions and the company’s ultimate direction while the receiver strives to salvage the businesses’ value for creditors. In fact, in most Wisconsin Chapter 128 receiverships the board and officers resign in conjunction with the ABC being filed.
Q: Do ABC’s and Chapter 11 bankruptcy share the same goals?
A: The primary goal of an ABC is to liquidate the debtor’s assets through one or more sales to benefit creditors, liquidation, or sale the entity (though in a small number of cases ABCs have been used to sell going concern businesses). The primary goal of Chapter 11 is usually to restructure the debtor’s business while continuing to take actions that benefit the company’s stakeholders. The primary difference in a Chapter 11 is the debtor’s ability to restructure debt, which is not generally the goal of an ABC, and the debtor’s ability to lien strip and sell assets free of liens, a power not available to state courts.
Q: When is an ABC likely to be more effective than Chapter 11?
A: This often boils down to the condition of the business. For example, Chapter 11 may be a better option for a business struggling due to temporary staffing or supply chain issues resulting from the pandemic, or a balance sheet that can be revised positively, and that is salvageable. An ABC may prove to be a more practical solution when issues with the company’s management and/or balance sheet are such that reorganization is simply not practical. If there is no hope of reorganizing or selling a debtor as a going concern, ABC is an efficient and inexpensive method to maximize the liquidation value of a business.
Q: How do businesses operate during bankruptcy and an ABC?
A: The biggest difference is that in Chapter 11, current management/ownership runs the business. In an ABC, a receiver runs the business—if there is an operating business. During the ABC, the debtor acts solely according to the orders and decisions of the receiver and generally maintains only a shell operation until an auction or sale can be scheduled. By contrast, Chapter 11 management maintains business operations to rehabilitate the balance sheet and return the business to profitability, or to stage the business for a sale to a third party, as a going concern, free of liens and encumbrances. Additionally, most businesses that file Chapter 11 do so to continue operations with as little disruption as possible while reorganizing under bankruptcy protection. For example, airlines continue to transport passengers and goods as usual while moving through Chapter 11. ABC’s are disruptive because the goal is a swift liquidation.
Q: What is the role of management during bankruptcy or ABC?
A: As noted above, the company’s management might remain as a caretaker group in an ABC, but management has no authority to act, except with the permission of the receiver. An ABC is viewed as a positive by secured lenders and many investors because they know a party without previous ties to the company will be making impartial decisions about what to do with the company’s assets. And, if the secured creditor is the only stakeholder “in the money”, an ABC is the most efficient way to repay the secured lender without major expense.
Existing management typically remains in control during a Chapter 11, guiding operations while the business and its finances are restructured in the bankruptcy process. They have the power to decide whether to assume or reject existing contracts, depending on the conditions laid out in the Chapter 11 filing, to reorganize or to sell. Management can also pursue additional capital infusions to fuel operational needs through debtor-in-possession financing.
Q: Do these processes occur at the federal level or the state level?
A: Chapter 11 is governed entirely by federal law (with Bankruptcy Courts applying state law where relevant). ABC’s are governed by state receivership laws that vary widely from state-to-state. There is no ABC equivalent to the federal Bankruptcy Code, although some state ABC laws attempt to emulate the Code.
Q: Are Chapter 11 bankruptcy and ABC the only options available to the parties?
A: No. Chapter 11 and ABC’s are two of the most common procedures utilized to address struggling businesses, but they are far from the only options available. For example, family farms and fishing operations can pursue debt-relief under a Chapter 12 reorganization process. A business can file Chapter 7 to liquidate its operations (although ABC’s are more likely to be cost effective here), and individual business owners can file for Chapter 13 relief. An experienced attorney can also pursue out-of-court workouts on behalf of the debtor. It is essential to discuss each situation with an experienced restructuring lawyer who can ensure management understands the benefits and drawbacks of all the available options.
About the Author
James Sweet is a partner at Steinhilber Swanson LLP. He has been representing businesses, individuals, secured creditors, creditor committees, buyers of assets, and other parties throughout Wisconsin, Minnesota, northern Illinois, Delaware, and northern Iowa for more than 40 years. He is a past member of the American Bar Association, former founding director, president, and chairman of the American Boards of Certification, is a Fellow of the American College of Bankruptcy, and a frequent lecturer on bankruptcy, insolvency, commercial law, and workout matters throughout the Midwest. Attorney Sweet can be reached by email at Jsweet@steinhilberswanson.com and by phone at 608-310-5501.
Steinhilber Swanson, LLP, is a powerhouse boutique law firm focusing on the relief from financial distress for businesses, farmers, and consumers. With offices in Madison, Milwaukee, and Oshkosh, our firm assists client throughout the state of Wisconsin and across the country.