Assignment for the Benefit of Creditors: An Alternative to Bankruptcy for Distressed Businesses

When a business reaches the point where it can no longer service its debts or otherwise resolve its liabilities, management is often faced with a difficult question: is a bankruptcy filing necessary or is there another way to perform an orderly liquidation or sale of the business assets?

While Chapters 7 and 11 of the Unites States Bankruptcy Code remain important and powerful tools, they are not the right solution for every company. In many situations—particularly where a company lacks the time and resources required for a federal bankruptcy proceeding—an Assignment for the Benefit of Creditors (ABC) may provide a viable alternative because it is generally faster, less expensive due to lower administrative and court costs, and more flexible regarding asset marketing and sale strategies compared to the highly structured process and rigid requirements under the Unites States Bankruptcy Code.

ABCs have long been recognized under state law, but they have received renewed attention in recent years as companies look for less expensive and more streamlined alternatives to federal bankruptcy proceedings. Recent market conditions—including elevated borrowing costs, tighter credit markets, and continued pressure on smaller businesses—have only heightened interest in these ABC proceedings.

What Is an Assignment for the Benefit of Creditors?

An Assignment for the Benefit of Creditors is a voluntary state-law insolvency process. The distressed company (the “assignor”) transfers all or substantially all of its assets to an independent fiduciary known as the assignee making the assignee the new legal owner of those assets. Once transferred to the assignee, the assets are, generally, safe guarded from immediate collection efforts by creditors because the assets are now held by the assignee who is not liable for the assignor’s obligations to its creditors.  The assignee then marshals, administers, and sells or otherwise liquidates those assets distributing the net proceeds to the assignor’s creditors.

Once the assignment is made, control of the company’s assets passes from management to the assignee. The assignee’s responsibilities typically include:

• Taking possession of and safeguarding company assets;
• Notifying creditors and other interested parties;
• Evaluating and reconciling claims;
• Conducting asset sales, whether piecemeal or as a going concern; and
• Distributing proceeds to creditors in accordance with applicable statutory priorities.

The assignee functions in many respects like a bankruptcy trustee, but the proceeding itself is generally administered under state law with substantially less court involvement than a Chapter 7 or Chapter 11 case. As a result, ABCs are often completed more quickly and at a lower cost than a federal bankruptcy proceeding.

In New York, ABCs are principally governed by Article 2 of the New York State Debtor and Creditor Law (DCL). New Jersey similarly provides a statutory framework governing general assignments for the benefit of creditors. Although the details differ from state to state, both jurisdictions recognize ABCs as a legitimate mechanism for liquidating an insolvent business outside of federal bankruptcy court.

Why Businesses Are Increasingly Turning to an Assignment for the Benefit of Creditors

Companies typically begin exploring an ABC when the cost and complexity of a bankruptcy filing outweigh its potential benefits. Several factors have contributed to the increased use of ABCs, including:

Lower Administrative Costs

For many small and middle-market businesses, the cost of a bankruptcy filing can be prohibitive. Professional fees, United States Trustee fees, reporting obligations, and ongoing oversight by the Bankruptcy Court, the United States Trustee’s Office and a Chapter 7 or 11 Trustee (if appointed) can quickly erode already limited estate assets. ABCs generally involve fewer procedural requirements and substantially less judicial oversight, often making them a more economical alternative. This is particularly true where the company lacks sufficient liquidity to fund even a relatively straightforward Chapter 11 bankruptcy case.

Speed and Efficiency

In distressed situations, delays often destroy value. Employees depart, customer relationships deteriorate, and inventory or intellectual property may lose value over time.

An ABC can often be commenced and administered far more quickly than a traditional bankruptcy case. Where stakeholders agree that liquidation is inevitable, that speed can preserve significant value for creditors and other stakeholders.

Flexibility in Asset Sales

Unlike a bankruptcy sale, which generally requires notice, motion practice, and court approval, many ABC sales can proceed on an expedited basis. This flexibility is often attractive to private equity sponsors, secured lenders, and boards seeking to preserve going-concern value or consummate a sale before key employees, customers, or contracts are lost.

Reduced Public Scrutiny

Although an ABC is not a confidential proceeding, it typically attracts far less public attention than a bankruptcy filing. For some companies, particularly privately held businesses, avoiding the publicity associated with bankruptcy can be an important consideration.

Why California ABCs Receive So Much Attention

California has emerged as one of the country’s most active ABC jurisdictions, particularly for venture-backed and technology companies. One reason is that California ABCs are generally administered without ongoing court supervision. Experienced assignees are frequently able to move quickly to market and sell assets, including intellectual property and operating businesses, without the delays commonly associated with bankruptcy proceedings.

In addition, investors, lenders, and acquirers in the technology sector are often familiar with the California process. In practice, this familiarity can streamline negotiations and facilitate distressed M&A transactions.

While California’s framework may be more business-friendly, companies should not assume that a California ABC is automatically available simply because they have operations, investors, or customers located there. The appropriate jurisdiction for an ABC depends on a variety of factors, including the company’s organizational structure, principal place of business, asset location, and creditor landscape.

Practical Considerations Before Proceeding

Businesses must also recognize that an ABC is not appropriate in every distressed situation. Before electing this route, management and boards should carefully evaluate several threshold issues:

• Secured Creditor Dynamics: In many distressed companies, secured lenders hold liens on substantially all assets. Their support—or at least their cooperation—can be essential to a successful ABC. Accordingly, discussions with secured creditors should occur early in the process.
• No Automatic Stay: Unlike bankruptcy, an ABC does not provide the broad protection of the Bankruptcy Code’s automatic stay. If the company is facing significant litigation, aggressive collection activity, or imminent enforcement actions, a bankruptcy filing may offer protections that an ABC cannot. This issue often becomes a critical factor in evaluating available alternatives.
• Board Fiduciary Duties: As insolvency approaches, directors and officers should ensure that major decisions are carefully documented and made with appropriate professional advice. Among other things, boards should evaluate whether an ABC maximizes value relative to other available alternatives, including a consensual workout, receivership, or bankruptcy filing.
• Employee, Tax, and Wind-Down Issues: Employee claims, any obligations under the Worker Adjustment and Retraining Notification(WARN) Act, tax liabilities, lease exposure, and contract termination issues should all be analyzed before initiating an ABC. Early planning can materially affect both recoveries and overall outcomes.

How Scarinci Hollenbeck Can Help

An assignment for the benefit of creditors can provide an efficient and cost-effective alternative to bankruptcy for businesses that require an orderly liquidation but do not need the protections of a formal Chapter 11 proceeding. The decision to pursue an ABC, however, is highly fact-specific. Creditor composition, litigation exposure, lender relationships, and the nature of the company’s assets will often dictate whether an ABC is the appropriate path.

Businesses confronting financial distress should consult experienced restructuring counsel early. Evaluating available options before liquidity is exhausted frequently provides the greatest opportunity to preserve value and protect stakeholder interests. For guidance, we encourage you to contact a member of Scarinci Hollenbeck’s Bankruptcy & Creditors’ Rights Practice.