The common-law assignment for the benefit of creditors is a popular alternative to bankruptcy for some debtors, but it can pose challenges for creditors. Here's how to look out for the creditor's interest in an ABC.
By BruceC. Scalambrino
l r he most common method of liquidating a company is a Chapter 7 proceeding. Once the bankrupt-
cy petition is filed, the court appointsa trustee, the business stops operating, Why an ABC? and the trusteeliquidates the company under court supervision.In most cases, Why usean assignment thebenefor a creditor's attorneyprepares and files a fit of creditorsinstead of the statutory proof-of-claim form on behalf of the bankruptcy schemewith all of its proclient,docketsthe first meetingof creditections for debtors? The relative merits of the two approaches to debtrelief are discussed more fully below, but among the most frequentusersof the ABC alternative are debtors who wish to sell their assetsto a third party buyer. In a nutshell, ABCs take less time than bankruptcyand require tors date, and perhaps even attends the lessin the way of court interventionand first meeting. The rules are clear and the approval, which can mean lower professional for debtors.Theycanpose fees process is usually simple. challenges creditors, for howevThere is, however, an alternative to serious below. bankruptcy -an out-of-court remedy er,which are addressed
Since the 1939 repeal of the stahlte, sends notice of the assignment to all of common law has controlled. Black v the assignor's creditors. The assignee then liquidates the asPalmer, ill App 2d 207,211-212, 15 145 signor's assets.The proceeds of the asNE2d 797,799-800 D 1957). (1st
signor's collateral liquidation are paid to creditors according to their priority. In lllinois, the common law priority scheme is substantially similar, but not identical, to the one set forth in the Bankruptcy Code (the "Code"). Lien creditors are paid first according to the priority among them, followed by administrative claims for the costs associated with the ABC, then federal taxes, state taxes,wage claims and, finally, unsecured creditors. See,e.g., lllinois ex rei Gordan v United States, 328 US 8, 1L (1946). See also 770 ILCS 85/1 (West 2003).
ABC and Chapter7: Pros and Cons for Debtors, Creditors 1. Assignee selection. ABCsoffer certain benefitsto a debtor not availablein bankruptcy. Perhapsthe most important is that in an ABC,the assignorgets to selectthe assignee. bankruptcy,the In
called an "assignment for the benefit of How is an ABC created? creditors," or "ABC." An ABC "is a voluntary transfer by a debtor of his propAn ABC is made by the debtor'sexeerty to an assignee in a trust for the purcution of a trust agreement transferring poses of applying the property or pro- all of its assets an assignee. to Federal ceeds thereof to the payment of his Deposit Ins. Corp.v Juran,713 F Supp debts and returning the surplus, if any, 1116,1119 (ND ill 1989). The debtor to the debtor." ill Bell Tel.Co.v Wolf Fur(nowthe assignor) theassignee and exeniture House, Inc., 157 ill App 3d 190, cutethe trust agreement. Theassignee's of 194-195,509 NE2d 1289, 1291-1292 Ost signature indicates acceptance the the assignee D 1987). From 1877 until 1939, ill Rev ABC. Once it's accepted, Stat, ch 10 3/4 0937) governed ABCs. recordsit with the county recorderand
ABOUT THE AUTHOR
BruceC. Scalambrino
is a parmer in the law firm of Scalambrino & Arnoff in Chicago, wherehe limits his practiceto commeroal litigation and bankruptcymatters.
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debtor does not select the trustee; one is appointed. 11 US<:: 701. 2. No court superoision. There is no court supervision of the ABC process. A winding down of a debtor's business and sale of its assetsis certainly quicker when the assignee does not have to petition a court for approval of each step in the process. From a creditor's perspective, however, the lack of court supervision may be problematic, given that the assignee is selected and paid by the assignor. Yet the assignee has fiduciary obligations to creditors. See, e.g., Page v Liberty Mut. Fire Ins. Co., 869 F Supp 596,600 (ND m 1994). 3. No automatic stay. Unlike in bankruptcy, there is no automatic stay in an ABC. 11 US<::362. A creditor with a pending lawsuit can proceed to judgment on its claim. In many cases, asthe signee will appear and consent to the entry of a judgment to allow the creditor to liquidate its claim. Once a judgment is entered, the judgment creditor can me a citation to discover assets against the assignee, forcing the assignee to appear and testify at the citation proceeding. The citation lien of the creditor, however, is subordinate to the assignee's common law lien right to the collateral. Therefore, the assignee'slien right takes precedence over a citation lien or garnishment if the ABC was perfected prior to the filing of the lien or garnishment. See,e.g., Consolidated Pipe& Supply Co. Inc. v RovancoCorp., 897 F Supp 364,370 (ND m 1995). If, however, the creditor perfects its citation lien or garnishment prior to the ABC, it can execute on the assigned assetsas the assignee simply stands in the assignor's shoes and takes the property subject to al1lien claims. See fll Bell Tel. Co., at 194, 509 NE2d at 1292. In fact, a properly served citation to discover assets precludes a debtor from doing an ABC, because it precludes a transfer of its assets. 735 ILCS 5/2-1402 (West 2003). 4. No preference or fraudulent conveyance actions. An assignee does not have the power to bring preference or fraudulent conveyance actions. Unlike many states, lliinois does not have a preference statute. Thus, if preferential transfers were made prior to the assignment, there is no legal mechanism for the assignee to recover the transfers.
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There is a state fraudulent conveyance statute.But,somevery old case law holds that an assignee cannotbring fraudulent conveyance actions. See, e.g.,Hinkley v Reed, m 440, 55 NE 182 337(1899).
What's a creditor's attorney to do? 1. Examine the documents. First, closely examine the trust agreement and the notice sent to creditors. The trust agreement must contain language establishing a trust and setting forth the assignee'sduties. It cannot allow the assignor to retain legal or equitable title to the property conveyed. Furthermore, the transfer of the property must be absolute and unconditional. See ill Bell Telephone 194-195, at 509 NE2d at 1291. Thus, no restrictions can be placed on the assignee with regard to the liquidation of the assets,the price paid for the assets,or the method of liquidation. Check that the assigneeis not a creditor, officer, director, or shareholder of the assignor, as he must be non-interested and independent of the debtor. Also, check that the trust agreement does not limit the assignee's liability for wilful misconduct or negligence or attempt in any way to release the assignee from suit. Any of these provisions are improper. Neither the trust agreement nor the notice can force creditors to release the assignor or assigneeof liability for their claims in exchange for a pro rata distribution on their claims. A demand for releasein return for a pro rata distribution voids the ABC. Further, ABCs that allow special treatment for the assignor's owners are improper. The notice of an ABC sent to creditors usually includes a proof-of-claim form for the creditor to execute and return to the assignee. In most cases,the form provides that executing and returning it to the assignee means that the creditor consents to the ABC. If the ABC is properly made, a creditor's claim is valid whether or not the creditor consents to the ABC. Consolidated Pipe, 897 F Supp at 370. The consent language is an effort to restrict a creditor's ability to me an involuntary bankruptcy action against the assignor and other creditors. If a creditor expressly consents to the ABC by returning the claim containing
the consentlanguage,the creditor may well have waived its right to put the debtor into bankruptcy at a later date. Thus/ you should scan the proof of claim into your word processingsoftware/deletethe consentlanguage,and then complete and return the claim form to the assignee. fact,sincethere In is no legal requirement to the form of as the proof of claim,you can simply complete and return a bankruptcyproof-ofclaim form. 2. Investigate possible preference and fraudulent conveyance issues.Becausean assignee cannot recoverpreferencesor fraudulent conveyances, he typically does not do a preferenceor fraudulent conveyanceanalysis. Ask the assignee do one. If the assignee to timely refuses to do so, demand the turnover of the assignor' checkingand s other financial accountledgers so you can perform theanalysis.If an assignee refusesto do an analysisor refusesto turn over theserecords/it is reasonable to concludethat preferentialand fraudulent transferstook place. 3. Monitor assetsales.An assignee must sufficiently advertise the sale of assets and liquidate them at fair value. As a result, carefully monitor any proposed sale of assets, particularly a sale of the entire companyas a //goingconcern." In some instances, assigneewill an send a notice that it is operating the companyto sell it as a "going concern" to a third party. Or/ perhapsthe notice will indicate that the third party has executed an operating agreement,allowing it to operatethe debtor company pending the sale of assets.Under these circumstances, notice might the indicate that the bidder has beengiven bid protection and that an auction is scheduledfor a datecertain.Sometimes the elapsedtime period from receiptof this notice to the auction date is quite short. Creditors usually ignore the notice and allow the saleto pl'OCeed. This may be a mistake. In some instances, the third party bidder is a new entity formed by the assignor/ owners or by someone s affiliated or relatedto them. This entity makes a bid for the debtor's assets. Since the assignee no other bids and no one has objects the sale,theassignee to sellsit to the new entity for theofferedprice/perhaps below fair value. The resultis that
the former owners or their affiliates get their company back and the creditors get little, if anything, in the form of a dividend. Upon receipt of any notice to sell assets, identify the buyer and investigate whether it is related in any way to the assignor's owners. 1£there is an overlap in ownership accompanied by a short notice period with little or no marketing of the assets other than newspaper advertisement, there is a chance that the sale is below fair value. 1£ these facts exist, an argument may be made that because the secured creditor consents to the sale, the sale is by definition for fair value. This explanation is simply untrue. In many instances, the secured creditor has personal guarantees from the assignor's owners and does not wish to incur the time or expense of marketing the collateral for sale. This is true even if marketing the assetswill lead to a higher price. Thus, in order to keep its exposure to a minimum, even if the collateral is being sold below fair value, the secured creditor accepts the sale proceeds and simply looks to the guarantors to make up any shortfall on the loan obligation. Thus, a secured party's consent to a sale does not mean the sale is at fair value. Even if the bidder is independent, investigate. Occasionally; the assignor's former owners will have prearranged a sale to a third party prior to an assignment. As part of the transaction, they negotiate employment or consulting agreements with the proposed buyer. In some instances, instead of the buyer paying the assignee the full value of the business, it pays a below market value amount as the purchase price, and pays the remainder to the former owners disguised as employment or consulting fees. Although there is nothing wrong with the former owners becoming consultants or employees of the buyer, make sure that the true value of the assets being sold is being paid to the assignee, not to anyone else. 4. Get status reports. Follow up with the assignee regarding the status of the ABC. Contact him at least monthly to ask about the status and when the dividend will be paid. 1£a clear answer is not given, it usually means something is wrong. ABCs should not drag on indefinitely.
What remediesare available if the ABC is void or problematic? 1. Injunctive relief. If a noticeof sale is receivedand insufficienttime is provided to investigate, theassignee ask to postpone until your questionsare answered. If he refuses, a state court file injunctive proceedingto stop the sale. Do this also if thereis evidence colluof sion, rigged bidding, improper notice, little or no marketing of the assets, or other things that impair the value received for the assets. Youcan also seek to remove an assignee a state court in proceedingfor failing to carry out his duties or for conductin breachof his fiduciary duties. 2. Declaratoryrelief. A declaratory action canbe filed seekingan orderdeclaring the ABC void for reasonsdiscussed earlier. 3. Citation proceedings. Perhaps the best way to test the validity of an assignmentis for a judgment creditor to file a citationproceedingagainstthe assigneeand then move for turnover of the assets the assignee's in possession. This savesthe expense seekingan inof junction. The citation judge can determine whether or not the ABC was done properly, or whether the assignee has breached fiduciary duties. his 4. Involuntary bankruptcy. File an involuntary bankruptcy proceeding if therewas fraud,'preferentialtransfers, or fraudulent conveyances, when the assigneebreacheshis fiduciary duties or there are large wage claims. In the absenceof these things, an assignee may be successfulin requesting the court to abstain from assuming juris-
diction over the case to allow the ABC to conclude. 11 USC 3O5(a)(I). H the bankruptcy court determines that the interests of the creditors and debtor would be better served by not assuming jurisdiction over the case,it will not do so. Under 11 USC 303 (b)(I), three creditors with claims, non-contingent as to liability or subject to bona fide dispute, can file an involuntary bankruptcy proceeding against the assignor. The three claims, in the aggregate, must total at least $11,625.Becausean assignee qualifies as a "custodian" under 11 USC 303(h)(2), the petitioning creditors need not show that the debtor was not paying its debts as they became due. Instead, they simply need show that a "custodian" was appointed or took possessionof the debtor's assetswithin 120 calendar days before the filing of the involuntary petition. Thus, if the ABC took place within 120 days of the filing of the involuntary petition, an order for relief will be granted against the assignor. The assignee,as a "custodian" of the assignor/debtor, must then turn over and account to the bankruptcy trustee for all property in his possession. 11USC 543. In ll1inois, there is an experienced group of professionals who act as assignees. They are generally honest, hard working, and independent. In most instances, they will answer your questions and provide whatever information you request. For this reason, do not hesitate to ask for whatever information you need to protect your client's interests. .
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