For Distressed M&A, An Alternative To Section 363 Sales

By Jason Taketa
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Law360 (June 22, 2020, 4:00 PM EDT) --
Jason Taketa
Jason Taketa
In the three-month period from March 1 through May 31, commercial business entities have filed 1,812 Chapter 11 bankruptcy cases in U.S. bankruptcy courts, representing a year-over-year increase of 31%.

What's more, the pace of monthly Chapter 11 filings has significantly increased, with the number of Chapter 11 filings in March, April and May representing year-over-year increases of 18%, 26% and 48%, respectively, signaling a potential wave of business bankruptcies and insolvencies on the horizon emanating from the economic shock of the COVID-19 pandemic shutdowns.

If this wave continues to build momentum, one can almost certainly expect a corresponding uptick in distressed M&A activity, as both strategic and financial buyers look to make acquisitions at reduced valuations.

Sophisticated buyers looking to acquire going-concern businesses will generally structure their acquisitions around a mechanism to "cleanse" the assets of claims from the business owner's creditors.

While the most commonly known and widely used mechanism to accomplish such a transaction is the bankruptcy court sale process under Title 11 of the U.S. Code, Section 363, through a Chapter 11 proceeding, buyers and sellers should strongly consider the alternative business liquidation device outside of bankruptcy known as an assignment for the benefit of creditors, or ABC, which may be a more expedient, efficient, cost-effective and flexible path for distressed M&A transactions than the traditional 363 sale route.

Nuts and Bolts of ABCs

ABCs — also sometimes referred to as "general assignments for the benefit of creditors" — are creations of state law.

While ABCs originated from common law, many states have codified the ABC process, either in whole or in part, while a minority of states still rely on pure common law. Consequently, each state's ABC law can differ in many important respects and as such, for purposes of this article, we will focus on California's ABC law, which by some accounts has been used more frequently in the past 20 years than the ABC laws in other states.

Fundamentally, ABCs are vehicles for selling or liquidating a business and/or its assets in an orderly, controlled way. As a business liquidation tool, ABCs function similarly to Chapter 7 bankruptcies wherein businesses, for a variety of reasons, can no longer operate and their remaining assets, to the extent there are any, are liquidated.

ABCs can also be used to facilitate a going-concern sale of the debtor's assets to a third party, similar to a Section 363 sale in a Chapter 11 bankruptcy; however, unlike in a Chapter 11 bankruptcy, ABCs cannot be used to financially rehabilitate a business or restructure its debt.

Generally speaking, an ABC involves the distressed entity, the assignor, assigning all of its right, title, interest in, and custody and control of its assets to a third-party assignee, which is designated to act in a fiduciary capacity for the benefit of the assignor's creditors.

Thereafter, the assignee liquidates/sells the assets and distributes the proceeds to the assignor's creditors. As in a federal bankruptcy proceeding, unsecured creditors have no right to pursue the assets assigned to the assignee.

Rather, these unsecured creditors are required to file a proof of claim to the assignee; if the claim is allowed, the unsecured creditor will ultimately participate in the assignee's distribution of funds of the assignor's estate, following certain rules of priority as established under the applicable state ABC law.

Beneficial Features of Going-Concern ABC Sales

California's ABC law, like those of many other states,[1] is nonjudicial, meaning that an ABC can be accomplished with few formalities and without any court proceedings or filings. Certain common features of an ABC process that spring from its nonjudicial nature make an ABC a more effective tool in distressed M&A than a sale through bankruptcy would be.

First, ABCs can be consummated in a relatively short period of time. For example, a prepackaged going-concern ABC sale can be consummated in a matter of weeks once the buyer and seller agree on the principal terms of the sale, whereas prepackaged or fully marketed Section 363 sales through Chapter 11 can involve weeks or months of prepetition planning and negotiation, and take weeks or months to complete after the initial bankruptcy filing.

For distressed businesses without the liquidity runway needed to successfully navigate a Chapter 11 bankruptcy, an ABC may be the only viable path to completing a going-concern or asset sale and avoiding shuttering a business permanently. Further, the speed of the ABC process allows buyers to move swiftly to acquire distressed businesses or assets, helping to greatly reduce knowledge leakage and/or employee, customer and vendor defections prior to closing.

Parties also have greater flexibility to structure the ABC process. Unlike in Section 363 sales, assignees in an ABC process are not required to hold any formal open bidding or auction as part of the liquidation of the assets and, in prepackaged ABCs, assignees can proceed to sell assigned assets to the designated purchasers almost immediately after assignment, recognizing that assignees are wise to explore and investigate a meaningful sale process, if possible.

As such, prearranged buyers in an ABC process do not risk losing out in the auction process, which can be attractive to potential distressed M&A buyers, who might otherwise be leery of devoting time, money and resources to an acquisition without relative certainty of closing.

By virtue of being nonjudicial and therefore nonpublic, ABC transactions can proceed discreetly and without the unwanted publicity that a public bankruptcy brings, thereby helping protect the goodwill and reputations of the underlying business, its owners, management and investors.

Further, an ABC transaction is often publicly characterized as an acquisition of a business or its assets, which does not carry with it the negative associations that bankruptcy does.

Finally, unlike Chapter 7 bankruptcy sales in which a trustee is appointed to a case at random from a list of preapproved trustees in a jurisdiction, troubled businesses considering an ABC are free to engage the assignee of their choosing.

In states such as California, in which ABCs are more common, troubled businesses have a number of known firms and professionals from which to choose, many of whom specialize in or focus on a particular industry. A knowledgeable and experienced assignee can be a great value to an ABC process by greatly reducing the assignee's learning curve with respect to a particular business.

Further, veteran assignees may have the necessary experience and infrastructure to operate the assigned business between assignment and liquidation or as part of the business wind-down, without the continued involvement of the assignor's management or directors.

The Trade-Offs of an ABC

There are, of course, certain trade-offs associated with ABCs, each of which may warrant special consideration depending on the circumstances.

First, as noted earlier, the ABC process is essentially a business liquidation device; it cannot be used to financially rehabilitate a business or restructure debt like a Chapter 11 case and therefore is not suitable for a business capable of restructuring.

Further, unlike bankruptcy proceedings, an ABC does not offer an automatic stay of claims against the debtor; rather, collection lawsuits and other claims can continue, notwithstanding the assignment to the assignee.[2]

ABCs lack certain protective provisions offered by bankruptcy law that help preserve the existing contract rights of a debtor's bankruptcy estate and facilitate the transfer of those rights in a sale. For example, bankruptcy law renders unenforceable certain contract termination provisions allowing a counterparty to terminate upon the insolvency or bankruptcy of the other party, thereby preserving the estate's rights in the underlying contract. An ABC does not protect against counterparty termination based on such provisions, and in many cases, the ABC itself will give rise to termination under most formulations of such contract provisions.

Further, executory contracts and unexpired leases can be transferred without the consent of the counterparty as part of a Section 363 sale, whereas an ABC does not give the assignee the same powers. In both cases, buyers of assets generally need to negotiate directly with the contract counterparty in order to assume the executory portions of these contracts, which can add layers of execution risk in a going-concern ABC sale.

Corporate ABCs also require stockholder approval because they represent a sale of all or substantially all of a corporation's assets, whereas a corporation may file for bankruptcy upon approval of the corporation's board of directors and without the vote or consent of its stockholders. If obtaining the consent of a distressed corporation's stockholders to effect an ABC in a timely manner (if at all) will be difficult or impractical, an ABC may not be the most advisable option.

Finally, because ABC laws can vary from state to state, attempting an ABC with a business that has assets located in multiple states can lead to multistate jurisdictional issues. An ABC conducted under one state's law[3] can shield attachment claims against assets in that particular state, but it may not be effective to shield similar attachment claims against assets in other state jurisdictions.

While a conflict-of-laws analysis is outside the scope of this article, generally speaking, there are no guarantees that other state courts will honor or recognize an ABC conducted under the law of a different state. Because of this, buyers may be uncomfortable purchasing multistate business assets through an ABC.

Conclusion

The question of whether to employ an ABC may not be as simple as A, B, C; structuring a distressed M&A transaction depends on the specific facts and circumstances involved. 



Jason Taketa is a partner at Manatt Phelps & Phillips LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Only seven states including Florida, Michigan, New Jersey, New York, Ohio, Pennsylvania and Wisconsin require judicial proceedings judicial proceedings and/or oversight.

[2] Claims by unsecured judgment creditors seeking attachment to assets can, however, be blocked through an ABC process.

[3] ABCs are generally conducted in accordance with the law of the state where the debtor is headquartered or incorporated.

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