A troubled company may use Chapter 11 bankruptcy to restructure its debts or to sell its assets. The assets of a troubled company can often be sold or otherwise liquidated relatively quickly and efficiently in a bankruptcy proceeding and leave far fewer loose ends afterward than most any other sale method.
However, Chapter 11 can be an expensive process. Further, sometimes bankruptcy is not fast enough, or the debtor may be in circumstances where another procedure will achieve a substantially similar end result in less time or at a lower cost. Creditors may prefer that the debtor not file bankruptcy and desire instead to assert their non-bankruptcy collection rights.
In these cases, the debtor and/or creditors will look to other alternatives to liquidate the debtor’s assets or restructure. The primary alternatives to bankruptcy for a troubled business are:
- Uniform Commercial Code foreclosure;
- Assignment for the benefit of creditors;
- Receiverships; and
- Creditor’s composition agreements.
The following provides additional detail on the alternatives.
UCC Foreclosure Sale
There is a Uniform Commercial Code (hereinafter called the “UCC”) that has been adopted as law, with typically only minor variations, in virtually all U.S. jurisdictions. This law is meant to promote uniformity between the states in the enforcement of commercial transactions.
The UCC has provisions that allow a debtor to grant security interests in personal property to a lender by agreement which serves as liens on the property. Upon the debtor’s failure to pay a debt in the manner or time agreed, the lender may take possession of the collateral and with appropriate notice to the debtor, other secured creditors, and guarantors, sell it, and use the proceeds to reduce the amount that the debtor owes. This can be done with the assistance of a court, or completely without court intervention as long as possession of the property may be obtained without creating a “breach of the peace.”
If the debtor agrees or at least does not object upon being given the opportunity, the creditor who has been granted the lien may keep the collateral in full or partial satisfaction of the debt and not even be required to sell the property subject to the lien.
If the creditor with the security interest does elect to sell the property, the sale must be conducted in a “commercially reasonable” manner. If the sale is not commercially reasonable, the creditor may be liable to the debtor, may not be able to collect any amount remaining after the application of the sale proceeds to the debt, or may not be able to pursue guarantors.
The advantages of a UCC sale, compared to other proceedings including bankruptcy, are:
- It generally costs much less than a bankruptcy proceeding.
- It can be conducted quite quickly as the notice required to be given can often be as little as 10 days.
- It can be accomplished by force. In most cases, the sale can occur without the debtor’s consent, though the sale may require court intervention if possession of the collateral can’t be obtained by the creditor.
The disadvantages of a UCC sale are:
- The only property that can be sold is personal property that can be the subject of a security interest under the UCC. Real estate interests and non-UCC personal property cannot be sold using a UCC foreclosure sale. Transfer of real estate interests must typically be done in a separate proceeding which usually requires the filing of a lawsuit with a court.
- It can’t be utilized by a creditor who does not have a security interest in the property. Unsecured creditors cannot force a UCC sale.
- The process can generally be derailed at any time prior to the final sale by the debtor filing bankruptcy.
- As there is almost always no court order approving the sale and the value obtained, it may require substantial litigation to collect the remaining amount owed from the debtor and guarantors.
Assignment for the Benefit of Creditors
An assignment for the benefit of creditors, commonly known as an “ABC,” is a type of proceeding which occurs by the debtor transferring its assets to an assignee who serves as a sort of trustee to sell the debtor’s assets for the benefit of creditors. The debtor that assigns its assets does not get a discharge. This means that the creditors of the debtor may continue to pursue the debtor for any unpaid amount. However, because the assignee will have sold the debtor’s assets and distributed the money to all creditors by the time a creditor gets a judgment, a suing creditor may receive a judgment that is worthless because there are no longer any assets available to pay it.
Some states have laws about ABC proceedings that set forth in detail the procedures to be followed by the assignee and the powers and responsibilities of the assignee and creditors. Other states have no specific statutory law concerning ABC proceedings and rely on common law principles (i.e. previous decisions by courts serving as precedent). ABC proceedings are used with varying frequencies in different states. For example, Indiana has an ABC statute that is fairly detailed but ABC proceedings are quite rare. Illinois’ ABC process is based on common law, and ABC proceedings there are relatively common.
Secured claims must be respected in ABC proceedings. If the debtor’s assets are all subject to liens that exceed the assets’ value, then there will be nothing left for unsecured creditors as a result of the ABC process. The secured creditor will get all of the proceeds of the debtor’s assets in which it has liens, even in an ABC proceeding.
The advantages of an ABC proceeding are:
- It is less expensive and time-consuming than bankruptcy in many instances.
- It can lead to a relatively beneficial outcome for creditors, as the creditors in each class can be expected to be treated similarly as other creditors in the class.
- It can limit the “race to the courthouse,” where creditors try to be the first to sue and be paid while leaving the remaining creditors with nothing.
The disadvantages of an ABC proceeding are:
- It requires the consent of the debtor. A creditor cannot force the debtor to assign its assets to the assignee.
- It is a liquidation proceeding only. There is typically no possibility for the debtor to reorganize.
- It generally requires the consent of secured creditors to work effectively, as any buyer taking the assets without the consent of the secured creditors will take the assets subject to the secured creditor’s liens.
A receivership involves the appointment of a third party to take over the troubled business and oversee its assets. This may be for the purpose of restructuring or reorganizing the business but is more typically used as a method to liquidate the business. The receiver may also bring claims that the debtor has against third parties in the name of the debtor.
A receiver is usually appointed by a state or federal court or federal agency and the court or agency will typically oversee the activities of the receiver.
Receiverships are typically initiated after the debtor fails to pay its debts as they come due or fails to meet other legal obligations. The ease of obtaining a receiver over a debtor or its property varies substantially by state. The receiver’s duties will typically be limited to those provided by the order of the court or agency appointing the receiver.
The advantages of a receivership include:
- A receiver can typically sell real estate in addition to personal property and is superior in that respect to a UCC foreclosure sale.
- A federal court presiding over a receivership may be able to stay litigation against the debtor in multiple jurisdictions so all creditors are required to participate in the receivership instead of pursuing the debtor’s assets piecemeal.
- The receivership can be imposed by the court upon the debtor without the debtor’s agreement.
- A receivership action can be filed by an unsecured creditor as well as a secured creditor. Generally, the court reviewing the request for a receiver to be appointed will consider candidates proposed by the creditor requesting the receiver.
- A receiver can pursue claims against officers and directors of the debtor on behalf of the debtor and disburse the proceeds of that litigation to the creditors.
The disadvantages of a receivership include:
- A receivership can be fairly expensive and time consuming as a process, as the receiver must be compensated and may also require counsel who is compensated from the debtor’s assets.
- If the receivership is ordered by a state court, the receivership court may not have jurisdiction over property in another state and a suit may be required in the non-receivership state to control such property.
A composition agreement is a contract between a debtor and some or all of the debtor’s creditors that allows the debtor to reorganize and stay in business or conduct an effective liquidation.
A composition agreement works best when the debtor has relatively few creditors who have an interest in the debtor’s future success. Composition agreements will almost always include an agreement by the creditors to accept less than full payment and/or extend the time for payment as well as an agreement to “standstill” and not pursue enforcement of the creditors’ debts for a period of time. There are a myriad of other provisions that can be used to provide special features in favor of the debtor and creditors in a composition agreement.
The advantages of a composition agreement are as follows:
- It can lead to a reorganization of the debtor’s business or can be used to effectuate a sale.
- It can be very quickly accomplished and cost effective, particularly if the debtor has a small number of larger creditors.
- As the composition is a contract, it can be extremely flexible and contain terms that are closely tailored to the debtor’s particular situation.
- It can occur quietly, as a private matter, and may help to avoid the negative publicity that a bankruptcy filing could create.
The disadvantage of a composition agreement is as follows:
- It requires that enough important creditors consent to make the process beneficial. If there are too many creditors who refuse to agree, the process will not work.
While Chapter 11 bankruptcy is a powerful tool, it can be quite expensive, risky, complicated, and time consuming. Prior to filing, debtors should always consider whether a more effective or efficient alternative is available to accomplish the same goals.
Many of these alternatives are also available to creditors if the debtor simply refuses to face its problems.
Of course, each of these alternatives has many more aspects than can be described in this summary. A debtor or creditor should always seek experienced counsel who can explain each alternative and help determine which works best in the particular circumstances.