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Alternatives to Bankruptcy: What Should Business Owners Know?

Bennet G. Young
Jeffer Mangels Butler & Mitchell LLP

The coronavirus pandemic has upended many sectors of the economy in unprecedented ways. Supply chains are disrupted. Businesses that rely on face to face interaction with their customers such as retailers and restaurants, are subject to financial distress. In turn, companies that supply products to businesses impacted by COVID-19 may also experience pressure as their customers delay or cancel purchases or are unable to pay their bills.

These stresses are likely to cause some owners of distressed businesses to explore their legal options. Bankruptcy is only one alternative for a struggling company Two other options are an assignment for the benefit of creditors (ABC) and a voluntary workout. These strategies are available to address a failing company; which can be faster and equally or more effective, at a lower cost, without the publicity of a bankruptcy filing. Business owners should be aware of these non-bankruptcy options and the circumstances in which they can be useful. 

Any discussion of bankruptcy alternatives must start with bankruptcy. Bankruptcy is the most widely known insolvency proceeding and, as the usual course taken by a failing company, forms the baseline. Any alternative should be compared to the likely outcome of a bankruptcy case. The business owner then can balance the bankruptcy and non-bankruptcy alternatives available to him or her to choose a strategy that is the best fit. 

One useful alternative to bankruptcy is an assignment for the benefit of creditors. This procedure, commonly known as an ABC, is a recognized state law procedure to sell the assets of a failing business while shielding the purchaser from liability for the old company’s debts. Usually, a distressed company is running out of cash and has limited runway to sell itself; an ABC provides a non-bankruptcy method to effectuate a prompt sale of the business. 

In an ABC, the company, called the assignor, transfers its assets to a third party, called the assignee, that typically is selected by the company. In legal terms an ABC is a trust in which the assignor transfers title to its assets to the assignee in trust for its creditors. The assignee is a fiduciary tasked with selling the assets and paying the proceeds pro rata to creditors. The assignee must give notice to creditors of the assignment and of the deadline to file claims and creditors can file claims with the assignee.

In California, no court filing is required to commence an ABC. This lowers the publicity dramatically. The proceeding is not secret or confidential, but it is not public in the way that filing a bankruptcy case is. Instead, an ABC is a matter of contract between the distressed company and the proposed assignee. The company’s board and shareholders must approve the ABC. 

The process is fast and flexible. Because the company picks the assignee, an ABC lends itself well to pre-packaging. A distressed company seeking a prompt sale, a potential buyer of the business, and the proposed assignee can negotiate a sale in advance of the ABC occurring on the understanding that the sale will be completed through the ABC. All parties know what to expect and the process can proceed on the parties’ schedule, with no delays imposed by court processes or availability. This enables a sale of a distressed business as a going concern to take place quickly with little uncertainty and minimal disruption to operations. 

Used in this manner, an ABC is a viable alternative to a sale of the business in a bankruptcy chapter 11 case. The speed and flexibility of the ABC process are its chief virtues. Since there is no court the process is usually less expensive than a chapter 11 bankruptcy case and the sale can often be completed more quickly than would occur in a chapter 11. The process provides an efficient method to sell a small to medium size failing company on a going concern basis. 

The ABC process is not without its downsides. A distressed business must weigh these downsides against the speed, flexibility and lower transaction costs of the ABC process. The most important is that the purchaser will not get a court order validating its purchase as it would in a bankruptcy. The purchaser must rely on the integrity of the process to shield it from the distressed company’s creditors. Furthermore, there is no automatic stay to restrain foreclosure as there would be in a bankruptcy case, so the cooperation of the assignor’s secured lenders is essential. Unlike in a bankruptcy case, there is no power to assign leases or contracts without consent. This can cause complications if the company’s contractual relationships are a major asset. Finally, by handing the company to the assignee, the business owner will lose control. This is not necessarily a negative, as it enables the business owner to move on to new opportunities. 

Another useful option is for the distressed company to attempt a voluntary workout with its creditors. This is not a formal process. Instead, a workout is a matter of negotiation between the distressed company and its creditors. The usual concept is to engage in a process that is substantially similar to what would occur in a chapter 11 bankruptcy case by agreement of the parties, without filing a bankruptcy case and without incurring the large legal fees or impact on the business that will result if a bankruptcy case is actually commenced. Chapter 11 thus forms the backdrop for the negotiations. 

Typically, in a voluntary workout the debtor will invite its creditors to a meeting. At the meeting, the debtor will make a presentation to the creditors in attendance regarding its financial condition, how it got there, and what the debtor intends to do to extricate itself from its predicament. The debtor will request that the creditors agree to a moratorium on collection action, similar to the automatic stay in a bankruptcy case, and that the creditors appoint a committee of creditors to negotiate a workout plan with the debtor. In return, the debtor will usually offer to be completely transparent with its creditors, to provide information regarding the business, and to refrain from engaging in any out of the ordinary course transactions. This creates a structure that mirrors what would occur in a chapter 11 case.

The goal of the process is for the debtor and the appointed committee to negotiate a repayment plan on behalf of all creditors. The plan can take whatever form the parties negotiate. Often the plan will consist of the debtor’s agreement to pay a percentage or even all of its profits or positive cash flow to its creditors over a period of time in exchange for the creditors agreeing to discount their debts in some amount. Another common structure is for the creditors to agree to a discount in return for an immediate cash payment funded by new capital contributed by a new investor. 

Once the debtor and committee have negotiated a plan, the plan is circulated to creditors to accept or reject it. Participation is voluntary. Only creditors that accept the plan are bound, so the debtor generally will insist that a high percentage of creditors accept the plan in order for it to go into effect. If a sufficient number of creditors accept the plan, it will go into effect. If the required majority do not accept, the debtor likely will end up in a chapter 11 case. The plan thus needs to provide a result that is at least as good, if not better, than the result would be in a chapter 11 case.

The voluntary workout thus can be a viable alternative to a chapter 11 case. The benefits of the process are its flexibility and reduced legal fees which can mean more funds available for creditors. A workout often is faster than a chapter 11 case, there is no public filing and therefore less publicity, and the business owner remains in control. On the other hand, a workout depends upon cooperation between the debtor and its creditors. If that cooperation is absent because creditors do not trust the debtor or for other reasons, a voluntary workout might not be possible. The process also depends upon creditors cooperating with one another and accepting equal treatment. There is no automatic stay, so creditors are free to pursue collection actions and to attempt to jump to the head of the line. If some creditors pursue collection actions and seek to improve their position relative to other creditors, the process can break down. Finally, creditor participation in a plan is voluntary. There is no way to bind creditors that reject the plan. Holdouts thus can create major hurdles.

The selection of the non-bankruptcy alternative depends upon the result the business owner desires to achieve. If the goal is to sell the business as a going concern, an ABC is a useful tool. Usually a distressed company is running out of cash and has limited runway to sell itself, and the ABC provides a non-bankruptcy method to effectuate a prompt sale. On the other hand, if the business owner’s objective is to retain his or her stake in the enterprise and to negotiate a payment plan with creditors globally, a voluntary workout can be a less costly way to achieve this goal.

Bankruptcy is not a one size fits all solution. There are other routes available to a distressed business which can be just as effective at a far lower cost. Owners of troubled companies should be aware of these options and should evaluate whether one of them might provide a better fit.

Bennett G. Young is a partner at the law firm of Jeffer Mangels Butler & Mitchell LLP. He represents parties in insolvency matters and has extensive experience in workouts, restructurings, bankruptcies, and assignments for the benefit of creditors. Ben is a member of the Bench-Bar Liaison Committee for the United States Bankruptcy Court for the Northern District of California and is a former Chair of the California State Bar’s Insolvency Law Committee, a past president of the Northern California Chapter of the Turnaround Management Association, and has been a member of the Board of Directors of the Bay Area Bankruptcy Forum. He is recognized by Best Lawyers in America® in the area of bankruptcy. Contact Ben Young at BYoung@jmbm.com

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Finance – Get Ready: Blockchain Will Transform the Legal Industry

Andries Verschelden 

Originally published on Armanino
13 June 2019

What if someone told you that a new technology would significantly impact every law firm within the next 10 years—and would influence how your firm gets paid, the types of services it offers, and everything in between?

Consider this a wake-up call for a future that looks very different than today, thanks to the technology called blockchain. While still a nascent trend, blockchain is already proving to be a transformational force, changing how people and businesses around the world transact with each other by enhancing the trust, accountability, efficiency, and effectiveness of those transactions.

Don’t assume that blockchain is only for cryptocurrency enthusiasts and specialists. It’s poised to make rapid inroads into all types of industries across many different use cases beyond cryptocurrency. As such, clients will need expertise and guidance for the proper legal frameworks for using blockchain. Law firms that don’t want to get left behind need to pay attention, and start gaining experience and planning their blockchain strategies now.

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An abstract digital structure showing the concept of blockchain technology with hexadecimal hash data inside each block. This image represents a conceptual design in the domain of IT, cyberspace, cyber security, cryptocurrency or similar industry sectors. The image is a made up 3D concept render.

Defining blockchain simply

Let’s start with what blockchain is not. It is not software that you can buy from a vendor nor is it “owned” by any one company. No one group or country controls it, and anyone, anywhere in the world can use it. While these characteristics can make blockchain seem complex and nebulous, when you think about it, the Internet has the very same characteristics. We don’t have to understand the technical details of the Internet to know it has tremendous impact on our lives and livelihoods.

So, what is blockchain? It’s open source technology that enables the creation and management of a global, autonomous network where information is secured in an immutable and transparent ledger. There are already thousands of networks in use, both publicly and privately. What’s special about a blockchain network is that it gives everyone who uses it access to the same information in a way that ensures the information can be trusted.

Changing the legal industry

Because it’s somewhat early days in the blockchain evolution, innovators are still identifying all the ways it can be used. Perhaps the most common application right now is for peer-to-peer transactions that transfer digital value between two parties in a trusted way without a third party involved.

However, blockchain is also being envisioned and tested to make supply chains more efficient, give artists greater control over digital ownership rights, streamline real estate transactions, manage Internet of Things networks and much more.

Because it changes the way people and businesses transact and communicate with each other, blockchain will begin to impact and evolve the way legal services such as contracts, escrow account management, transactions and much more are handled. Here are some ways blockchain is already poised to reshape how law firms work:

  • Smart contracts: Instead of being traditional, static documents (whether digital or paper-based), contracts will evolve to be programmatic components of a blockchain network, where the terms and conditions of the contract are automatically applied.
  • Automated securities settlement: Many of the routine change of ownership transactions handled today by law firms will be automated within blockchain networks in the future, such as transferring real estate or ownership shares in a business. Compliance and restrictions all happen automatically, as they are built into the blockchain protocol code.
  • Payments via digital assets: As clients adapt digital assets such as cryptocurrency, it will be increasingly important to be able to accept these types of payments.
  • Escrow accounts: Smart contracts can automatically release funds into a digital wallet at the completion of some pre-determined criteria, eliminating the need for escrow accounts in many transactions.

Establishing an essential role in the blockchain evolution

For forward-thinking law firms that have embraced the changes on the horizon with blockchain, it’s already opening up new practice areas and service opportunities, which can eventually replace those that will shrink and go away. Sharp legal minds are required right now to help organizations understand the appropriate legal framework for using various blockchain networks for different use cases. There is much to do to move from physical assets to digital ones, and the legal industry must be a vital part of the effort.

Lawyers who understand the concept of smart contracts will be in high demand as more businesses begin moving to blockchain. By combining understanding of how blockchain networks function with deep legal knowledge, firms can create blockchain practices that provide legal guidance to organizations of all kinds as they both create and participate in blockchain networks.

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Taking the first step

As the world evolves towards transferring assets and information digitally using blockchain, your firm must be ready to both adopt blockchain and provide legal counsel on how your clients can adopt it as well. One way to ease into the world of blockchain is to begin accepting digital assets as payment for legal services rendered. Unless you already have blockchain expertise on staff, turning to a trusted service provider can expedite your implementation while helping your firm avoid missteps.

In any case, you need to begin understanding blockchain now. If clients aren’t already asking about it, they will be soon, which means you need to start establishing blockchain expertise before your competitors beat you to it.

For more information contact Andries Verschelden or Terri Oppelt