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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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Profile – McCann Asset Management

McCann Asset Management

Martin McCann is passionate about retirement. During his 25 years as a financial planner, he has seen clients, friends, and family members experience their golden years in very different ways. The people who plan their retirements in advance tend to enjoy active, fulfilling post-career lives. Those who did not take the time to plan end up struggling financially, and fearing overpriced long term care expenses. Martin realized how important it is to help others successfully invest for their futures, which is why his professional goal is to deliver long term guaranteed streams of retirement income for all of his clients. 

Martin began his financial planning career in Lodi, California in 1994. Only nine months into his career at American Express (previously IDS Financial Services and currently Ameriprise Advisors), he was promoted to Training Manager and relocated to Fresno, California where he continued to excel in the industry. Martin was promoted again only three years into his career, but this time to Field Vice President. Shortly thereafter, Martin transitioned to Prudential, where he was ranked the #1 manager in the world. 

Full disclosure, I have known Martin professionally and personally since his time with Prudential. I have always considered him kind and very knowledgeable about his industry, but I did not realize how accomplished he was until we spoke for this article. I worked with Martin towards the beginning of his 18 year career with One America, where he accumulated most of his certifications: LUTC, Chartered Financial Consultant, and Certified Financial Planner, to name a few. His clients always spoke well of him, and I have entrusted him with some of my own retirement needs. 

In November, 2018 Martin founded McCann Asset Management, where he is currently the president and an acting financial advisor. He attributes his passion for retirement to his personal and professional experiences with the stock market crashes in the first decade of this century. The kind of instability he witnessed made him want to help others find long term financial security for themselves and their loved ones. Martin helps his clients determine how much money they need in order to support their lifestyle and long term care needs for themselves, their relatives, and their dependents after retirement. 

McCann Asset Management specializes in small businesses, ideally between 10 and 300 employees, although they will happily serve businesses of any size. The goal is to help employees plan for their retirement while also protecting the business owner from retirement lawsuits. Martin developed his own retirement software to best assess retirement needs and guarantee them for life. He understands the complexities of providing these services for his clients and your employees, and he has success in defending employer’s rights. Martin was recently an expert witness regarding 401ks and won 21/21 accusations in the class action lawsuit. This success got Martin featured in various law journals throughout the country.