Making assignments for the benefit of creditors as easy as A-B-C.

• Author: Landon, Carly

Introduction I. Understanding the Basics of Assignments for the Benefit of Creditors A. What Is an Assignment for the Benefit of Creditors?.... B. How Do ABCs Work? C. How ABCs Fit into the Bigger Insolvency Picture: Comparing ABCs to Chapter 7 and Chapter 11 Bankruptcy 1. Chapter 11 Bankruptcy 2. Chapter 7 Bankruptcy 3. Advantages of ABCs over Federal Bankruptcy 4. Disadvantages of ABCs over Bankruptcy D. A Brief History of ABCs and Their Reform II. A Spectrum of ABCs and Comparing the Various Forms Across the States A. States with Common Law ABCs B. States with Minimally Regulated ABC Processes C. States with Heavily Regulated ABC Forms III. Making ABCs a Viable Alternative to Bankruptcy Throughout the States A. States Need to Reform ABCs but Maintain Minimum Statutory Regulation B. While Minimally Regulated ABCs Are Not Perfect, they Provide the Best Opportunity for ABCs to See More Frequent Use C. Legal Education, Including Law School Classes and CLE Programs, Ought to Adjust Their Curriculum to Include Instruction on ABCs in Order to Make Reforms as Successful as Possible and Make ABCs an Alternative to Be Considered Conclusion INTRODUCTION

Small business ownership remains the American dream, (1) inspiring many Americans to create their own businesses--there are nearly 550,000 new start-ups each month. (2) These start-ups create new jobs and occasionally spur the beginning of new industries. (3)

Unfortunately, however, not all new start-ups succeed. It is common for start-up businesses to fail in their first years of existence. (4) In fact, according to the United States Small Business Administration (SBA), "[Twenty] percent of all small businesses survive the first year, [thirty] percent survive the second year, and half survive the first five years." (5) Further, while seventy percent of new businesses survive at least two years, this rate drops to fifty percent by the five-year mark and thirty-three percent at the ten-year point, with just twenty-five percent of all new businesses lasting fifteen years or more. (6)

Many new business owners thus find themselves consulting lawyers about how to handle business failure. (7) More often than not, lawyers recommend filing for bankruptcy. (8) Although bankruptcy is frequently the default response, it is not the only option. For financially troubled companies, one size does not fit all. (9) In 2003, of almost 550,000 failing small businesses, only 34,000 filed for bankruptcy. (10) What happened to the other ninety-four percent of these businesses? Some scholars have attempted to answer this question by inferring that the "vast majority of small businesses resolve distress under state law" in a process called an "assignment for the benefit of creditors" (ABC). (11)

ABCs provide a state-law alternative to the filing of a federal bankruptcy case. Aptly named, they involve the assignment of an insolvent company's assets to a third-party assignee, who is selected by the company and charged with the duty of liquidating the company's assets to satisfy creditors' claims against the company. (12) In recent years, states such as California, Florida, Illinois and Massachusetts have seen frequent use of ABCs; in the majority of states, however, ABCs are routinely passed up for bankruptcy and its other alternatives. (13)

Despite the varying frequency of use across the states, ABCs have become much more commonplace since the turn of the twenty-first century as venture-capital and private-equity firms saw investments in high-tech, dot-com companies fail at an enormous rate. (14) In the early 2000s, many California dot-com and technology companies used the California ABC to deal with the collapse of the dot-com industry. (15)

As a result, California became the "capital of ABCs" during the dot-com meltdown. (16) The management of a deteriorating dot-com or other failing technology company often required a faster and more cost-efficient process than bankruptcy so that it could "engage in last-ditch efforts to sell the business in the face of mounting debt." (17) Potential buyers of those companies, on the other hand, were only willing to move forward if they were able to continue producing and using the technology assets of the insolvent company. (18) Thus, these companies needed to work fast to assure that certain key employees, whose departure from the company would greatly diminish the value of the firm and its assets, would continue working for the successor company and would not look elsewhere for jobs. (19) Time was of the essence for these companies because the more time that passed, the more likely that those key employees would find other employment. (20)

Interested buyers were also often only willing to move forward if they could be assured that they would be free of liability from unsecured debt of the insolvent company. (21) ABCs were ideal for addressing these unsecured debt and time issues because "the assignee [could] act more quickly; the assignee [was] likely to be more experienced at dealing with technology-related assets; and the use of an assignee [involved] lower transaction costs." (22)

Moreover, the benefits of ABCs over bankruptcy are not confined to only dot-com and technology industries, or even to the past. After credit markets experienced a dramatic increase in defaults in the second half of 2007, many expected an increase in corporate federal bankruptcy filings. (23) Nevertheless, business bankruptcy filings dropped significantly in the period since 2008, specifically in the commercial context. (24) Some theorize that this low number of filings can be explained, in part, by small business debtors relying on simpler ABC practices rather than federal bankruptcy. (25)

Today, the debate about the advantages of bankruptcy versus ABCs remains urgent. (26) In light of the many advantages of ABCs to small businesses, which are not limited to technology industries, it is surprising that ABCs have not seen more widespread use outside of a select few states. ABCs are currently in a unique position because they have become "particularized to fit the needs of those states that have found the process a useful tool." (27) In doing so, ABCs have become so diverse on a state-by-state basis (28) that the divide between the states that find ABCs to be a useful tool and the states that rarely, if ever, use ABCs has increased and will continue to increase if no reform occurs.

This Note evaluates the different approaches to ABCs across the states, and suggests that these procedures can be used in a wider range of companies, especially if states reform their current ABC laws. It argues that a state would enhance the benefits of ABCs and minimize the current disadvantages if it were to adopt a minimally regulated ABC. Part I begins by explaining the process of an ABC, its differences from bankruptcy, and the varying frequency of its use amongst the states. Part II sorts the varying forms of ABCs into three categories to address the positive and negative aspects of each of these ABCs and explain three general forms in which ABCs are found. Finally, Part III proposes reforms to increase reliance on ABCs throughout all states. This Note concludes by arguing that adopting a minimally regulated ABC form, like the ABC found in California, offers the best solution after which to model ABC reforms.

1. UNDERSTANDING THE BASICS OF ASSIGNMENTS FOR THE BENEFIT OF CREDITORS

   This Part explains what ABCs are and how the ABC process works. It also briefly explains how ABCs differ from federal bankruptcy proceedings, particularly Chapter 11 and Chapter 7 bankruptcy cases. Using federal bankruptcy as a point of comparison, this Part explores the advantages and disadvantages of ABCs to demonstrate those types of companies that would especially benefit from the ABC process. This Part finally provides a brief history of ABCs, and discusses ABCs in their current use and form.

   1. What Is an Assignment for the Benefit of Creditors?

      ABCs are the state or common law alternatives to bankruptcy, which trace their roots back to English common law. (29) ABC statutes today may supersede common law assignments entirely, or merely supplement them, allowing common law assignments to continue. (30) Black's Law Dictionary defines a "general assignment for the benefit of creditors" as "a transfer of legal and equitable title to all debtor's property to a trustee, with authority to liquidate the debtor's affairs and distribute proceeds equitably to creditors." (31) An ABC is a business liquidation device available to an insolvent debtor as an alternative to bankruptcy proceedings. (32) However, "ABCs are not limited to liquidations. Just as in bankruptcy, an ABC can be used to facilitate a going-concern sale of the debtor's assets to a third-party." (33) Basically, ABCs are used as a vehicle for the sale or liquidation of a business in an orderly, controlled way. (34) It is important to note that ABCs are not used to turn a business around, restructure, or financially rehabilitate the business. Rather, ABCs are purely used to wind the business down by selling or liquidating it. (35)

      At the risk of oversimplifying the process, an ABC involves a trust arrangement in which an insolvent business assigns its assets to an assignee, i.e. the trustee, who then holds property for the benefit of a special group of beneficiaries, i.e. the creditors. (36) Some suggest ABCs are the "functional equivalent" of liquidation under Chapter 7 of the U.S. Bankruptcy Code. (37) However, bankruptcy holds distinct federal advantages over ABCs. (38) For example, it imposes an automatic stay, allows for avoidance of preferential transfer, and may grant a discharge to an individual debtor--for example, a sole proprietor. (39) Further, ABCs have become particularized to fit the needs of those states that have found the process of a useful tool in managing debtor-creditor relationships and as a vehicle for the orderly...