Introduction
For the past several decades, when commercial borrowers, their partners and creditors have faced a deadlock or a default, they have preferred resolution of disputes in the Bankruptcy Courts. The Bankruptcy System has provided extraordinary remedies, specialized commercial judges, and an expedient, cost-effective forum for relief.
However, the Bankruptcy System has become expensive, with Bankruptcy attorneys charging hourly rates near the upper end of all lawyers’ fees. The system has become bureaucratized; the advent of the United States Trustee’s system has increased the number and cost of required filings, meetings, and court hearings. The bankruptcy statute, with its unique remedies, has been expanded with special interest sections and marginalized by a hostile Congress. Relief for debtors — consumers, individuals beset by commercial problems, single asset real estate entities, and small businesses — no longer seems to be the focus of a system more intent on procedure and suspicion.
A review of the recent case law reveals an institution, refocused by the Executive Branch, Congress, and the Supreme Court. The Court and its trustees seem to no longer be able to serve their traditional responsibility of providing a “fresh start.” Instead, as the credit industry has convinced Congress, the Bankruptcy System is left to raise the bar, and the cost, for relief, while a populace of financially troubled consumers and businesses look elsewhere.
This outline examines two debtor-creditor procedures: receiverships and assignments for the benefit of creditors.
The laws are less comprehensive and local in nature; they are however cheaper, often working with alternative dispute resolution procedures, and are largely administered by the parties and their attorneys with the imprimatur of a laissez-faire judicial system. Bankruptcy remedies are, in certain situations, still unique and this article details situations where the Bankruptcy Court is still preferable to other remedies.
Receiverships
Receiverships are most common in real property foreclosure situations. Pending trustee’s sales or judicial foreclosures, mortgage lenders may at times desire their collateral be placed in the hands of independent caretakers. Provisions for receivers are routinely included in trust deeds and mortgages. Some states’ laws now make clear that the remedy of receivership can be the subject of a court complaint, without the plaintiff needing to include substantive counts for judicial relief. This permits the appointment of a receiver, while a party seeks non-judicial relief, e.g., a non-judicial foreclosure like a trustee or UCC sale.
Receivers can also play a valuable role in deadlocked or dissolving business entities. Complaints seeking dissolution or division of assets often include a second count praying for the appointment of a receiver to hold the assets being liquidated or divided or to even accomplish the monetization and distribution of assets.
Private, as well as public parties, may use receiverships where there are allegations of fraud, breach of fiduciary duties, or Ponzi schemes. Receiverships can assist victims in preserving assets while criminal or civil fact-finding is on-going.
Receiverships have been used increasingly in the recent downturn in the economy, both in real estate and business cases. Lenders are allowing borrowers additional time to raise capital or sell assets, so long as the collateral is being overseen by a fiduciary. Defaulting borrowers and their lenders are agreeing to receiverships so that feasibility studies and appraisals can be accomplished by industry experts, feasibility consultants, brokers and valuation experts. Equipped with independent analysis, the parties can proceed cooperatively or adversely as they choose.
Receiverships are not bound by the timelines imposed by the bankruptcy laws or judges. Cases may remain pending while the parties evaluate a turbulent market, allow the market to steady, or while the parties search for a business solution. Bankruptcy relief remains an option should the parties’ interests diverge precipitating foreclosure, litigation, or funding termination.
Assignment for the Benefit of Creditors (ABC)
An assignment for the benefit of creditors (ABC) is a voluntary transfer by a debtor of all of the debtor’s non-exempt property to an assignee in trust to apply the property for, or (more usually) to liquidate the property and pay its proceeds to, the debtor’s creditors. The assignment procedure is treated much like a probate/receivership, and the assignee has the same relationship with the court as a court-appointed receiver. The assignee may bring actions on behalf of the assignor and creditors for fraudulent conveyances, and can have the status of a lien creditor, generally entitling the assignee to avoid unperfected security interests in the debtor’s property.
An ABC provides that an insolvent debtor may assign all of his assets to a third party designated as an ‘assignee’ for the benefit of his creditors. Any attempted preference, in the assignment, of one creditor or creditors of the assignor, is fraudulent and without effect. Any creditor who consents to the assignment is entitled to share in the assets so assigned, and by so consenting agrees to take his proportional share of the assets and thereby discharge the debtor from all further liability.
However, only consenting creditors are allowed to share in the assets and non-consenting creditors retain their cause of action for their total indebtedness against the debtor but are not allowed to share in the distribution of assets. An assignment for the benefit of creditors may be effective only to a portion of the debtor’s creditors, or to all. The benefits of the assignment flow only to those creditors who consent to the arrangement, and they must release their claims when paid their proportionate share of the estate. Where a debtor executes an assignment for the benefit of creditors, creditors retain the right to file an involuntary bankruptcy petition after the assignee was appointed or took possession.
A debtor’s petition for Assignment for Benefit of Creditors is sometimes filed with the Court of the county where the debtor’s principal place of business is conducted and the Court has the same jurisdiction over the insolvent estate and the assignee as that of a receiver appointed by the court. Following the filing of Creditor’s Consent and Claims, the assignee is empowered to reduce the debtor’s assets to cash, pay the consenting creditors’ proven claims proportionately, receive discharges from these creditors and terminate the assignment ABC’s have application in small business settings when the creditor body is generally aware of the debtor, its assets, and the reason for failure.
The stigma of bankruptcy can be avoided; the parties can pick their own “Assignee”, eliminating the involvement of a trustee or bankruptcy judge. Disclosure of assets and creditors is necessary and specifically required, but the other documentation and requirements of a bankruptcy petition are avoided. The expense of an Assignee can exceed the cost of a bankruptcy filing, though the tradition of appointing an “industry elder” as the assignee can mitigate this administrative cost and maximize return to creditors in an insolvency.
While some state statutes specifically provide that actions taken pursuant to common law Assignments are void, they are still available to a debtor and a body of creditors who participate and where creditors accept “payment in full” upon distribution of proceeds.
Most debtors seeking bankruptcy relief have “corporate creditors” who are unlikely to participate in an ABC. Situations may arise in the construction industry or similar fields where familiarity between the Assignor and the creditors would allow an ABC, and permit a debtor to avoid the “means-testing” and other hurdles of a bankruptcy discharge.
Unique Bankruptcy Remedies
Automatic Stay
A bankruptcy filing results in the issuance of the automatic stay. This terminates all collection proceedings, all collection attempts and all litigation. When you absolutely, positively have to put a stop to litigation, a foreclosure or garnishment, there is nothing as effective as the automatic stay in bankruptcy.
Sales Free and Clear of Liens, Claims and Encumbrances
The Bankruptcy Code uniquely allows a bankruptcy court to sell a property, passing clean title with all liens, claims and encumbrances attaching to the proceeds. Again, where there is a sale of troubled property involved in litigation or property subject to title disputes, the Bankruptcy Court can order and approve the property’s sale with liens and claims against the property transferred to the proceeds of the sale.
Rejection of Leases or Burdensome Contracts
When a business is subjected to a burdensome lease or an executory contract that is interfering with its continued operation or its reorganization, the Bankruptcy Code uniquely allows such a lease/contract to be rejected. The non-debtor party is given a “pre-petition” claim against the business and the debtor is excused from performance on the lease or contract.
Plans of Repayment
The Bankruptcy Code permits reorganization plans that can restructure payment terms, interest rates and other loan provisions. A plan of reorganization is comprehensive, in that it can propose changes in repayment terms for one or all of the debtor’s obligations. The repayment terms must be voted on by the creditors, but can be approved by the court over the rejection of certain creditors, so long as the repayment plan is fair and equitable and does not discriminate unfairly against a particular creditor or creditors.
Debtor-in-Possession Financing
When a troubled business or project needs new financing, the provisions of the Bankruptcy Code permit this to be done in such a manner that provides comfort to “DIP Lenders.” The ability of the bankruptcy court to approve such loans and the security for such loans, including priming liens, even over creditor dissent, is a unique bankruptcy remedy.
Dealing with the Dishonest or Unscrupulous Debtor
Creditors or business partners dealing with an unscrupulous or dishonest individual often have greater comfort when operations are placed under the protection of the bankruptcy laws. The specter of federal, criminal prosecution and the oversight provided by the United States Trustee and bankruptcy judges can often normalize operations. Many lenders finding their borrowers in a default situation are more comfortable when their borrower is required to account to the bankruptcy court and obtain court authorization for all extraordinary actions.
Familiarity
To some extent, people, parties and businesses know what to expect from bankruptcy. Commercial entities generally have procedures and protocols to deal with bankruptcies. Workouts, receiverships, or assignments for benefit of creditors are often perceived as secretive, foreign proceedings. When dealing with large numbers of creditors, bankruptcy and its familiar procedures are also at times more manageable than other remedies.
Conclusion
Bankruptcy laws continue to provide certain remedies and procedures that cannot be found anywhere else. That being said, business parties may not always be willing to turn over their financial fates to a bankruptcy judge. A less intrusive receivership proceeding may, in certain instances, be more desirable. When a developer finds himself upside down in a project and a handful of creditors are owed money and can look to the build-out of the project, an assignment for the benefit of creditors may be a quicker, less expensive and more appropriate workout tool, than a bankruptcy case.
An informed and trusted commercial real estate broker can often serve as a receiver or as an Assignee in an assignment for benefit of creditors. Such state court remedies avail themselves of the expertise and local knowledge that a broker may have about a particular situation. In other instances though, a bankruptcy proceeding actively overseen by an independent judge may be preferable.
This information is provided as a matter of information and education only. It is not intended to provide legal advice or counsel. Do not take action in specific cases without full knowledge of the facts, and competent legal advice from your attorney.
