Published by Blueprints
When the owners of family-run A. LoPresti & Sons Inc. decided they could no longer continue in business last year, they chose a less-common method to liquidate the business in place of a traditional bankruptcy. Turning its assets over to an independent trustee through an Assignment for the Benefit of Creditors, or ABC, enabled the century-old food and produce distribution company to cease operations without the legal hassles and high costs associated with the federal bankruptcy process. It most likely shortened the time required to complete the liquidation and may have recovered more funds for creditors.
Cleveland-based A. LoPresti & Sons fell victim to the economic downturn. Despite maintaining its market share, the firm with annual revenues of around $40 million, saw business plummet by 25% and two major customers go out of business, resulting in $500,000 in unrecoverable receivables, Patricia LoPresti, president and CEO, said in a statement.
Companies facing insolvency have a number of options to consider. But in recent years, with the rising costs and length of time it takes to complete a bankruptcy filing, ABCs – which have been around for years – have become increasingly popular. “We’re in a period where there is a favorable outlook on these types of proceedings and you’re seeing them more than Chapter 11,” said Anthony J. Pacchia, founding partner of Traxi LLC, a New York City special situations advisory firm. “It seems that nobody likes the process in Chapter 7 anymore.”
Bankruptcy is an adversarial process, with creditors and their attorneys on one side of the table, the debtor and his counsel on the other. Each significant event must be decided by a judge, often after reviewing multiple filings and hearing arguments, a process that lengthens the time it takes to complete a bankruptcy and adds to its cost. An ABC “is a more collegial process,” says Pacchia, who is an attorney.
“An ABC is a faster and more cost effective process that gets to the same end and a bankruptcy can be substantially more costly for all interested parties,” said Howard Samuels, owner of Rally LLC in Chicago. Rally specializes in distressed situations and Samuels estimates his firm has handled more than 1,000 assignments over the past 20 years.
Assignments are less public than bankruptcy. Unlike a bankruptcy, an ABC is conducted privately, in most cases administered by an assignee or trustee selected by the debtor.
“ABCs have become attractive in a number of situations where there’s cooperation with a senior lender, there is no senior lender, or the senior lender is the owner, a hedge fund type,” notes Steven A. San Filippo, managing director with Traxi, which also handles corporate restructuring, asset recovery, investment banking and other financial services.
The turnover of assets is governed by a trust agreement for the specific purpose of sale or liquidation, Samuels said. The debtor retains its liabilities. The transfer of assets must be made to an unrelated third party purchaser to avoid any potential liability. Creditors must deal with the trustee from that point forward.
An ABC “is a process or procedure of choice among bankruptcy or insolvency professionals in Illinois when you want to close a business or facilitate a transfer of assets to a purchaser,” Samuels said. He notes that “There are other alternatives – anything from just locking the doors in the middle of the night and walking away to filing bankruptcy.”
The size of the firm using an ABC doesn’t matter, experts say. It is easier, obviously, for a small, privately-owned firm with a simple structure to liquidate through an ABC. “The more complicated [the debtor firm is], the harder it is to do an assignment,” said Edward Hostmann of Edward Hostmann Inc. in Lake Oswego, OR.
No common rules
There is no common set of rules governing the use of ABCs across the country. Each state has its own rules. Forty-one states have specific laws governing the process; nine do not. In those states, the practice is governed largely by case law and custom, Samuels said.
The level of court involvement varies from state to state. In some jurisdictions, a state court must approve the trustee assignment; in others, an agreement between the creditor company and the trustee is all that is required.
Most tend to follow the same order for distribution of funds followed by federal bankruptcy rules. Secured creditors are first in line; government obligations, such as taxes, are next; employees come third; general and unsecured creditors are last. Final distributions are made when liquidation has been completed, and in some cases earlier, at the discretion of the trustee.
A sweet outcome
Cherrydale Manufacturing opted for an ABC rather than bankruptcy. The century-old Allentown, PA candy manufacturer assigned its assets to Traxi in April 2009. The company operated out of two buildings with a total 360,000 square feet of space. Cherrydale owned the Bartons trademark, a well-known chocolatier.
The candymaker essentially collapsed. A dozen lawsuits were pending. There was perishable inventory in a number of locations that needed to be dealt with. Deliveries in the months preceding the assignment had fallen behind.
“With food, and in the case of Cherrydale, we saw a lot of food products which have a shelf life and a lot of costs – cooled warehouses, inventory everywhere – and the need to move with some speed and knowledge of the space to get the maximum value in the shortest time,” San Filippo said.
To preserve the value of the assets, Traxi operated the company for a about 90 days, liquidating assets, obtaining appraisals and maximizing value.
Appraisals were obtained, assets were auctioned off, receivables were collected. The assignee chose lawyers to represent the company. Resolving claims “is a big part of the process,” San Filippo said.
The Bartons trademark, despite being “very distressed,” was sold for the value it was appraised at as a going concern.
A bit over a year later, the final distribution of funds was filed with the Chancery Court in Pennsylvania, and was awaiting court approval in mid-June.
“Sometimes it’s about returning assets to a productive use and getting on with life, closing out a failed venture,” Pacchia said.
Another candy company bought many of the Cherrydale assets, rehired a number of employees and took over one of the two buildings. The other building was turned back over to the landlord, so “Two landlords got their assets back efficiently,” Pacchia noted.
The Cherrydale ABC “was deemed a success because it would have been administratively insolvent and in bankruptcy and we did significantly better than that,” San Filippo said. “We estimated going in that we would recover $1 to $2 million on the inventory and assets that we had, less the costs.”
He estimates the final recovery at $1.1 to $1.2 million. “It was much worse than we thought going in,” San Filippo said.
Keys to ABC success
The Cherrydale Manufacturing example illustrates two key elements necessary to a successful ABC.
As soon as an assignment is made – in some states that requires approval by a court – the original owner is out of the picture. Assets are taken over by a separate trust to be liquidated by the assignee.
When a situation has deteriorated to the level where a restructuring or an orderly shutdown is required, there are often a lot of tensions, frayed nerves, anger and distrust between the debtor and its creditors and vendors. Often communications have broken down.
Turning the situation over to an independent third party gives everyone a fresh start.
“We were very communicative, and people might not have liked what they wound up with, but people understood [Cherrydale] would have been administratively insolvent,” San Filippo said.
“The way an ABC works best is through disclosure and communication; we don’t do magic,” Pacchia said. “We can’t return the losses people are going to suffer in these bad situations. But generally, we’ve found that people are realistic. Often the anger, the frustration, the litigation is a result of not getting answers to legitimate questions. Once you explain what’s really happening, what potential outcomes are going to be, you tend to spend less time in court.”
A trustee may also continue to operate a business to maintain its value as a going concern to prospective buyers or to complete work-in-progress inventory to an account receivable, or finish orders. To operate, an assignee or trustee must have a funding source as he is precluded from incurring fresh debt, said Samuels.
A bank that will work with the trustee can play an important role. Rally is operating one company in an ABC where the bank is essentially funding its ongoing operations, he said. If the bank has a solid first position – usually the case if it is a secured lender – it stands to recover more when the assignment results in a good outcome.
“So they want somebody in there who is independent, but who is a fiduciary for not just the bank, but all creditors. I’m not involved in the company other than to secure the highest and best return for the assets,” Samuels said.
PACA’s role in an ABC
Fresh produce suppliers have the same priority rights to payment in an Assignment for Benefit of Creditors under the Perishable Agricultural Commodities Act as they do in a bankruptcy, according to attorney Mark Amendola of Martyn and Associates in Cleveland. The law firm has practiced PACA Trust law exclusively since 1987.
PACA is a federal law that is designed to help unpaid suppliers of fresh produce get paid on a priority basis ahead of other creditors.
Produce suppliers would likely see the same benefits as other types of creditors from an ABC: more funds become available because the process is less costly and faster payouts because of the less formal structure, Amendola said.
Not one size fits all
While some very large companies have successfully liquidated through assignments, the experts agree that it is easier for smaller, less complicated private firms to accomplish.
One of the biggest benefits of the ABC process can also be its Achilles’ heel.
“In the pecking order of law in America, federal law trumps state law,” Pacchi points out. Even after an assignment is under way, “Three disgruntled creditors can always put your ABC into a federal bankruptcy.”
An assignment does not work well with service firms or those that require special licensing, such as a medical practice or a liquor store, according to Samuels.
It is also not a good idea when there are large, contentious issues to be sorted out. “Sometimes it’s just better to bite the bullet and be in bankruptcy because you’re going to wind up there anyway,” Pacchi said.
“If the situation has deteriorated past where you can effectively liquidate, you’ve got to be careful,” San Filippo adds.
An ABC liquidation is not the answer for every situation, but it can be a quick way for company facing financial difficulty to get out from under a bad situation and for creditors to get the most for their recovery efforts.