When ABC Proceeding And Involuntary Bankruptcy Meet (In re Scandia)

By: Donald L Swanson

The interrelationship between an assignment for benefit of creditors (“ABC”) proceeding and an involuntary bankruptcy filing, for the same debtor, is governed by various portions of the Bankruptcy Code. 

But that relationship remains ill-defined, nonetheless.

What follows is an attempt to summarize a bankruptcy court opinion dealing with that relationship.  And here is two of its main conclusions:

1. “If the only point of this” involuntary bankruptcy filing by creditors “was to try to terminate” their “potential preference liabilities” under state ABC laws, “then I would have abstained. It is not a proper function” of an involuntary bankruptcy petition “to terminate a creditors’ liability for preferences under state law,” but
2. There has been “an appalling lack of diligence” by the ABC assignee.

–from In re Scandia Seafood (New York), Inc., Case No. 17-10744,  SDNY Bankruptcy Court (issued May 12, 2017, Doc. 42).

Facts

Debtor is a New York corporation selling fresh fish and prepared foods.  

On November 29, 2016, Debtor initiates a formal ABC proceeding under New Jersey law; whereupon, Debtor appoints an ABC assignee (“Assignee”), who takes possession of Debtor’s property.

120 days later (on March 28, 2017), nine creditors with claims totaling $389,860.49 (“Creditors”) file an involuntary bankruptcy against Debtor.

ABC = Grounds for Involuntary  

Under § 303(h) of the Bankruptcy Code, an involuntary bankruptcy petition is valid if, within 120 days before the involuntary petition is filed, a “custodian” is appointed or takes possession of debtor’s property.[fn. 1]  An ABC assignee qualifies as a “custodian.”[Fn. 2]

Debtor concedes that its ABC proceeding under New Jersey law began within 120 days before Creditors file their involuntary bankruptcy petition.  Accordingly, requirements for an involuntary bankruptcy against Debtor, under § 303 of the Bankruptcy Code, are satisfied.

But that’s not the end of the story.

Abstention/Dismissal Issues

Assignee asks the Bankruptcy Court to abstain from and dismiss the involuntary case: 

1. under § 305, in favor of completing the ABC proceeding in New Jersey; and
2. “for cause” under § 707, because Creditors acted in bad faith.

–Bad faith claim

The bad faith claim is based on Creditors’ intention to use the involuntary petition as a litigation tactic: to avoid preference liability, under New Jersey’s ABC laws, for payments they received within four months before the ABC proceeding began.

–Creditors’ arguments

Creditors oppose the abstention/dismissal motion, arguing that Debtor’s ABC proceeding exists for the sole benefit of, (i) Debtor’s owners, and (ii) attorneys who will work on the preference claims.

Creditors insist that Assignee has been acting as a puppet of Debtor’s owners:

• Debtor’s owners, through an insider entity (“Insider Purchaser”), acquire Debtor’s business and assets from Assignee for the inadequate price of $45,000;
• Assignee enters into an interim management agreement with Insider Purchaser on terms highly-favorable to Insider Purchaser; and
• Assignee and counsel are to receive excessive fees—a combined 60% of proceeds recovered—from ABC preference actions against Creditors.

–Findings after trial

After trial of the abstention/dismissal motion, the Bankruptcy Court finds:

• Owners have many discussions with Assignee, before appointment, on how the ABC will be conducted;
• Assignee agrees to Insider Purchaser acquiring Debtor’s assets and business, without having any information on Debtor’s business or asset values;
• Debtor’s owners obtain Assignee’s consent (before Assignee’s appointment) to a management agreement, under which Insider Purchaser gets (i) all Debtor’s inventory, without paying for it, and (ii) all Debtor’s profits;
• Assignee does not negotiate with anyone else or retain an advisor to conduct the sale, insisting upon the need to move quickly—without supporting evidence;
• Assignee makes no due diligence effort on asset values or fairness of the deal, except for reviewing an appraisal from Debtor’s owners;
• Assignee asks a New Jersey state court to approve the proposed sale on 10-days notice to creditors;
• Creditors do not appear or oppose any part of the ABC proceeding, until preference actions are filed against them under New Jersey’s ABC law; and
• Creditors admit that Assignee’s preference actions prompted their investigation in into Debtor’s ABC proceeding.

Such evidence suggests:

• “an appalling lack of diligence in ensuring that the prior owners paid a fair price for keeping the business and its assets” and “were not stealing value” that belongs to creditors; and
• a breach of Assignee’s fiduciary duty to act diligently toward maximizing value for creditors.

Whether to Abstain/Dismiss

Since the involuntary case is properly filed under § 303, the question is whether the Bankruptcy Court ought to abstain from and dismiss the chapter 7 case.

–Legal standards for abstention/dismissal

Under § 305(a)(1), a bankruptcy court “may dismiss” a bankruptcy case or “may suspend all proceedings” if “the interests of creditors and the debtor would be better served by such dismissal or suspension.”

The burden of proof is on the moving party, but abstention/dismissal are an “extraordinary relief” that should not be granted lightly.

Non-exclusive factors to consider, on the abstention/dismissal question, are:

1. economy and efficiency of administration;
2. whether another forum is available or a state court proceeding is already pending;
3. whether federal proceedings are necessary for a just and equitable solution;
4. whether an alternative exists for achieving an equitable distribution;
5. whether a less expensive and better out-of-court arrangement is possible;
6. whether the ABC has proceeded so far that starting over in bankruptcy would be costly; and
7. whether bankruptcy jurisdiction is sought for a proper purpose.

The overall inquiry is whether abstention/dismissal in the best interests of creditors and debtor?

–Value from ABC preference claims

Assignee insists that the ABC preference claims have value that would be lost, without abstention and dismissal.  It is true that:

• New Jersey laws permits an ABC assignee to recover preferences—i.e., transfers to creditors within 120 days before the ABC begins; but
• A chapter 7 Trustee cannot succeed to an ABC assignee’s right to pursue such claims because,
  • Bankruptcy Code allows a trustee to avoid transfers avoidable by “a creditor holding an unsecured claim” (§ 544(b)(1)); but
  • Under New Jersey law, unsecured creditors cannot pursue ABC preferences—only an ABC assignee can do that; so
  • The Chapter 7 trustee cannot pursue preference claims under state ABC laws.

So, without abstention/dismissal, ABC preference claims are nullified in this case, the only available preference claims are under § 547 of the Bankruptcy Code, and the 90 days window for such claims closed before the involuntary bankruptcy began.

Ruling: No Abstention/Dismissal

On the overall record, this Chapter 7 will remain in effect, without abstention. The Bankruptcy Court declares:

• A Chapter 7 trustee, as an independent fiduciary, needs to review what has happened in the ABC, with authority to take corrective action, if needed, to maximize the value of Debtor’s assets.

Other Court observations

Further, the Bankruptcy Court declares that, because Creditors had legitimate concerns and reasons for filing the involuntary, there is:

• no issue of Creditors’ “good faith” under § 303(j); and
• no grounds for awarding attorney fees against Creditors under § 303(i).[Fn. 3]

Conclusion

The In re Scandia Seafood opinion provides a helpful analysis and example of how an ABC proceeding and an involuntary bankruptcy proceeding, for the same debtor, can interact and relate to each other.

—————-

Footnote 1:  11 U.S.C. § 303(h)(2) provides: “(h) . . . the court shall order relief against the debtor in an involuntary case under the chapter under which the petition was filed, only if— . . . , or (2) within 120 days before the date of the filing of the petition, a custodian . . . was appointed or took possession.”

Footnote 2: An ABC assignee is a “custodian” under the Bankruptcy Code, because § 101(11)(B) says: “The term “custodian” means— . . . (B) assignee under a general assignment for the benefit of the debtor’s creditors.”

Footnote 3: 11 U.S.C. § 303(i)&(j) read:

“(i) If the court dismisses a petition under this section other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to judgment under this subsection, the court may grant judgment—(1) against the petitioners and in favor of the debtor for—(A) costs; or (B) a reasonable attorney’s fee; or (2) against any petitioner that filed the petition in bad faith, for—(A) any damages proximately caused by such filing; or (B) punitive damages.

(j) Only after notice to all creditors and a hearing may the court dismiss a petition filed under this section—(1) on the motion of a petitioner; (2) on consent of all petitioners and the debtor; or (3) for want of prosecution.”

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