Hypothetical: Debtor’s business is failing, and everyone agrees that its assets need to be liquidated.
What follows is, (i) a list of tools available, in the debtor/creditor toolbox, to use in accomplishing the liquidation, and (ii) a generalized explanation of each tool.
Debtor’s Self-Liquidation Tool
The debtor’s self-liquidation tool works best when the debtor, (i) is motivated to achieve the highest possible value from liquidating debtor’s assets, and (ii) is trusted by the major secured creditors to manage the liquidation process. In such circumstances, this tool is the best-possible approach to maximize value and minimize costs.
I have utilized this tool many times, in representing debtors. Typically, my debtor clients have specific-and-limited goals they want to accomplish, and I tell creditors that we expect grace at the end of the process toward achieving those specified goals. My experience is that such grace is always given . . . except for the time it wasn’t.
Lien Foreclosure Tool
My experience is that lien foreclosures are the least likely approach to produce a good economic result from liquidation.
Lien foreclosures tend to minimize the net price received. Often, the secured creditor’s credit bid is the winning bid at a foreclosure sale: (i) creditors rarely bid top dollar with a credit bid because they are hoping for a cash over-bid from someone else, and (ii) other buyers have no interest in bidding real dollars against credit bid dollars.
Lien foreclosures also tend to maximize the costs involved. Such costs can include legal fees, repossession and storage costs, insurance costs, etc., all of which can be significant. And in the case of mortgage foreclosures, the cost of time delays can be prohibitive.
I’ve seen many economic disasters at lien foreclosure sales. And I’m continually surprised at the confidence of lenders, who are inexperienced at liquidating collateral, in their ability to maximize value through lien foreclosures.
Chapter 7 Bankruptcy Tool
Individual debtors will, often, want to file a Chapter 7 bankruptcy as part of the liquidation process because they, (i) need the bankruptcy discharge, and (ii) are able to keep assets through a combination of exemptions and reaffirmations. And if their debts are mostly business debts, individual debtors are entitled to Chapter 7 relief without meeting the low-income requirement of § 707(b).
Entities, by contrast, will rarely choose the Chapter 7 tool because they:
- can’t get a discharge in Chapter 7 (see § 727(a)(1));
- can’t utilize reaffirmations, which are an exception to discharge (see § 524(c)&(d)), and
- can’t take advantage of any exemptions (see § 522(b)(1)).
Further, (i) owners of entities often want to avoid being associated with the stigma of bankruptcy, and (ii) if any of the debtor’s assets are fully encumbered, the Chapter 7 trustee will abandon such assets, instead of selling them.
Reorganization Bankruptcy Tools
Business reorganization bankruptcies are in the form of standard Chapter 11, Subchapter V of Chapter 11, and Chapter 12.
Liquidation (including partial liquidation) is a recognized form of bankruptcy reorganization. Each of the reorganization schemes provides for liquidation:
- in standard Chapter 11 and Subchapter V — “a plan may . . . provide for the sale of all or substantially all of the property of the estate” (§ 1123(b)(4)); and
- in Chapter 12 — “the plan may . . . provide for the sale of all or any part of the property of the estate” (§ 1222(b)(8)).
Business liquidation under the bankruptcy reorganization schemes tend to be highly effective at selling debtor’s assets at top dollar. That’s because such bankruptcy schemes provide:
- automatic stay protections;
- sale free-and-clear powers under § 363;
- expanded free-and-clear powers under confirmed plans;
- competitive bidding processes; and
- court approval of the successful bid.
Two problems with liquidating through bankruptcy reorganization schemes are that the bankruptcy process (i) can be expensive, and (ii) can take a significant amount of time to accomplish.
I’ve been involved in utilizing bankruptcy reorganization as a liquidating tool—successfully—many times.
Receivership Tool
Receiverships are designed to dispossess the debtor of assets while litigation over those assets progresses—and then liquidate those assets when the litigation reaches conclusion. My experience is that receiverships are effective in this role.
A typical receivership is in mortgage foreclosures: a receiver takes possession of and manages debtor’s real estate while a mortgage foreclosure lawsuit progresses—and then sell the mortgaged property after a judgment of foreclosure is obtained.
Four problems with liquidating assets through receivership proceedings are:
- receiverships are costly—with the same types of legal fee and time costs that a bankruptcy proceeding has, plus the cost of a bond that may be required;
- receiverships have no automatic stay;
- receivership courts have limited authority over the debtor’s assets (in rem jurisdiction) and debtor’s creditors (in personam jurisdiction) located outside the court’s geographic reach; and
- a receivership’s primary beneficiary tends to be the creditor who initiates and manages the proceeding.
My experiences with receiverships, outside the typical mortgage foreclosure context, have mostly been unsatisfactory.
Assignment for Benefit of Creditors (“ABC”) Tool
ABC under the common law is an out-of-court process, within the law of trusts, that relies on fiduciary duties of the assignee to liquidate debtors assets for the benefit of all creditors.
It is an efficient tool because it avoids most of the fee and time costs of a bankruptcy or receivership, and it avoids the stigma of a bankruptcy.
It has the disadvantage of no automatic stay and no free-and-clear sale powers.
But when the debtor and major secured creditors work together, an ABC can maximize value from sale of debtor’s assets and minimize related costs—for the benefit of all debtor’s creditors. It is for this reason that creditors often recommend a common law ABC process to a cooperative debtor.
The Uniform Assignment for Benefit of Creditors Act updates and codifies the common law of ABC.
ABCs under statutes requiring court supervision and a bond are akin to receiverships and have the same problems as receiverships.
Conclusion
Above is a list of tools in the debtor/creditor toolbox for liquidating a debtor’s assets.
Some of the tools are cooperative in nature (e.g., debtor’s self-liquidation and a common law ABC). Other tools are adversarial (e.g., a debtor’s voluntary bankruptcy, a creditor’s involuntary bankruptcy filing, and a creditor’s receivership filing).
Some of the tools tend to be expensive in both money and time (e.g., anything involving a court or a bond). Other tools tend to be efficient (e.g., debtor’s self-liquidation and a common law ABC).
Debtors and creditors each get to make choices on which of the tools to pursue in any given circumstance. Sometimes they choose well. Sometimes they don’t.
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