The Common Law Of ABCs Is Effective: And Statutory Limitations On ABCs Are Bad Policy

The Common Law Of ABCs Is Effective: And Statutory Limitations On ABCs Are Bad Policy

Assignment for benefit of creditors (“ABC”) laws are, historically, a debtor remedy. ABC laws are a voluntary debtor tool for shutting down and winding up the debtor’s failed business.

Ancient History

ABC laws began under the common law, back in merrie olde England, arising out of the law of trusts. Under trust law, any person can, without restriction, transfer assets into a trust for the benefit of one or more people.

ABC are a particular type of trust, in which debtor is trustor and beneficiaries are debtor’s creditors. Such ABC trusts have functioned effectively, for a very long time, as a voluntary debtor remedy under the common law.

A More Recent Temptation

But over the last century and more, there has been an intense temptation, in these United States, to convert ABC laws from a voluntary debtor remedy into a creditor remedy.

That temptation began to take effect, around the Civil War era, in the form of ABC statutes that place limitations on the common law of ABCs. Such limitations come in may forms, including:

  • Court supervision of ABC trusts;
  • Bonding requirements for assignees (which necessitate judicial action to set the bond amount); and
  • Bankruptcy-like provisions.

The effect of such limitations on ABCs, as a voluntary debtor remedy, is this: debtors stop using ABC trusts in states with those limitations.

The Dot-Com Bubble

The dot-com bubble (circa 1995 – 2001) gives ABC activity a comeback. That’s because lots of dot-com start-ups are created, with outside investor funds, many of those start-ups fail, and they need to shut down and wind up. ABC, as a voluntary debtor remedy, fits and fills that need: to shut down and wind up efficiently and with credibility.

It’s no surprise that the ABC comeback, out of the dot-com bubble, flourishes in states like California, Illinois and Delaware. That’s because ABC laws in those states follow the common law of trusts.

Back to the Temptation

Even ABC laws in California and Delaware are beginning to bow to the temptation toward converting ABC laws away from a voluntary debtor remedy under the law of trusts and into a creditor remedy, via statutory restrictions.

Such restrictions, in turn, impair ABC as a debtor remedy—which leads, once again, to debtors stop using ABCs.

–California

While ABCs in California are under the common law, California’s legislature enacted a lengthy statute for avoiding preferential transfers made within 90-days before the assignment—like the Bankruptcy Code’s preference statute.

Judicial disputes exist over the legal propriety of that preference statute: the Ninth Circuit declares it unenforceable, in a split decision, while California state courts reject that decision.

But the judicial dispute misses the main policy point:

  • preference laws are mostly for the benefit of creditors, not debtors; and
  • debtors might, and often do, decide against an ABC because of the existence of the preference statute—this is the very same reason for a debtor to avoid filing bankruptcy.

–Delaware

Court supervision exists under Delaware’s ABC laws for one limited reason: because the ABC statute requires a bond, based on the value of debtor’s assets, and a court ruling is needed to set the amount of the bond.

The result is this: Delaware courts are now requiring ABC debtors to file detailed information, much like what’s used in a bankruptcy declaration supporting first day motions in Chapter 11.

Such a requirement is understandable . . . but it:

  • is a departure from the trust law foundation for a voluntary ABC remedy; and
  • becomes an impediment to debtors using the ABC remedy.

–Other States

Some states make no pretense about jettisoning ABC laws as a voluntary debtor remedy.

These states combine statutes on ABCs and receiverships into a single remedy. The effect, of course, is to eliminate ABCs as a voluntary debtor remedy. That’s because business debtors will rarely, with unimpeded volition, choose such a remedy.

Long ago, my state, Nebraska, had an ABC statute: enacted in 1877 and repealed in 1945. That statute is the result of a legislative decision to make ABC laws a creditor remedy—one that’s not debtor friendly. Here are its former requirements:

  • an ABC must begin by an assignment to the sheriff;
  • the sheriff then assembles the creditors; and
  • the creditors then choose an ABC trustee.

Surprise, surprise! No one used that statute. So, Nebraska’s unicameral Legislature repealed it, presumably for lack of interest and use.

Bad Policy

State ABC statutes, with substantial limitations on common law ABCs (e.g., court supervision or 90-day preference avoidance) are bad policy. Here’s why:

  • they presume that debtors will abuse the process; and
  • they attempt to anticipate and prevent the presumed abuse.

That’s bad thinking and bad policy.

In fact, it’s the same bad thinking and bad policy that gives us the bankruptcy presumption that any middle-class consumer who files Chapter 7 is abusing the bankruptcy system (whether that presumption has any connection with reality or not) and imposes a punishment upon all of them (i.e., their only bankruptcy relief is under a 5-years Chapter 13 plan):

  • That’s a terrible policy; and
  • It’s an actual, legislatively-imposed policy that has harmed many, many honest but unfortunate people, over the past two decades!

Better Policy

Here’s a policy everyone (debtors and creditors alike) can agree upon:

  • If an insolvent debtor is willing to liquidate and genuinely pursues the goal of maximizing value for creditors;
  • Allowing the debtor to pursue that goal without impediment is the best-possible course.

–Some Experience

In representing hundreds of financially-distressed debtors over the years (note: Nebraska has no ABC statute and does not recognize ABCs under the common law), I’ve learned this. When a debtor diligently pursues the goal of maximizing value for creditors through liquidation, creditors:

  • will allow those efforts to proceed;
  • will cheer those efforts on;
  • will give important concessions to debtor, in support of those efforts; and
  • will say, “No, no, no!” to the question, “Do you want debtor to file bankruptcy?”

–What ABCs Add

ABCs add, to a voluntary liquidation effort, the additional creditor-protection of a third person, with authority and responsibility of a trustee, stepping in to maximize value.

That has many benefits, not the least of which is this: a trustee eliminates the risk of debtor having a change of heart, midstream, and abandoning the liquidation effort.

–Judicial Declaration of Policy

Here’s the judicial declaration of a good-and-correct ABC policy (from nearly two centuries ago) that applies to ABCs today:

  • “A general assignment of a debtor’s property in trust for all his creditors, is valid when it is coupled by no unjust conditions for the purpose of coercing the creditor.” Cross v. Bryant, 3 Il.. 36, I(3) (1839).

Remedies for Abuse

Abuses will happen, of course.

But creditor remedies already exist for addressing ABC abuse. If creditors smell a rat in the ABC process, they can:

  • pursue remedies under state law; or
  • file an involuntary bankruptcy petition—a general ABC assignment is, in itself, grounds for an involuntary petition under § 303(h)(2) (note: an ABC assignee is a “custodian” under § 101(11)(B)).

What’s not needed, and what should be avoided at all cost, is this: (i) legislatures anticipating ABC abuses that might happen, and (ii) trying to prevent those abuses by statutory limitations on the voluntary ABC process.

Conclusion

ABCs exist, under the common law and its law of trusts, as a voluntary debtor remedy. Such ABC processes have met a need and filled a role, in both England and the United States, for centuries.

State statutes limiting the ABC common law are an impediment to the voluntary ABC trust process—and are, therefore, bad policy and need to be rejected.

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