When the ABC procedure and involuntary bankruptcy meet (In re Scandia)

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

However, this relationship remains ill-defined.

The following is an attempt to summarize a bankruptcy court’s view of this relationship. And here are two of its main findings:

  1. “If the sole purpose of this ‘involuntary filing for bankruptcy by creditors’ was to try to terminate ‘their ‘potential obligations of preference’ under the state’s CBA laws,” then I would have It is not a proper function of “an involuntary bankruptcy petition to terminate a creditor’s liability for preferences under state law”, but
  2. There was “appalling lack of care” on the part of assignee ABC.

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

Facts

The debtor is a New York company selling fresh fish and prepared foods.

On November 29, 2016, the debtor commences formal ABC proceedings under New Jersey law; after which, the debtor appoints an ABC assignee (“assignee”), who takes possession of the debtor’s property.

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

ABC = Involuntary Grounds

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

The debtor admits that its ABC proceeding under New Jersey law began within 120 days before the creditors filed their petition for involuntary bankruptcy. Accordingly, the conditions for involuntary bankruptcy against the debtor, under Article 303 of the Bankruptcy Code, are satisfied.

But that’s not the end of the story.

Abstention/dismissal issues

The assignee asks the bankruptcy court to forbear and dismiss the involuntary case:

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

– Complaint in bad faith

The bad faith claim is based on the creditors’ intent to use the involuntary petition as a litigation tactic: to avoid preferential liability, under New Jersey’s ABC laws, for payments they received within four month preceding the start of the ABC procedure.

– Arguments of creditors

The creditors oppose the motion to forbear/dismiss, arguing that the Debtor’s ABC procedure exists for the sole benefit of (i) the debtor’s owners and (ii) the attorneys who will work on the preferential claims.

The creditors insist that the assignee acted as a puppet of the debtor’s owners:

  • The Obligor’s owners, through an insider (“Insider Buyer”), acquire the Obligor’s business and assets from the Assignee for the insufficient price of $45,000;
  • The Assignee enters into an interim management agreement with the Insider Buyer on terms very favorable to the Insider Buyer; and
  • The assignee and the attorney are to receive excessive fees – a total of 60% of the proceeds recovered – from ABC’s preferred actions against creditors.

– Findings after trial

After reviewing the forbearance/dismissal petition, the bankruptcy court concludes:

  • The owners have many discussions with the assignee, prior to the appointment, about how the ABC will be conducted;
  • The transferee accepts that the insider buyer acquires the debtor’s assets and business, without having any information about the business or the value of the debtor’s assets;
  • The owners of the debtor obtain the consent of the assignee (prior to the appointment of the assignee) to a management agreement, under which the insider buyer obtains (i) all the inventory of the debtor, without paying for it, and (ii) all debtor’s profits;
  • The transferee does not negotiate with anyone else or hire an adviser to complete the sale, insisting on the need to act quickly, without supporting evidence;
  • The assignee makes no due diligence on the values ​​of the assets or the equity of the arrangement, except for reviewing an appraisal of the debtor’s owners;
  • The transferee asks a court in the State of New Jersey to approve the proposed sale on 10 days’ notice to creditors;
  • Creditors do not appear or oppose any part of the ABC proceeding, until preferred actions are filed against them under New Jersey’s ABC law; and
  • Creditors admit that the assignee’s preferred actions prompted their investigation into the debtor’s ABC proceeding.

Such evidence suggests:

  • “an appalling lack of diligence in ensuring that the former owners paid a fair price to keep the business and its assets” and “did not steal the value” that belongs to creditors; and
  • a breach of the assignee’s fiduciary duty to act diligently to maximize value for creditors.

Should we abstain/reject

Since the involuntary case is properly filed under § 303, the question is whether the bankruptcy court should forbear and dismiss the Chapter 7 case.

– Legal standards of abstention/dismissal

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

The burden of proof is on the submitter, but abstention/dismissal is an “extraordinary remedy” that should not be given lightly.

The non-exclusive factors to consider, on the issue of abstention/dismissal, are:

  1. economy and efficiency of administration;
  2. if another forum is available or if a proceeding in state court is already pending;
  3. whether federal proceedings are necessary for a fair and just solution;
  4. whether there is an alternative to achieve a fair distribution;
  5. whether a cheaper and better out-of-court arrangement is possible;
  6. whether the ABC has gone so far that it would be costly to start over in the event of bankruptcy; and
  7. if bankruptcy jurisdiction is sought for a legitimate purpose.

The general question is whether forbearance/revocation is in the interest of creditors and debtor?

–Value of ABC Preferential Claims

The assignee insists that the ABC preferential claims have value that would be lost, without forbearance or revocation. It is true that:

  • New Jersey laws allow an ABC assignee to recover preferences—that’s to say., transfers to creditors within 120 days of the start of the ABC; but
  • A Chapter 7 trustee cannot inherit the right of an ABC assignee to pursue such claims because,
    • The Bankruptcy Code allows a trustee to avoid avoidable transfers by “a creditor holding an unsecured claim” (§ 544(b)(1)); but
    • Under New Jersey law, unsecured creditors cannot sue ABC preferences – only an ABC assignee can do so; then
    • The Chapter 7 trustee cannot pursue preferential claims under state ABC laws.

Thus, without abstention/rejection, the ABC preferential claims are canceled in this case, the only preferential claims available are under Article 547 of the Bankruptcy Code and the 90-day window for these claims is closed before the start of the involuntary bankruptcy.

Decision: no abstention/dismissal

On the overall balance sheet, this chapter 7 will remain in force, without abstention. The bankruptcy court declares:

  • A Chapter 7 trustee, as an independent trustee, must review what happened in the CBA, with the power to take corrective action, if necessary, to maximize the value of the debtor’s assets.

Other observations of the Court

Further, the bankruptcy court says that because the creditors had legitimate concerns and reasons for filing the involuntary, there is:

  • no issue of “good faith” of creditors under section 303(j); and
  • no grounds to award attorneys’ fees against creditors under § 303(i).[Fn. 3]

Conclusion

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

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