In a recent opinion in an assignment for the benefit of creditors (ABC) proceeding, the Delaware Court of Chancery provided an illustrative account of the assignee’s failures to comply with the relevant statutory scheme, and ultimately granted “an extreme form of equitable relief” in removing the assignee from the case. Despite a statutory requirement that assignees in ABC actions submit information analogous to that contained in “First Day” bankruptcy declarations, the court noted that ABC proceedings had trended towards bare bones paperwork that often failed to meet the clearly defined requirements of Delaware’s ABC statute. Because ABC proceedings have historically taken place ex parte, statutory violations have gone largely unchecked. As such the Court of Chancery’s decision is an attempt to remedy what it called the pervasive “lawlessness of a period in which Delaware ABC proceedings were known as ‘the Wild West of bankruptcy.’”
Wack Jills USA, Inc., formerly known as Jack Wills, Inc. (Assignor), assigned all its property and assets to SM Financial Services Corporation (Assignee) in August 2019, following the Assignor’s parent company being placed in insolvency in the United Kingdom. Through that insolvency proceeding, many of the Assignor’s affiliates’ assets were sold to third-party Sports Direct.com Retail Limited (Sports Direct), though the Assignor’s assets were not sold in the proceeding. The Assignor entered into an assignment agreement (the Agreement) to assign its property and assets to the Assignee, a New Jersey-based liquidation firm, which was also appointed as trustee of a trust for the benefit of the Assignor’s creditors. Under the assignment agreement, the Assignee was empowered to, among other things: (i) cause the trust to perform or continue performance under any contracts or leases that are trust assets; (ii) retain professionals, employees, and consultants on behalf of the Trust; (iii) collect, liquidate, and administer the trust’s assets; (iv) maintain the trust’s books and records; and (v) pay administrative expenses of the trust.
In the opinion, the court denied the Assignee’s motion to approve final distributions and close the case and found that there was “more than sufficient cause” to remove the Assignee from its position. In particular, the court focused on repeated violations of the ABC statute, other problematic behavior, and a concerning retention arrangement with counsel for the trust.
With respect to the statutory requirements, the court found the Assignee failed to comply with Delaware’s ABC statute in multiple ways. By statute, ABC proceedings require (1) a petition containing general background on both the assignor and assignee, typically including the relevant assignment agreement and corporate resolutions authorizing the assignment as exhibits; (2) an affidavit of inventory within 30 days of the assignment; (3) the court’s appointment of two disinterested and competent persons to appraise the assigned estate and the filing of their appraisals; (4) the court’s setting of a bond; and (5) annual accountings. The Assignee failed to meet nearly all of these requirements, omitting the affidavit of inventory, failing to seek the appointment of appraisers, unilaterally posting a bond, and failing to file the annual accountings. The court noted that not only did the Assignee fail to comply with the statute, it also made no attempts to justify or correct its pervasive non-compliance even after the court identified its shortcomings.
In addition to these statutory violations, the court identified other problematic conduct by the Assignee, including failures to inform the court of inventory sales and subleasing arrangements and to communicate with Assignor or its directors or officers.
Finally, the court found problematic the Assignee’s retention of additional counsel for the trust. The Agreement permitted the Assignee to retain counsel in the Assignee’s sole discretion. The Assignee’s general counsel, whose family owns the Assignee, also owned a New Jersey law firm, SM Law, PC (SM Law), which the Assignee hired to provide legal services to the trust. The Agreement provided that, as compensation for serving as trustee, the Assignee would receive 20% of all funds distributed to the Assignor’s creditors and an amount equal to 20% of all costs and expenses incurred during the assignment process, including fees paid to SM Law. The court noted that this structure created no incentive to minimize expenses, and, in fact, allowed Mitnick to increase the Assignee’s share of the assignment estate by billing for SM Law’s legal services and then receiving a 20% commission on top of those expenses.
Ultimately, the court found that repeated violations of the statute “alone” were not enough to warrant removal of the Assignee, but that, combined with these other issues, especially the retention of SM Law, which appeared to be unnecessary and inappropriate given the Assignee’s compensation structure, the Assignee’s actions justified the “extreme sanction” of removing the Assignee.
This opinion demonstrates a renewed emphasis on compliance with statutory requirements in ABC proceedings and the Court of Chancery’s willingness to enact strict penalties against assignees who fail to fulfill their duties to protect assets for the benefit of creditors. This opinion is a sign that the “Wild West of bankruptcy” in Delaware ABC proceedings has ended.
[View source.]
