Strangers to the insolvency profession might be surprised to learn that it is often expensive to go bankrupt. Indeed, the high cost associated with obtaining relief under Chapter 11 of the federal Bankruptcy Code is a routine criticism of the federal bankruptcy scheme and an issue many commentators argue is ripe for reform. Given the potentially preventative costs, many distressed companies elect to wind down their operations by making an “assignment for the benefit of creditors,” or an ABC.
Unlike the federal bankruptcy scheme, which is governed by the U.S. Bankruptcy Code, an ABC process is governed by state law. Some states have a robust ABC statute that, in many places, mirrors or even incorporates aspects of the Bankruptcy Code. Other states, including Delaware, have a lean statute, relying instead on developed case law and parallel corporate statutes to provide companies with flexibility in winding down their operations. Adding to the variety of approaches, some states require judicial oversight of an ABC, while others permit ABCs to be made out of court. In Delaware, ABCs must be approved by the Delaware Court of Chancery upon a petition asking the court to accept jurisdiction over the assignment.
There are many notable distinctions between the Bankruptcy Code and the Delaware’s ABC statute. One of the most prominent is that the Bankruptcy Code imposes a stay of creditor collection efforts and litigation that arises immediately and automatically when a debtor files for bankruptcy. See 11 U.S.C. Section 362(a). The Delaware ABC statute does not expressly provide any “automatic stay” protections. Nevertheless, the Court of Chancery has historically entered orders enjoining creditor actions in a manner akin to the Bankruptcy Code’s automatic stay. See, e.g., In re Classic Designs (Case No. 9556-VCP); In re Gilbert Iron & Steel (Case No. 8746-CS); In re Regional Elevator (Case No. 7578-VCN). Recently, however, in In re Kidbox.com, Case No. 2022-0379-PAF (Del. Ch. May 16, 2022), Vice Chancellor Paul Fioravanti entered an order denying a petition made by the assignee for the benefit of creditors that requested an injunction barring creditor action during the pendency of the ABC proceeding.
According to its ABC petition, Kidbox was a distributor of branded children’s apparel, which the company typically sold via subscription-based, e-commerce transactions. Kidbox became unable to pay its debts and, in effort to satisfy its creditors to the extent possible, made an assignment of its assets for their benefit. The assignee – a specially formed Delaware LLC—was charged with liquidating the company’s assets and establishing a procedure to reconcile and ultimately pay creditor claims.
On May 2, the assignee filed a petition in the Court of Chancery that requested the court accept jurisdiction over the assignment consistent with Delaware’s ABC statute. In addition, the petition asked the court to enter an injunction staying “collection and litigation against Kidbox and the assignee” comparable to the Bankruptcy Code’s automatic stay. Notably, while the petition cited prior orders granting similar relief, it did not identify any express statutory authority for the requested relief or include any detail explaining the specific need for the creditor injunction. Rather, the petition focused on the fact that the requested injunction was only intended to apply to persons subject to the Court of Chancery’s personal jurisdiction. The petition also emphasized that the requested injunction was intended to be temporary and that the proposed form of order provided a mechanism for parties to obtain relief from the automatic stay.
On May 16, the Court of Chancery entered an order denying the petition. In a comment appended to the order, the Court of Chancery highlighted the fact that the petition contained “no stated grounds for the need to enter a stay in this matter.” The Court of Chancery also noted that the petition in the instant case was “largely copied, nearly verbatim” from a prior ABC case wherein the same vice chancellor declined to grant nearly identical relief on similar grounds. See In re BeautyCon Media, C.A. No. 2021-0368-PAF (Del. Ch., June 28, 2021).
In that prior case, In re BeautyCon Media, the assignee sought a similar creditor injunction at the outset of the ABC proceeding. During a hearing on that request, the vice chancellor stated that at a minimum, before the court could enter the requested injunction, it would require a formal notice and hearing process. The vice chancellor was also skeptical of prior Court of Chancery orders that granted similar relief without a hearing.
Beyond that procedural issue, Fioravanti explained that in order for the assignee to obtain the requested injunction, the petition must address three things. First, the petition must identify “some authority for the proposition” that the Court of Chancery could enter an automatic stay order enjoining creditor action. Second, the petition must include an explanation as to why a stay of litigation is necessary in the particular case. Third, Fioravanti directed that the petition should also include “a description of whether there is any pending litigation that’s out there that will be affected by [the requested order] immediately.”
Returning to Kidbox, the petition in that case arguably satisfied the first criteria by citing prior orders and a respected treatise on ABCs for the proposition that the court had sufficient authority to enjoin creditor actions. But it failed to meet the second and third criteria because it did not sufficiently explain why a stay of creditor litigation was needed or provide a description of the affected litigation. As the Court of Chancery explained in its order denying the requested relief, “In ex parte matters such as this counsel have a heightened obligation to provide information to the court.”
The lesson from Kidbox is clear. In order for an assignee to obtain a stay of creditor action in a Delaware ABC, the petition must address three principal points: the Court of Chancery’s authority to impose an automatic stay of creditor action; the need for such relief with respect to the particular case; and the effect a stay order would have on pending litigation. In addition, in an apparent shift from past practice, the request must be presented upon notice and a hearing. Hopefully, an assignee that follows these steps and meets this criteria will obtain relief as easy as A-B-C.
Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.