When a business is in financial distress — unable to meet its obligations as they become due, operating with negative equity, or on the brink of insolvency — the standard M&A playbook does not apply cleanly. Distressed M&A transactions operate under a different set of legal constraints, risk profiles, and deal mechanics than healthy-company transactions. Buyers who want to acquire a distressed business must understand the legal frameworks that govern these sales, the successor liability risks that accompany them, and how deal documents must be structured differently when the seller’s financial condition creates unique legal and commercial challenges. Business owners who find themselves on the selling side of a distressed transaction must understand their options and the legal obligations that govern their conduct.
Outside Bankruptcy: The Alternative Frameworks
A financially troubled business does not have to file for bankruptcy to be sold or to have its assets distributed to creditors. Several out-of-court mechanisms allow for the orderly sale or disposition of a distressed company’s assets without the cost, time, and complexity of a formal bankruptcy proceeding. The most common are the assignment for benefit of creditors (ABC), the UCC Article 9 secured party foreclosure sale, and the structured workout or out-of-court restructuring that results in a negotiated sale.
Each of these mechanisms has different implications for the speed of the transaction, the level of court oversight, the treatment of unsecured creditors, and the protections available to buyers against successor liability claims. Choosing the right framework depends on the specific circumstances of the distressed company, including the nature and amount of its obligations, the composition of its creditor base, the urgency of the sale, and the preferences of its secured lenders.
Assignment for Benefit of Creditors
An assignment for benefit of creditors (ABC) is a state law insolvency procedure in which an insolvent company (the assignor) transfers all of its assets to a neutral third party (the assignee) who winds down the business, liquidates or sells the assets, and distributes the proceeds to creditors in an orderly manner according to priority. ABCs are available in most U.S. states, though the specific statutory framework varies significantly. California has a particularly well-developed ABC statute that is frequently used in technology and startup liquidations.
From a buyer’s perspective, purchasing assets through an ABC process has several potential advantages over a distressed asset purchase directly from the company. The assignment to a neutral assignee may cut off certain fraudulent transfer and preference claims that creditors could assert against a direct asset purchaser. The assignee, who is a fiduciary to all creditors, can provide representations and disclosures about the assets with more authority and credibility than a distressed company’s management. And the ABC process provides a framework for dealing with the company’s creditors that is less confrontational than an ad hoc workout.
The primary limitation of an ABC is that it does not provide the bankruptcy court’s power to bind non-consenting creditors and counterparties. Contracts cannot be assumed and assigned without counterparty consent, secured creditors retain their liens unless they consent to their release, and creditors who disagree with the assignee’s conduct of the proceedings may need to resort to state court litigation rather than the streamlined bankruptcy process.
UCC Article 9 Foreclosure Sales
When a distressed company has pledged its assets as collateral under a security agreement governed by Article 9 of the Uniform Commercial Code, the secured lender has the right to foreclose on those assets after a default. Article 9 allows the secured party to sell, lease, or otherwise dispose of the collateral in a commercially reasonable manner, with the proceeds applied to the outstanding obligation. A secured party foreclosure sale can be used to transfer a distressed company’s assets to a buyer quickly, with the secured party’s cooperation, and potentially with some protection against successor liability claims.
The key advantage of an Article 9 foreclosure sale in the distressed M&A context is its potential to cut off the claims of junior creditors and unsecured creditors, because those creditors’ claims attach only to the proceeds of the sale (after satisfaction of the secured obligation) rather than to the assets themselves. A buyer who acquires assets through a properly conducted Article 9 sale takes the assets free of the claims of junior lienholders and (in many cases) unsecured creditors, which reduces the buyer’s successor liability risk.
However, the protection provided by an Article 9 foreclosure sale is not absolute. Courts have scrutinized Article 9 sales to ensure that they were conducted in a commercially reasonable manner and that the secured party did not collude with the buyer to suppress the sale price or otherwise disadvantage creditors. If a court finds that the sale was not commercially reasonable, it can award damages to junior creditors or set aside the sale entirely. Buyers should work with legal counsel experienced in Article 9 sales to ensure that the process is properly designed and conducted.
Bulk Sales Law
Historically, the Uniform Commercial Code included a bulk sales statute (UCC Article 6) that required buyers of a business’s inventory and other assets in bulk to notify the seller’s creditors before the sale and to give them an opportunity to assert their claims against the assets. The purpose was to prevent business owners from secretly selling their inventory and absconding with the proceeds, leaving creditors with no assets to pursue.
Most states have repealed or substantially limited their bulk sales laws, following the UCC’s official recommendation in 1989 to repeal Article 6. However, a few states still have bulk sales notification requirements, and buyers of business assets in those states should verify whether bulk sales compliance is required. Failure to comply with applicable bulk sales notification requirements can expose the buyer to claims by the seller’s unsatisfied creditors, which is a form of successor liability risk.
Successor Liability Risk in Distressed Acquisitions
Successor liability is the risk that a buyer who acquires a business’s assets will be held responsible for the seller’s pre-closing obligations, even though the buyer only contracted to acquire specific assets rather than the entire entity. As noted in the discussion of deal structure elsewhere on this website, common law doctrines including the mere continuation doctrine, the de facto merger doctrine, and product line liability can impose successor liability on asset buyers in certain circumstances.
Distressed acquisitions carry a heightened successor liability risk because they are more likely to be challenged by creditors who are left with inadequate recovery from the sale proceeds. A creditor who receives less than the full amount of its claim from a distressed asset sale may look to the buyer as a potential source of recovery, arguing that the buyer’s acquisition of the seller’s business constitutes a continuation of the seller’s enterprise. Environmental claims, product liability claims, and employee benefit claims are among the most common sources of successor liability risk in distressed acquisitions.
Buyers can reduce (but not eliminate) successor liability risk by structuring the acquisition to emphasize the departure from the seller’s operations: changing the name, changing the management, changing the customer and supplier base, and demonstrating that the acquired business is genuinely new rather than merely renamed. Buyers should also obtain comprehensive title searches on all acquired assets, ensure that all liens are identified and addressed, and consider environmental and other specialized due diligence even in expedited distressed transactions where the normal diligence timeline is compressed. Where the assets include real property or operations with significant environmental history, the risk of CERCLA successor liability should be carefully evaluated.