O
n oct. 3,the U.S. Supreme Courtdeclined to hear an appeal fromthe 9th U.S. Circuit Court of Appeals’ decision earlier this yearin
Sherwood Partners v. Lycos Inc.
,394 F.3d 1198 (9th Cir. 2005). In that case,a divided panel ofthe 9th Circuit held thata state statute authorizing an assignee underan assignment for the benefit of creditors toavoid and recover a preferential transfer ispre-empted by § 547 of the federalBankruptcy Code. The majority’s decisionhas been widely criticized for calling intoquestion the validity of not only state lawpreference actions but also assignments forthe benefit of creditors generally. This articlediscusses this decision and its impact oninsolvency practice going forward.
ABCs allow debtors toavoid bankruptcy court
As a general matter, an assignment forthe benefit of creditors (ABC) is a voluntarytransfer by a debtor of substantially all of itsassets to a designated person, the assignee, intrust for the purpose of having the assigneeliquidate the assets and distribute theproceeds to creditors according to applicablelaw. ABCs have long been recognized bystate and federal courts as legitimate tools forliquidating insolvent estates for the benefitof creditors without having to institutefederal bankruptcy proceedings, which canbe more costly and time-consuming.Management and boards of directors of insolvent technology companies haveincreasingly resorted to ABCs as the fastestand most unobtrusive method of exiting afailed enterprise.A principal goal of any insolvencyproceeding is to provide fair and equitabletreatment of creditors in accordance withapplicable law. The ability to avoidand recover preferential payments madeto creditors by the debtor is a vitalinstrument in the pursuit of that goal. Underthe Bankruptcy Code, the ability tobring preference actions is squarely vestedin the bankruptcy trustee (or debtor inpossession in Chapter 11). In the ABCcontext, an assignee stands in the place of the assignor and cannot avoid and recoverpreferential payments made by thedebtor-assignor, unless there is a statuteexpressly authorizing him to do so. Statestatutes typically mirror the requirements of § 547 of the Bankruptcy Code that thepayment or other transfer be made during aprescribed period of time before the start of the ABC, that the payment or transfer bemade by the debtor to one of its creditors onaccount of a pre-existing debt, and that thepayment or transfer providethe creditormore than the creditor would haveotherwise received in the proceeding.In
Sherwood Partners
, the debtor hadmade a payment of $1 million to thedefendant within the 90-day statutorilyprescribed period. The debtor subsequentlymade its general assignment for the benefitof its creditors to the plaintiff, as assignee, inaccordance with California law. Theplaintiff then filed a lawsuit againstthe defendant in state court seeking to avoidand recover the $1 million payment forthe benefit of the debtor’s creditors pursuantto the state statute.The defendant removed the action tofederal court based upon diversity jurisdic-tion. Following motions to dismiss by thedefendant and for summary judgment by theplaintiff, the district court held that the statepreference statute was not pre-empted by theBankruptcy Code, and the defendantappealed. Despite the fact that no such statestatute had ever been held to be in conflictwith federal bankruptcy law, the 9th Circuitreversed the district court and ruled in thedefendant’s favor.The 9th Circuit majority held that thestate statute at issue, § 1800 of the CaliforniaCivil Code, is pre-empted by federalbankruptcy law based on its reasoning thatstatutes giving assignees avoidance powersbeyond those that may be exercised byindividual creditors trench too close uponthe exercise of the federal bankruptcy power.The majority also opined that, like statedischarge laws that intrude upon federalbankruptcy law, state statutes that implicatea major goal of federal bankruptcy law, suchas the equitable treatment of creditors, are
WWW.NLJ.COM
THE WEEKLY NEWSPAPER FOR THE
LEGAL PROFESSION
MONDAY, OCTOBER 24, 2005
BANKRUPTCY LAW
9th Cir. ‘Sherwood’ Case
By Craig Rankin and Christopher Alliotts
Craig Rankin
is a partner at Los Angeles-basedbankruptcy boutique Levene, Neale, Bender,Rankin &Brill.
Christopher Alliotts
is of coun-sel to the Menlo Park, Calif., office of Los Ange-les-based SulmeyerKupetz.
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