State Law Preference Actions: A Thing of the Past?

By Nathan, Bruce S.; Cargill, Scott | Business Credit, March 2005 | Go to article overview

State Law Preference Actions: A Thing of the Past?


Nathan, Bruce S., Cargill, Scott, Business Credit


Sherwood Partners v. Lycos, Inc.

Introduction

Credit grantors usually think of a preference claim as part and parcel of a debtors bankruptcy case. However, numerous states have insolvency proceedings that also permit the recovery of preferences. Wow, another source of preference headaches!

An assignment for benefit of creditors ("ABC") is one such state law liquidation proceeding that resembles a liquidation case under Chapter 7 of the Bankruptcy Code. California has a modern and widely used ABC statute, including a preference statute that is similar to Section 547 of the Bankruptcy Code (the "Bankruptcy Preference Statute"). California's preference statute enables an "Assignee" for the benefit of creditors, who is akin to a Chapter 7 bankruptcy trustee, to recover preferential transfers.

However, the United States Court of Appeals for the Ninth Circuit in Sherwood Partners v. Lycos, Inc., recently ruled that the California preference statute is preempted by the United States Bankruptcy Code and directed dismissal of the Assignee's pending preference action. If that ruling stands, and it is subject to a request for rehearing and reconsideration, state law preference actions in California and possibly other states might become a thing of the past.

An Overview Of ABCs

An ABC is an alternative means of liquidating a financially troubled debtor, in lieu of a liquidation under Chapter 7 of the Bankruptcy Code. An ABC is governed by state law, either by common law or by statute. ABC's are not uniform nationwide, unlike the uniform liquidation regimen of Chapter 7 of the Bankruptcy Code. Each state has different ABC procedures. Some states, like California, have a modern ABC statute that has led to the widespread use of ABCs, while other states, like New York, have more antiquated, less used ABC statutes.

As a general proposition, an ABC is a contract under which a debtor transfers all of its right, title, interest in and custody and control of its property to a third party, an Assignee, in trust. An ABC is designed to be a more expeditious, less expensive liquidation than a federal bankruptcy case. In an ABC, the debtor, who could be an individual, partnership, corporation, or limited liability company, selects the Assignee. A bankruptcy trustee is either selected by the United States Trustee, an arm of the United States Department of Justice, or--in rare cases--elected by creditors. The Assignee is charged with liquidating the debtor's property and distributing the proceeds to the debtor's creditors according to priorities established under state law. Creditors usually must file a proof of claim to participate in an ABC and the Assignee is responsible for reconciling and, if necessary, objecting to claims.

The Califormia Assignment Of Benefit For Creditors Statute

Section 1800 of the California Code of Civil Procedure and other provisions of the California Code of Civil Procedure, California Civil Code and California Commercial Code govern ABC proceedings in California and the rights and duties of the Assignee of benefit for creditors. Among other things, they: (i) require that the Assignee send notice of the assignment to creditors and set a deadline for the submission of claims against the debtor; (ii) give certain priorities for payment of claims for wages, salaries, commissions, employee benefit contributions and consumer deposits; (iii) grant the Assignee the right to occupy and utilize the debtor's business premises during the liquidation process; (iv) grant the Assignee the status of a "lien creditor" with priority over unperfected security interests; and (v) grant the Assignee the power to recover preferential transfers.

An Assignee's statutory right to avoid preferences under California Code of Civil Procedure [section] 1800 (the "California Preference Statute") was the only part of California's ABC statute that was considered by the Sherwood decision. …

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