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VOLUME 29
NUMBER 2
2007
A QUARTERLY PUBLICATION
THE IRS IS YOUR FRIEND How TRUSTEES
CAN USE TAX LIENS TO WEAVE STRAW
INTO GOLD
DEEPING INSOLVENCY A DOCTRINE
IN DECLINE?
WHAT TO EXPECT FROM HEDGE FUNDS
TODAY AND IN THE FUTURE AN OvERVIEW
AN INSOLVENCY PERSPECTIVE
THE YEAR IN REVIEW CASE LAW
DEVELOPMENTS UNDER THE BANKRUPTCY
ABUSE PREVENTION AND CONSUMER
PROTECTION ACT OF 2005
THE ERRONEOUS ApPLICATION OF THE
DEFENSE OF IN PARI DELECTO TO
BANKRUPTCY TRUSTEES
CALIFORNIA GENERAL ASSIGNMENTS
STILL ALIVE KICKING AND USEFUL
TAX NEWS &
VIEWS Peter A
Davidson LanceJurich Gregory
Schwed Christina M
Moore Cynthia
Futter Anne E
Wells Helen Ryan
Frazer Laurel R
Zaeske Lynda T
BuiWilliam
McGrane Joel B
Weinberg Elmer Dean
MartinIII
CALIFORNIA GENERAL ASSIGNMENTSSTILL ALIVE KICKINGAND USEFUL
By Joel B Weinberg!
State law general assignments providing for the liquidation of a debtor s
assets and the ratable distribution of the proceeds to creditors have existed priorto ratification ofthe United States Constitution They like other state insolvencylaws have long since been held to be consistent with the Constitution providedthat the state law does not discharge the debtor from debt
2Despite a recent
challenge to the California assignment law and the enactment of the BankruptcyAbuse Prevention and Consumer Protection Act of 2005
3general assignments
remain aviable option for a liquidating business entity
This article will begin with a discussion of the California law of generalassignments The impact of Sherwood Partners v 250 LLC 4 Haberbush v
Charles and Dorothy Cummins Family Limited Partnership5
Credit ManagersAssociation v Countrywide Home Loans Inc
6and the 2005 Act will then be
discussed The article will conclude with adiscussion of transitioning assets on a
going concern basis through employment of a general assignment to facilitate thetransaction
IX California General Assignments Law Provisions
Under California law general assignments are created by agreement andnot by the initiation of a court proceeding In essence general assignmentsestablish a trust pursuant to which the debtor as assignor assigns all of its assets
to an assree as the trustee for the benefit of the assignor s general unsecuredcreditors The assignee then liquidates the assignor s property and makes
1 Joel B Weinberg is an Adjunct Professor of Law at Loyola Law School and president of
Insolvency Services Group Inc an entity which serves as an assignee for the benefit of creditors2
Sturges v Crowninshield 17 U S 122 203 1819 Marshall Ch 1 Pobreslo v Joseph M
Boyd Co 287 U S 518 525 1933
3 The 2005 Act
4 394 F3d 1198 9th Cir 2005
s 139 Cal App 4th 1630 2006
6 144 Cal App 4th 590 2006
7 Brainard v Fitzgerald 3 Cal 2d 157 163 44 P 2d 336 1935 See also Jarvis v Webber 196
293 Vol 29 Cal Bankr J No 2 2007
distribution to creditors in accordance with certain priorities recognized under
California and applicable non bankruptcy federal law
General assignments are analogous to cases filed under Chapter 7 of the
Bankruptcy Code 8 In its simplest sense it is a liquidation device available to an
insolvent debtor as an alternative to formal bankruptcy proceedings9 Common
law assignments are at present the only method of making ageneral assignment
which is recognized in California The former statutory procedure under Civil
Code section 3448 et seq wasrepealed as it was rarely if ever invoked
D The Parties toand Property of the General Assignment
1 The Assignee
An assignee can be an individual or an entity typically a corporationThe assignee stands in the place ofthe assignor and asserts claims to property co
equal but no greater than the assignorIO However the assignee does not assume
the liabilities ofthe assignor s contractual agreementsII
An assignee owes a fiduciary duty to preserve the assets for the benefit of
the assignor s creditors As aresult the assignee must exercise ordinary prudence
and good faith in dealing with the assignor s contract obligations12
An assignee
may be liable for those losses caused if the standard of care is not met
The assignee must protect the assets of the estate and upon liquidationadminister the assets fairly for the creditors of the assignor Because title of the
property is vested in the assignee an assignee is charged with the duty of
protecting the property against all fraudulent claimsJ3 In addition an assignee
may in its discretion and according to what it considers to be in the best interest
of the creditors perform or refuse to perform the assignor s part of an executory
Cal 86 98 236 P 138 1925 But see discussion ofcharacterization ofan assignment estate ofa
corporation for federal income tax purposes in Tax News & Views in this issue of the
Journal 8Allreferences to the Bankruptcy Code are toTitle 11of theUnited States Code 101 et
seq 9Credit Managers Ass nvNational Indep Bus Alliance 162 Cal App 3d 1166 1169 209
Cal Rptr 119 1984 see also CAL CIV PROC CODE 493 010 et
seq 10National Indep Bus Alliance 162 Cal App 3d at 1170 quoting Francisco vAquirre 94
Cal 180 183 29 P 495
1892ICredit Managers Ass nvBrubaker 933 Cal App 3d 1587 1594 285 Cal Rptr 417
1991 12SweetvMarkwart 158 Cal App 2d 700 707 323 P 2d 192
1958 13National Indep Bus Alliance 162 Cal App 3d at
1171 294 Vol 29 Cal Bankr J No
22007
contract14 When an assignee induces another party to perform on a contract or
otherwise obtains the benefit of a contract the assignee must also assume that
contracts obligations15
As a fiduciary to the assignor s creditors under common law trust
principles an assignee is charged with certain duties in the administration of the
assignment estate Similar to a bankruptcy trustee an assignee must liquidate the
assignor s assets and distribute the proceeds among the assignor s creditors
equitably16 A California District Court of Appeal declined to hold that
conspiracy liability or liability for breach of an independent fiduciary duty of an
assignee s counsel to creditors of the estate arose where the gravemen was
essentially that the assignee s attorneys charged unnecessary and excessive fees17
California law also recognizes the unique standing of the assignee and facilitates
the transfer of assets by excepting assignees from certain restrictions applying to
the transfers of assets For example a transfer of assets to the assignee does not
violate the requirements for bulk sale transfersI8
Likewise an assignee may
transfer liquor licenses of the assignor without violating the rules restricting the
transfer of such licenses19
An assignee must render an accounting to creditors
within a reasonable time?OAn
assignee is required to give notice of the assignment
toall creditors ofthe assignor andtoestablisha bar date by which the creditors
may assertaclaim against the assets ofthe assignor?l2The
Assignor The assignor
may be a corporation individual or partnership 22 Howeveras
ageneral rule except to the extent for the actual amount ofany payment general
assignments for thebenefit of creditors do not discharge the 14 Sweet
158Cal App 2dat 707 IS Id
16 Bumb
v Bennett 51 Cal 2d 294 303 333 P 2d 23 1958 17 Berg
&Berg v Sherwood Partners Inc 131 Cal App 4th 802 2005 18
CAL COM CODE 6103 c6 19
Bus & PROF CODE 24071 24075
20 Schneider v Moncur 30 Cal App 734 737 159 P 259 1916
21 CAL CIV PROC CODE S 1802 See generally Seigel Assignments for the Benefit ofCreditors
Pending Changes to California Law 20 CAL BANKR J 207 1992
22 See Bumb v Bennett 51 C2d 294 333 P 2d 23 1958 Assignor was a partnership
295 Vol 29 Cal Bankr J No 2 2007
assignor?3Therefore in an individual case or apartnership orjoint venture where
the partners are individuals a general assignment is generally not advantageous
3
The Property All
property of the assignor whether personalorreal may be assigned?4 Thisincludes
among other things leasehold interests choses in action bank accounts contract
rights intellectual property accounts and equitable interests However in
the case of an individual assignor theassignor may exempt certain property?5 As
toreal
property a general assignment constitutesa conveyance under California law26
and issubject to all the recording provisions of the California Civil Code
relating to transfers of real property?7 Where the assetsinclude
real property the
assignee should record an appropriate notice with theddfh
28 county recor erso
asto provl econstructIve notIce 0 teasSIgnment In protecting the assigned
assets the assignee isconferred with certain rights which are not
available to the assignor For example an assignee can enjoin an eviction by
a landlord?9 The assignee has therightto occupy up to 90 days after the date of
the assignment any of the assignors leased business premises upon payment of the
monthly rent notwithstanding any clause inthe lease permitting termination upon insolvency
ofthe lessee or assignment This right tooccupy the assignor
s business premises enables theassignee toadminister and liquidate theassetsof
the assignor without fear of being evicted from the premises Where the lease does
not containa waiver ofCivil Code section 1950 7alandlord may be held
liable tothe assignee for violating Civil Code section 19507where the landlord
fails to returna security deposit to theassignee and the actual damages atthe time
ofsurrender of the premises were less than the security deposit The landlord cannot offset
future damages against the sec urity deposit because section 19507 allows
asecurity deposit tobeapplied only against unpaid 23 Botelerv Robinson 105Cal
App 611288 P135 1930 24 Bumb 51 C 2dat
299 25 See CAL CIV PROC
CODE 703 010 et seq or property exempt under CAL CIV PROC CODE 180126 CAL CIV CODE
1215
Moore v Schneider 196 Cal 380 238 P81 1925 27 Id at 392 28
SeeCAL CIV CODE
1213 and 1214 29 See CAL CIV CODE
1954 1296 Vol 29 Cal Bankr
J No2 2007
rent that has accrued as of the date called for in the statute for the return of the
deposit30
Moreover the assignee is not personally liable for an award of
attome11 fees pursuant to a written lease between the landlord and the assignor
tenant
Like a trustee in bankruptcy an assignee has standing to prosecute and
defend claims against the assignor Rather than a bona fide creditor of the
assignor or a purchaser for value an assignee is the successor in interest to the
assignor32
As such an assignee is the legal representative of the assignor and
as atrustee for all the creditors is charged with the duty to defend the property in
its hands against all unjust adverse claims33
However an assignee acquires no
greater right in the property assigned than the assignor had at the time of the
34assIgnment
E Assignee s Avoidance Powers
An assignee can recover certain transfers or avoid certain interests for the
benefit of the assignor s creditors These avoidance or recovery claims augment
the assignment estate and potential recovery for the assignor s creditors
By statute an assignee is conferred with a special standing to prosecute
and recover preferential transfers pursuant to California Code of Civil Procedure
section 1800 for the benefit of the assignor s creditors The Ninth Circuit in
Sherwood Partners held that section 1800 is preempted by the Bankruptcy
Code35
Subsequently two California intermediate appellate courts in
Haberbush and Credit Mangers Association upheld section 1800 and disagreed
with the Ninth Circuit s conclusion of preemption?6These
cases and the 30
Sherwood Partnersv 250 LLC 131 Cal App 4th 703 2005 31
Sherwood Partners Inc v EOP Marina Business Center 2007 Cal App Unpub LEXIS 1862 Mar
6 2007 32
Vollstedt Kerr Lumber Cov Production Homes Inc 130 Cal App 2d 507 510 279 P 2d 615
1955 33
National Indep Bus Alliance 162 Cal App 3d at 1172 34
Idat 1170 35
394 F 3d1198 9th Cir 2005 36
Haberbush 139 Cal App 4th 1630 2006 and Credit Managers 144 Cal App 4th 590 2006
297
Vol 29 Cal Bankr J No 22007
implications for California preference claims will be discussed at length later in
this article
As under section 547 of the Bankruptcy Code an assignee may recover
any transfers of property that refer certain creditors if they are made within 90
days of a general assignment3
To avoid atransfer ofproperty as preferential the
assignee must prove that a the assignor made atransfer to or for the benefit ofa
creditor b the transfer was on account of an antecedent debt owed by the
assignor before the transfer was made c made while the assignor was insolvent
d made within 90 days of the before the date of the making of the general
assignment unless the creditor is an insider and has reasonable cause to believe
that the assignor was insolvent at the time of the transfer and the transfer occurs
between 90 days and 1 year of the assignment38
e the transfer enables the
creditor to receive more than another creditor of the same class39 Insolvent is
defined in a balance sheet sense as essentially having more debts than assets
except for property transferred with the intent to hinder delay or defraud
creditors An action by an assignee to recover preferences must be commenced
within 1 year after the making ofthe general assignment4o
Similar to section 547 c of the Bankruptcy Code the California
preference statute contains similar exceptions or defenses to preferenceavoidance Some of those exceptions include a a contemporaneous exchange
for new value given to the assignor4I
b transfers made in the ordinary course of
business of the assignor and the transferee42
c enabling loan exception43
and
d the new value exception44 The differences between the section 1800 c
defenses and the current exceptions to avoidance contained in Bankruptcy Code
section 547 will be explored elsewhere in this article
37 CAL Civ PROC CODE 1800
38 CAL CIV PROC CODE 1800 b 4
39 CAL Civ PROC CODE 1800 b
40 CAL CIV PROC CODE 1800 g
41 CAL Civ PROC CODE 1800 c 1
42 CAL CIV PROC CODE 1800 c 2 Brubaker 233 Cal App 3d at 1594
43 CAL Civ PROC CODE 1800 c 3
44 CAL Civ PROC CODE 1800 c 4
298 Vol 29 Cal Bankr J No 2 2007
Benefit to an assignor s unsecured creditors is not a prerequisite to
recovering atransfer of property as apreference At least one California appellatecourt has held that the assignee for the benefit ofcreditors had standing to bring a
claim against a secured lender to invalidate its security interest as a preferentialtransfer even where the secured property was already sold to athird party and the
transfer would not result in any benefit to unsecured creditors45
The court held
that the application of section 1800 of the California Civil Procedure Code is
analogous to avoidance under section 547 of the Bankruptcy Code which does
not reauire that the avoided transfer result in a recovery for the bankruptcyestate
4 The court also held that California courts deem it appropriate to look
toward federal statutory and case law in interpreting section 1800 of the
California Civil Procedure Code47
An assignee also has a right to avoid fraudulent transfers under the
California Uniform Fraudulent Transfer Act48
An assignee may recover those
transfers which were made with the intent to hinder delay or defraud any creditor
of the assignor or which are de facto fraudulent including without limitation
those transfers made without receiving a reasonably equivalent value in exchange49
for the transfer
An assignee does not however have standing to bring suit in the name of
a corporation to enforce liability of shareholders of a corporation for unlawful
distributions in violation of California Corporations Code section 50050
In
Credit Managers in addition to the unlawful distribution issue the assignee
45Blonderv Cumberland 71 Cal App 4th 1057 1999
46Id
47 It is important to note that while Section 1800 has its genesis in several Bankruptcy Code
Sections including Section 547 unlike the Bankruptcy Code many ofthe terms defined in Section
101 ofthe Bankruptcy Code are notdefined for purposes of Section 1800 For example the term
claim is not defined in the preference statute However the Uniform Fraudulent Transfer Act as
enacted in California CAL CIV CODE 3439 et seq does include a definition of claim similar
to Bankruptcy Code Section 101 5 CAL Civ CODE 3439 01 It is not clear that Blonder
supra would supply the missing definition Also it is not clear that a court would necessarily
adopt the definition from the state uniform fraudulent transfer law This has implications such as
whether a contingent creditor such as a guarantor who has notbeen subrogated to the rights ofthe
creditor whose claim is guaranteed is a creditor for purposes of Section 1800 Similarly state law
does notappear to have an analogue to Bankruptcy Code Section 550
48 CAL CIV CODE 3439 et seq
49Id
soCredit Managers Ass n ofSouthern Cal v Fed Co 629 F Supp 175 188 cn Cal 1985
299 Vol 29 CaJ Bankr J No 2 2007
brought an action to set aside a leveraged buyout as a fraudulent conveyance
Although the holding was that the leveraged buyout was not a fraudulent
conveyance the court analyzed the structure of the leveraged buyout as it would
any other potential fraudulent conveyance51
Thus pursuant to Credit Managersan assignee has standing to bring an action to set aside a leveraged buyout as a
fraudulent conveyance
Transfers of personal property which are made without immediate
delivery or change of possession of the property are avoidable by an assignee52
California law also contains exceptions to avoidance53
Security interests in personal property which are unperfected may be set
aside by an assignee54
This follows from the fact that under the California
Commercial Code an assignee is conferred with the status of a lien creditor whose
rights are superior to all other secured creditors if the secured creditors lien is not
perfected55
As a result the assignee as a judicial lien creditor can file a
declaratory relief action to set aside the unperfected security interest for the
benefit of the assignor s creditors
An assignee may set aside a prejudgment attachment or temporary
protective order levied on the assignor s property if the lien was created within 90
days of the assignment56
A trial court is required to dissolve attachments
d d h57
H hprovI e t e statutory reqUIrements are met owever t e aSSIgnee IS
subrogated to the rights of plaintiffs lien under the temporary protective order or
attachment58
The California Code of Civil Procedure also establishes the
procedure for obtaining arelease of the attached property59
51 Id at 182
52 CAL Civ CODE 3440 b
53 See CAL CIV CODE 34401 et seq
54 CAL COM CODE 9317
55 CAL COM CODE 9102 52 A
56 CAL CIV PROC CODE 493 010 et seq
57 Peck v Hagen 215 Cal App 3d 602 609 263 Cal Rptr 198 1989
58 See CAL CIV PROC CODE 493 060 a
59 CAL Civ PROC CODE 493 030
300 Vol 29 Cal Bankr J No 2 2007
A judgment lien obtained after the assignment may be set aside by an
assignee on the basis that no lien was created because title had already passed to
the assignee Prior valid perfected liens or mortgages on property are unaffected
by an assignment Additionally a valid conditional sale agreement which is
enforceable against the assignor is also enforceable against the assignee6o
F Distribution and Priorities
Similar to bankruptcy cases property of the assignment estate is
distributed in accordance with certain priorities pursuant to California Civil
Procedure Code section 1204 However unlike the Bankruptcy Code section
1204 does not state those priorities as clearly as does the Bankruptcy Code and
does not refer to other California statutes that also grant priority to certain claims
when an assignment is made Moreover section 1204 does not establish a
priority for administration costs and expenses incurred in the assignment Thus it
is unclear whether California provides a mechanism for administrative expenses
to be paid ahead of other priority claims However a general assignment is
essentially a trust under California law61 As such where the trust or in this
particular case the general assignment agreement fails to specify the trustee s or
assignee s compensation the trustee or assignee would nevertheless be entitled to
compensation as is reasonable under the circumstances and may have a lien for
advances made for the benefit ofthe estate62
The following is the priority scheme applicable to general assignments
under California Law
i Secured creditors receive their collateral or its value
ii Debts due to the United States including tax debts63
It should be
noted that this priority is more extensive than would be the case in a case
60 Southern Cal Hardware & Mfg Co v Borton 46 Cal App 524 530 189 P 1022
1920 61 1Witkin SUMMARyofCALIFORNIA LAW Contracts 924 9th Ed 2006For
characterization ofthe assignment bya corporation for tax purposes however see thediscussion in Tax
News & Views inthis issue ofthe JournalFor federal corporate income tax purposesan
assignment estateofa corporation is characterized inamanner similar toa Chapter7
corporate estate 6211Witkin SUMMARY OF CALIFORNIA LAW Trusts 59 63 9th
Ed 2006 63 See 31 V SC3713 United States v Moore 423 U S 77 83 96 S Ct 310
1975 United States v Cole 733 F 2d 653 54 9th Cir 1984 Inthe regard also see the discussion
in Tax News &Views in this issue
of the Journal 301 Vol 29 Cal Bankr
JNo22007
under the Bankruptcy Code For example a breach of contract claim
between the assignor and the United States would have priority
Ill Allowed claims for wages salaries or commissions including
vacation severance and sick leave pay earned by an individual but only to
the extent of $4 300 for each earned within 90 days before the date of
assignment64 Several Ninth Circuit decisions have held that under the
former section 1204 an assignment for benefit of creditors creates a lien
and not merely apriority upon the property assigned in favor of wage
claimants of the assignor which is superior in entitlement to expenses of
administration65 These cases raise the concern that labor liens as
opposed to mere priority claims could potentially wipe out the assignee s
administrative claim
iv Allowed claims for contributions to any employee benefit plans
generally arising from services rendered within 180 days before the date
ofthe making ofthe assignment to the extent of $4 300 per employee66
v Delinquent state taxes including interest end penalties for sales
and use taxes income taxes and bank and corporate taxes67 This tax code
section specifically states that it does not give a preference over any
recorded lien which attached prior to the date when the State records or
files its liens
vi Unsecured creditors claims arising from deposits ofup to $900 for
the purchase lease or rental ofproperty or the purchase of services for the
personal family or household use of such persons that were not delivered
or provided68
64 CAL CIV PROC CODE 1204 a I
65Meyer v Bass 281 F 2d 728 730 9th Cir 1960 Division of Labor Enforcement v Stanley
Restaurants 228 F 2d 420 9th Cir 1955 West Beverly Corp v Division of Labor Law
Enforcement 166 F 2d 429 9th Cir 1948 also holding that such lien rights survive subsequent
bankruptcy filing66
CAL Civ PROC CODE 1204 see also Dunlop v Tremavne 62 Cal 2d427 431 42 Cal Rptr
438 398 P 2d 774 1965
67 CAL REv & TAX CODE
19253 68 CAL CIV PROC CODE1204
5 302 Vol 29Cal Bankr J No
22007
vii Unpaid unemployment insurance contribution including interest
and penalties69 The right to interest and penalties is not cut offby the
mere fact of assignment but continues as prior right in the State until all
principal interest and penalties have been actually paid7o
Vlll The State of California Department of Fish and Game for all
moneys owing the State for the sale oflicenses and license tagS7I
IX General unsecured claims which have been timely filed
It is quite rarethat there will be sufficient assets in ageneral assignment to
pay all unsecured creditors the full principal amount of their respective claims
However in the rare case that there are sufficient assets unsecured creditors
would in such event be entitled to payment ofinterest in addition to principal72
If there is a surplus it will be held in trust by the assignee and returned to
the assignor after creditors who did not participate have an opportunity to reach
the surplus73
X Sherwood Partners Haberbush Credit Managers the 2005 Act and
Their Impact on General Assignments
A The Preemption Issue
In a two to one opinion the Ninth Circuit in Sherwood Partners v Lycosheld that California Code of Civil Procedure section 1800 which since 1979
vested in an assignee the right to recover preferential transfers under provisionssubstantially the same as 11 U S C section 547 is preempted by federal
bankruptcy law 74Subsequently two California District Courts of Appeal
reached the opposite conclusion and expressly rejected Sherwood Parners in
69 CAL UNEMP INS CODE 1701
70 See People v Warfel 162 Ca! App 2d400 328 P 2d 456 1958
71 CAL FISH & GAME CODE
1058 72 McDougall v Fuller 148 Cal 521 525 83 P 701
190673Mechanics Bank v Rosenberg 201 Cal App 2d 419 424 20Cal Rptr 202 1962 See
also Heath v Wilson 139 Cal 362 369 73 P 1821903 74 394 F 3d 1198 9th Cir
2005 303 Vol 29Cal Bankr J No
22007
Haberbush v Charles and Dorothy Cummins Family Limited partnership15 and
Credit Managers Association v Countrywide Home Loans Inc16
The Haberbush court adopted the dissent in Sherwood Partners and
reasoned that Congress intended to permit the co existence of state laws
governing voluntary assignments for the benefit of creditors along with
bankruptcy The Haberbush court observed that Sherwood majority reaches too
far in suggesting that any state statute that implicates the federal bankruptcy law s
second major goal of equitable distribution is preempted Because the common
law right to make an assignment of property for the benefit of creditors is well
established it is illogical that state laws which provide a forum for the equitable
distribution ofthat property should be preempted by federal bankruptcy law That
California s voluntary assignment system has a preference statute substantially
identical to the Bankruptcy Code s preference statute making California general
assignments more capable of effectuating the equality of distribution which is the
aim of the federal bankruptcy law does not necessarily interfere with
bankruptcys goal of achieving equal distribution
The Haberbush court held that federal regulation should not be deemed
preemptive of state regulatory power absent persuasive reason to the effect that
either the nature of the regulated subject matter permits no other conclusion or
that Congress has unmistakably so ordained Congress has not indicated that
voluntary assignments generally or preferential transfer avoidance laws
specifically are to be preempted California general assignments therefore do
not stand as an obstacle to the accomplishment ofthe full purposes and objectives
ofthe federal bankruptcy system11
In response to Sherwood Partners Haberbush and Credit Managers
defendants in state court preferences will no doubt seek to remove state
preference claims to district courts within the Ninth Circuit For defendants akey
consideration will be whether federal subject matter jurisdiction exists so as to
invoke the preemption holding of Sherwood in the United States District Court
As a general matter adefendant may remove a case to the United States District
75 139 Cal App 4th 1630 2006
76 144 Cal App 4th 590 2006
77The U S Supreme Court has already held in several instances that state preference statutes
similar to California Code of Civil Procedure Section 1800 are not preempted by Federal
Bankruptcy Law Stellwagen v Clum 245 U S 605 1918 The Supreme Court upheld an Ohio
preference statute against a claim that the state statute was preempted by the Bankruptcy Act of
1898
304 Vol 29 Cal Bankr J No 2 2007
Court in the district where the state court proceedings are pending provided the
case could have been filed original in the federal court ie based on federal
question grounds78 or diversity79 8 Thus there are two possible bases for
removal jurisdiction the first predicated on federal question and the second on
diversity
It appears that there would be no basis for federal question jurisdiction in a
suit filed pursuant to California Civil Procedure Code section 1800 in the
California state courts Federal question jurisdiction is provided for in section
1331 of title 28 of the United States Code which states in relevant part t he
district courts shall have original jurisdiction of all civil actions arising under the
Constitution laws or treaties of the United States The critical question is what
constitutes civil actions arising under In the case of a general assignment
preference claims are predicated on a state statute the California preferencestatute California Code of Civil Procedure section 1800
81 The assignee s claim
is wholly dependent on state law An attempt by a defendant to assert that
preemption which is an affirmative defense constitutes a civil action arisingunder should not succeed
The well pleaded complaint rule has been adopted by the SupremeCourt for determining whether a state court action where the complaint allegesstate created causes of action may be initiated or removed to the federal district
court W hether acase is one arising under the Constitution or a law or treaty of
the United States in the sense of the jurisdictional statute must be determined
from what necessarily appears in the plaintiffs statement of his own claim in the
bill or declaration unaided by anything alleged in antici ation of avoidance of
defenses which it is thought the defendant may interpose2
The Supreme Court has had occasion to fortify the well pleaded
complaint rule in a removal case where the complaint asserted state created
causes of action and the only issue was whether federal law pre empted state
law83
78 28 U S C 1331
79 28 D S C 1332
80 28 U S C 1441 See Snow v Ford Motor Co 561 F 2d 787 789 9th Cir 1977
81 CAL CIV PROC CODE 1800
82
Taylor v Anderson 234 Us 74 75 76 34 S Ct 724 724 1914 See also Caterpillar v
Williams 482 U S 386 392 93 1987
83 Franchise Tax Board of the State of California v Construction Laborers Vacation Trust for
305 Vol 29 Cal Bankr J No 2 2007
In the Franchise Tax Board case the complaint stated two causes of
action the first alleging defendant failed to comply with three levies issued under
California Revenue and Taxation Code section 18817 and a second for
declaratory relief under state law Defendant asserted that the state statutes were
preempted by ERISA and that there were no factual disputes Defendant in turn
removed the matter from the California Superior Court to the district court In
remanding the case and holding that the federal courts lacked federal question
jurisdiction the Court held as follows
Even though state law creates appellant s Franchise Tax
Board causes of action its case might still arise under the laws
ofthe United States if awell pleaded complaint established that its
right to relief under state law requires resolution of a substantial
question of federal law in dispute between the parties For
appellant s first cause ofaction to enforce its levy under 18818
a straightforward application of the well pleaded complaint rule
precludes original federal court jurisdiction California law
establishes a set of conditions without reference to federal law
under which a tax levy may be enforced federal law becomes
relevant only by way of a defense to an obligation created entirelyby state law and then only if appellant has made out a valid claim
for relief under state law The well pleaded complaint rule was
framed to deal with precisely such a situation As we discussed
above since 1887 it has been settled law that a case may not be
removed to federal court on the basis of a federal defense
including the defense of preemption even if the defense is
anticipated in plaintiffs complaint and even if both parties admit
that the defense is the only question at issue in the case84
If the preference defendant resides outside ofCalifornia and the amount in
controversy exceeds $75 000 then subject matter jurisdiction over a California
law claim would exist Diversity jurisdiction exists where the matter in
controversy exceeds the sum or value of $75 000 exclusive of costs and is
between 1 citizens ofdifferentstates
28 U S C 1332 However unless
there is complete diversity where none of the opposing parties are citizens of the
Southern California 463 U S 1 103 S Ct 2841 1983
84 Franchise Tax Bd v Construction Laborers Vacation Trust 463 U S 1 14 103 S Ct 2841
2849 emphasis added Caterpillar Inc v Williams 482 U S 386 393 93 1987 Preference
defendants in CAL CIV PROC CODE 1800 should not be able to circumvent the well pleaded
complaint rule by filing a declaratory relief action based essentially on the defense of
preemption Alton Box Board Co v Esprit de Corp 682 F 2d 1267 9th Cir 1982
306 Vol 29Cal Bankr J No 2 2007
same state diversity jurisdiction would not exist This has been a long
established principal as articulated by Justice Marshall in Strawbridge v
Curtiss85
There are however several strategies which an assignee could employ to
defeat diversity jurisdiction and the application of Sherwood Partners For
example joining non diverse parties where there are multiple transferees who
reside in California such as aguarantor or a co lender If the gross amount ofthe
California Civil Procedure Code section 1800 claim is close to the $75 000
threshold the assignee could commence suit on the net preference claim after
allowed new value or otherwise reducing the claim below that amount The
assignee might also consider filing the Calfornia law preference claim in the state
court where the defendant resides The defendant could not remove the action to
the United States District COurt86
B The 2005 Act
In the wake ofHaberbush Credit Managers and the 2005 Act recoveries
in a general assignment under state law may result in a greater yield than a
comparable case under Chapter 7 ofthe Bankruptcy Code
Preference claims under California Civil Procedure Code section 1800
appear to provide less liberal exceptions to avoidance than the present version of
section 547 of the Bankruptcy Code The standard for establishing the ordinary
Course of business exception has been eased considerably under the 2005 Act
As a result recoveries on preference claims pursuant to Bankruptcy Code section
547 against vendors will be diminished87
85 3 Cranch 7 U S 267 2 L Ed 435 1806
86 Korea Exchange Bank v Trackwise Sales Corp 66 F 3d 46 48 3d Cir 1995 because
defendants were citizens ofNew Jersey and the casewas originally filed in New Jersey state court
the action was not removable Spencer v United States Dist Ct Altec Industries Inc 393
F3d 867 879 9th Cir 2004
87 Prior Law Under prior law preference defendants creditors have had to prove three
elements of 11 V S C 547 c 2 to except transfers from avoidance Pursuant to Section 409 of
the 2005 Act new 11 V S C 547 c 2 a creditor need only prove that the transfer was in
payment of a debt incurred in the ordinary course of business and either A that the transfer was
ordinary as between the debtor and the defendant based on their historical dealings or B the
transfer was made according to ordinary business terms construed to mean in accordance with
the standards in the defendant s industry
Case Law The change to 547 c 2 will significantly reduce potential preference recoveries at
307 Vol 29 Cal Bankr J No 2 2007
In addition section 409 of the 2005 Act creates a new $5 000 safe
harbor for preference defendants in business cases A trustee or debtor in
possession may not avoid a transfer if in a case filed by a debtor whose debts are
not primarily consumer debts the aggregate value of all property that constitutes
or is affected by such transfer is less than 55 00088
Curiously this change was
added as a defense exception and not as part of plaintiffs prima facie case eg
that the transfers must exceed $5 000 to be actionable No such exception exists
under California law
The 2005 Act changed a number of provisions of the Bankruptcy Code
which will adversely affect the net recovery to unsecured creditors in a
bankruptcy liquidation as opposed to unsecured creditors recoveries in a generalassignment Some of those changes include the following
least as to claims against rank and file vendors due to the relative ease ofestablishing ordinary
business terms under current case law Judicial interpretation of the phrase ordinary business
terms beginning with the now landmark case ofIn re Tolona Pizza Products 3 F3d 1029 1033
7th Cir 1993 Tolona has made proving this element exceptionally easy Tolona concluded
that ordinary business terms refers to the range ofterms that encompasses the practices inwhich
firms similar in some general way to the creditor in question engage and that only dealings so
idiosyncratic as to fall outside that broad range should be deemed extraordinary and therefore
outside the scope ofsubsection C
The Tolona standard dealings so idiosyncratic as to fall outside the broad range and
therefore be deemed extraordinary has been further refined The Third Circuit adopted Tolona
but believed that Tolona was toorestrictive Ordinary business terms for an industry has become
malleable as between the debtor and the creditor It fuses the subjective and objective tests by
adopting a rule that holds that the more cemented as measured by its duration the pre insolvency
relationship between the debtor and the creditor the more the creditor will be allowed to vary its
credit terms from the industry norm yet remain within the safe harbor 0 547 c 2 The Third
Circuit approach which adjusts the objective test based on the length of the parties relationship
has been referred to as the sliding scale standard or sliding scale window In re Molded
Acoustical Products Inc 18 F3d 217 225 3d Cir 1994 Accord Advo System Inc v Maxway
Corp 37 F3d 1044 1050 4th Cir 1994 Some decisions now suggest that the proper
interpretation of ordinary business terms should be by reference to the industry debtor creditor
practices vis a vis troubled debtors only In fact Ganis Credit Corp vs Anderson In re Jan
Weilert RV Inc 315 F3d 1192 1198 9th Cir 2002 Weilert contains dicta to the effect
that broad range of terms encompasses the practices employed by those debtors and creditors
including terms that are ordinary for those under financial distress
Unlike the 2005 Act California preference law retains the ordinary course of business
exception in substantially the same form as federal bankruptcy law prior to the effective date of
the 2005 Act As a result preference recoveries could be greater in a general assignment than in a
comparable bankruptcy case
88 New 11 U S C 547 c 9
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Expanded Wage and Benefit Priority Under Bankruptcy Law
The 2005 Act expands the wage and benefit priorities to $10 000
per employee and lengthens the time of accrual from 90 to 180
days before the petition date89 State wage and priority benefits are
still $4 300 per employee and the time for accrual remains at 90
days before the date of the general assignment is made90
Expanded Reclamation Rights Under Federal Law The rightsof reclaiming creditors have been expanded under the 2005 Act
First the period for making a reclamation demand has been
increased from 10 to 45 days after receipt of the goods by the
debtor9I If the 45 day period expires after the petition date then
the demand must be made not later than 20 days after the
commencement of the bankruptcy case92 Even if the reclaiming
creditor fails to make a proper reclamation demand the creditor
will be entitled to an administrative expense the highest level of
priority for goods received by the debtorwithin 20 days before the
bankruptcy case is commenced 93By contrast in a general
assignment there is no administrative expense for goods shippedto the assignor prior to the date the general assignment is made As
to reclamation rights they are limited to 10 days after buyer s
receipt ofthe goods94
The 2005 Act s Addition Of a Consumer Privacy Ombudsman
Could Delay and Increase the Costs of Sale of the Debtor s
Assets If certain conditions are met the 2005 Act requires that a
consumer privacy ombudsman must be appointed at the expense of
the bankruptcy estate and its creditors and the appointment process
could also delay the sale95
No such ombudsman exists in the case
of an assignment as amatter ofCalifornia law
89 11 U S C 507 a 4 &
5 90 CAL Civ PROC CODE 1204 a
1 91 11 U S C 546
c 92
Id 93 11 U S c503bX9 94 CAL COM CODE
270295 See 11 U S C 363 b 1and
332 309 Vol 29 cat Bankr J No
22007
XI Facilitating the Sale ofa Business Through a General Assignment
Like section 363 of the Bankruptcy Code a general assignment can
facilitate the transition the assets of a financially distressed business to a buyerThe going concern value of the assets can be preserved resulting in a greaterrecovery for creditors As a general matter assignees do not operate the business
of the assignor96 Therefore these types of transactions are typically structured
prior to the making of the general assignment The assignor remains in control
and possession of its assets until the actual assignment is made
As an initial matter the assignor must first select the potential assigneeThe experience and reputation of the potential assignee is critical in several
respects First an experienced assignee will be better able to plan for and deal
with the potential and actual issues which arise along the way and therefore
maximize the potential for actually closing the transaction Second the reputationof the assignee is critical in gaining the confidence of creditors and the court in
the event an involuntary petition is filed
Once the potential assignee is selected the assignee must commence due
diligence The extent of the assignor s assets and their value is an important partof this inquiry Valuation of the assignor s tangible and intangible personalproperty and any real property interests must be performed Similarly a search
for security interests including filed financing statements filings with the
department of motor vehicles real property records copyright mortgages and
similar filings against patents and trademarks and other encumbrances should be
conducted at this initial phase If the assignor s business is in any way related to
the food production or food consumption then the assignor s trade payables must
be carefully scrutinized for possible trust claims The assignee must also assess
the degree to which the assignor s assets have been exposed to the market placeFor example has the assignor previously retained abroker or investment banker
to market the assets
96Assignees who obtain the benefit from pre assignment contract may find themselves personally
liable for the corresponding duties Under certain limited circumstances an assignee may liquidateby completing work in process and converting that inventory into accounts and cash proceedsThis of course will depend on whether the assignee can recover more than the cost of completionand provided that all wages and related expenses can be paid In rare instances an assignee may
operate to prepare the assets for sale where there is sufficient cash flow to cover all
administrative claims including employee related expenses and in the case of any doubt an
indemnification from a an individual or entity with sufficient financial resources Ifoperations are
contemplated for an extended period of time then the options of a receivership or a liquidatingchapter 11 bankruptcy ought to be considered
310 Vol 29 Cal Bankr J No 2 2007
After the initial investigation the potential assignee then determines an
appropriate strategy for selling the assets as a going concern In some cases the
potential assignee is approached by an assignor who has already identified a
buyer Whether the assignee proceeds with the buyer which is identified by the
assignor will depend on a number of factors Those factors include a the
present condition of the assignor s business and whether it can sustain continued
operations pending further marketing efforts b the degree to which the buyerhas been identified as the result of a comprehensive marketing efforts c the
degree to which of the price and terms offered by the buyer differs from the
appraised values and c whether the buyer is affiliated with the assignor or its
insiders The potential assignee will then proceed with a marketing strategyappropriate to the particular circumstances Marketing strategies could also
include apublic auction ofthe assets as agoing concern with the employment of
an auctioneer The selection of the auctioneer can in some instances be
determined through a competitive bid among auctioneers Certain buyerprotections such as a reasonable breakup fee so as to compensate the initial
offeror for its due diligence and legal costs could be considered
During the marketing phase the much of the legal work for the potentialassignee is performed including preparation of the purchase and sale documents
negotiation with secured creditors and preparation of related documents such as
subordination agreements consents and the like Typically secured creditors
holding properly perfected security interests or liens are paid from the sale
proceeds In some instances a secured creditor will consent to the transfer ofthe
assignor s assets subject to its security interest As to other third parties such as
licensors of intellectual property or lessors both as to real and personalproperty the buyer must negotiate suitable agreements if it seeks to obtain the
benefit from such agreements in connection with the sale transaction There is no
state law analogue to section 365 ofthe Bankruptcy Code
The sale process culminates with a targeted sale date which often is also
the date of the making of the general assignment As a result the assignorcontinues to operate up to the assignment date and immediately the assets are
transitioned through the sale a going concern with the buyer operating the
business the next day with little or no interruption The making of the generalassignment and the closing of the sale transaction occur almost simultaneouslyThe assignor makes the general assignment and then the assignee executes the
purchase and sale agreement as the seller While consent of general unsecured
creditors is not required in certain instances such as a sale to insiders or an entityin which insiders have an interest an assignee may want to call a meeting of
creditors and following appropriate disclosure obtain their vote prior to
concluding the sale Once the transaction closes then the assignment proceeds in
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much the same manner as any liquidation with notice to creditors the vetting of
creditor claims pursuit of avoidance power actions and liquidation of other claims
which constitute property ofthe assignment trust and the distribution of proceeds
to creditors
XII Effect OfBankruptcy Proceedings
Where a creditor or creditors are disenchanted with ageneral assignment
one of their available remedies is to file an involuntary bankruptcy petition
against the assignor A general assignIllent for the benefit ofcreditors is grounds
for an involuntary case in bankruptcy97 Generally if acreditor or creditors file
an involuntary case the bankruptcy court will enter an order for relief if
within 120 days before the date of the filing of the involuntary
petition a custodian other than a trustee receiver or agent
appointed or authorized to take charge of less than substantially all
of the property of the debtor for the purpose of enforcing a lien
against such property was appointed or took possession
The definition of custodian includes an assignee under a general
assignment for the benefit of creditors98
Even though a general assignment for the benefit of creditors is grounds
for the entry of an order for relief courts may nevertheless abstain from
exercising jurisdiction or grant a motion for dismissal under sections 305 a 707
and 1112 of the Bankruptcy Code99 Dismissal or suspension is particularly
warranted under section 305 a if another forum is available to protect the
interests of both parties or there is already a pending proceeding in a state court
eg assignment for benefit ofcreditorsnlOo
The cases note that one factor leading to abstention is the existence of a
nonfederal insolvency proceeding which has progressed so far as to make a
bankruptcy duplicative and costly The pending proceedings which have been
97 11 U S C 303 h 2
98 11 Us c 101 11 B
99 Although courts seem to use the terms abstention and dismissal interchangeably it would
appear that the tendency of an assignment for the benefit of creditors under state law would
provide a basis for abstention under 11 U S C 305 or in the alternative cause for dismissal
undereither 11 U S c 707 or 1112
100 In re Mineral Hill Corp 16 BR 687 688 Bankr D Md 1982
312 Vol 29Cal Bankr J No 2 2007
sufficient to invoke different courts abstention have been assignments for the
benefit of creditorsl01
Bankruptcy courts specifically emphasize that abstention
is most appropriate in an involuntary case102
Other courts have declined to abstain from a bankruptcy case where the
creditors could exercise Rowers under the bankruptcy code which were
unavailable under state law03
The court may also require that the petitioning creditors bear the costs of
the debtor and assignee of defending an involuntary petition where the petition is
dismissed 104
Other cases have dealt with the issue of abstention or dismissal under
section 305 of the Bankruptcy Code in the context of pre bankruptcy workouts to
which the analysis would be substantively the same as for assignments for the
benefit of creditors105
101 In re M Egan Co 24 B R 189 191 Bankr W D N Y 1982
102 See In re Pine Lake Village Apartment Co 16 BR 750 753 Bankr S D N Y 1982 see
also In re Bailey s Beauticians Supply Co 671 F 2d 1063 7th Cir 1982 For example in In re
Bailey s Beauticians Supply Co the Seventh Circuit Court ofAppeals found that the bankruptcycourt did not abuse its discretion in dismissing an involuntary petition where the debtor had
executed a general assignment for the benefit of its creditors prior to filing of the petition The
court held that the assignee s administration ofthe estate was competent and that the creditors as a
whole would profit from the continued administration of the estate by the assignee Id at 1067
See also In re Artists Outlet Inc 25 BR 231 234 Bankr D Mass 1982 court abstained from
exercising jurisdiction where assignment for benefit of creditors had occurred and no facts
suggested any prejudice to creditors retention of case would only consume estate s assets and
provide no correlative protection103 In In re John Oliver Co 24 BR 539 Bankr Mass 1982 the court accepted jurisdiction over
an involuntary bankruptcy arising from an assignment for the benefit of creditors One of the
creditors perfected its security interest in the amount of $350 000 in the debtor s equipment two
weeks after the assignment for the benefit of creditors took place The grant of the securityinterest however was pre assignment The court held that the bankruptcy court should retain
jurisdiction in that section 547 ofthe bankruptcy code provides the remedy of avoidance ofa lien
perfected within 90 days before commencement of a bankruptcy case and this remedy would be
unavailable to creditors understate law Id at 541 see also In re Kenval Mktg Corp 40 BR 445
Bankr E D Pa 1984 court declined to abstain from an involuntary bankruptcy case holdingthat the bankruptcy court was obliged to try ancillary preference actions under 11 U S C 547
based upon transfers in excess of $ 1000 000 made for the benefit ofinsiders within one
year prior to thepetition 104 In re EdJansen s Patio Inc 183 B R 643 644 Bankr M D Fla
1995 105 Cases granting abstention ordismissal under section 305 include In re Colonial Ford Inc
24B R 1014 Bankr D Utah 1982 Inre Rimpull Corp 26B R 267 Bankr W D Mo 1982 In
re 313 Vol 29 cat Bankr J No
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The bankruptcy court Iliay order the assignee to turn over the assignors
property under section 543 of the Bankruptcy Code Upon commencement of a
bankruptcy case the assignorlO6 may not make any disbursements from the
assignment estateI07 The assigriee must turnover to the trustee the property ofthe
assignor and file an accounting with the trustee or risk being surcharged after
notice and hearing by courtJOB If the assignee took possession of the assignor s
assets more than 120 days before the filing of the petition the assignee shall be
excused from complying with the above requirements unless compliance is
necessary to prevent fraud or injusticeJ09
Where the courts decline to abstain from exercising jurisdiction over a
general assignment for the benefit ofcreditors they may grant the trustee the right
to relate back to the date of the assignment for purposes of avoiding a
pre assignment preferential transferJIO
XIII Conclusion
General assignments remain a viable tool for liquidating the assets of a
business entity As a practical matter general assignments will be an available
alternative where some ofthe coercive powers of the Bankruptcy Code are not
required such as the automatic stay and the power to assume and assign
executory contracts and unexpired leases Often general assignments can be less
costly and more expeditious than would be a liquidation under Chapter 7
Audio Visual Workshop Inc 211 BR 154 BanIa SD N Y 1997 Cases declining to abstain or
dismiss under section 305 include In re Nina Merchandise Corp 5 B R 743 Bankr SD N Y
1980 In re B D IntI Discount Corp 13 B R 635 Bankr S D N Y 1981 In re Midwest
Processing Co 41 B R 90 BanIa N D 1984
106 11 U S C 543 deals with turnover ofproperty by acustodian 11 U S C 101 11 provides
that anassignee undera general assignment for the benefit ofcreditors is a custodian
107 11 V S C 543 a
108 11 U S C 543b and c
109 II U S C 543 d2 In reSundance Corp 83 B R 746 747 Bankr D Mont 1988
110 In In re Kenval Marketing Corp 69 B R 922 Bankr E D Pa 1987 the trustee filed an
action to set aside a prepetition transferunder 11 V S C 544b The trustee wasunable to bring
an action under section 547 in that the transferoccurred four months before the petition date The
court held that the trustee has the authority to exercise the avoiding powers of an assignee for the
benefit of creditors under a state statute which on its face may vest the avoidance power
exclusively in the assignee Id at 927 The filing of the bankruptcy substitutes a binding federal
proceeding for equitable distribution of a debtors assets to its creditors for a voluntary state
proceeding In superseding the state insolvency proceeding surely Congress intended to allow the
creditors the benefits ofthe superseded state proceeding Id at 930
314 Vol 29 Cal Bankr J No 2 2007
Consequently they should be considered in connection with any decision to
liquidate abusiness entity
315 Vol 29 CaI Bankr J No 2 2007