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

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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

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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

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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