The Receivership Alternative - A Response

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Jul/Aug 2001

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In the February 2001 issue of the ABI Journal, Paul Lucey discussed "The
Receivership Alternative" to a chapter 11. Unfortunately, Mr. Lucey's reference to
voluntary receiverships as state law processes initiated by an assignment for the benefit
of creditors is not giving the assignment alternative its proper due.

To begin with, under most state statutes and the common-law governing assignments,
a general assignment is not a receivership, as the assignee is a fiduciary to all
creditors, unlike receivers, whose interests are generally aligned with the creditor
who sought the receiver's appointment. Second, the receiver is chosen by the creditor,
subject to court appointment and/or approval. Assignees are usually selected by the
debtor and in most instances must be a disinterested party not otherwise affiliated with
the debtor or a creditor.<a href="#1" name="1a">1</a>

Mr. Lucey also suggests that general assignments are then subject to state court
supervision and that state law may enjoin creditor collection efforts. This is not
always the case. In those states where general assignments are not statutory and are
not court supervised,<a href="#2" name="2a">2</a> enjoining creditors from collection efforts can only be done by
the filing of a bankruptcy and triggering the automatic stay provisions of §362.<a href="#3" name="3a">3</a>
Rather, application of state law will generally result in creditors being unsuccessful
in their collection efforts. Section 9-301 of the Uniform Commercial Code, as
enacted by each state, gives an assignee the rights of a lien creditor.<a href="#4" name="4a">4</a> This
enables the assignee to assert the rights a lien creditor would have as of the date
of the assignment. Therefore, a creditor whose claim was unsecured on the date the
debtor made the assignment would remain an unsecured creditor, and any judgment the
creditor obtained post-assignment would only serve to liquidate (fix the amount) of
the claim. The post-assignment judgment would not give the claim any greater priority
over the other claims of unsecured creditors.

Mr. Lucey suggests the "receiver" will operate the business prior to a sale. An
assignee will operate a business after the making of the assignment only if the assignee
can be assured that his operation will not cause a loss for the estate and, indeed,
if the operation is necessary to preserve value or will likely add value. If this
cannot be assured, or the assignee does not receive an indemnification from creditors,
the business will be closed and the assets then sold. Anything less may result in the
assignee being subject to attack, either in state court or in any subsequent bankruptcy
proceeding, as having breached its fiduciary duty to creditors. Similarly, allowing the
management team of the debtor to "remain in place" is a decision each assignee makes,
depending on the facts of the matter. Management that brought the business to failure
may not be the best to maintain the business; some key personnel may of course be
necessary to provide continuity to the assignee to help maximize the recovery from the
assets.

Mr. Lucey mixes the rights of a receiver and an assignee throughout his article;
this description may not pertain to many state law assignments. Under most state laws,
creditors can assert their security interests in collateral over the rights of all other
creditors, including an assignee. Experienced assignees will generally obtain the secured
creditor's consent to the use of the collateral, and the right to liquidate the
collateral before they accept the general assignment. That negotiation usually includes
the obligation of the assignee to confirm the validity of the secured creditor's
security interest once the assignment is accepted.

The points raised by Mr. Lucey as "disadvantages" are generally on point. State
law generally will not enable an assignee to avoid ipso facto clauses, and counsel
advising debtors with executory contracts with value (i.e., under-market leases of
real property) need to consider this issue before the decision is made to make the
general assignment. In assignments of technology-based companies, the limitations (even
in chapter 11) of relating to the debtor's ability to assign license agreements must
be considered. Reorganization is not generally effected through general assignments or
receiverships. General assignments are a method of liquidating assets and are generally
more efficient and yield a greater recovery than bankruptcy proceedings, but both
options must be considered in light of all the facts before an assignment is made.

The issues related to the filing of an involuntary bankruptcy case against a debtor
that made a general assignment are somewhat complex. While Bankruptcy Code §305
allows the court to dismiss or abstain from asserting jurisdiction over the debtor,
as Mr. Lucey points out, a key issue will be the potential recovery of preferences
in a bankruptcy proceeding where state law does not provide a means to avoid and
recover the preferential transfers. California, for example, has a state-law
preference statute.<a href="#5" name="5a">5</a> However, many states do not.<a href="#6" name="6a">6</a> Therefore, in those states where
there is no such state-law power, the assignee should immediately review the debtor's
payments to trade and insider creditors to determine what, if any, payments may
constitute a recoverable preference. If the amounts in question are considerable, the
assignee may be obligated to file (or have creditors file) a bankruptcy proceeding
to preserve those claims for creditors; allowing the state law process to proceed is
not in the best interests of creditors and could also be considered a breach of the
assignee's fiduciary duty to creditors.

In summary, bankruptcy lawyers, whether debtor's or creditors' counsel, should
understand the differences between receiverships, general assignments and bankruptcy
proceedings. Each has its benefits and its deficiencies, and a failure to understand
those nuances can result in significant losses for your clients.

Author's Note: The ABI publication, General Assignments for the Benefit of
Creditors: A Practical Guide, is available by calling ABI at (703)
739-0800, or e-mailing <a href="mailto:info@abiworld.org">info@abiworld.org</a>.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> This is not intended to minimize the importance of creditors having input or some form of veto over the choice of the assignee,
but the debtor, or sometimes a senior secured creditor, will have the final choice as to the assignee. In those states where assignments
are court-supervised, the court has the authority to confirm or approve the selected assignee. <a href="#1a">Return to article</a>

<a name="2">2</a> For example, neither California nor Maine require the filing of the general assignment with the state court, nor does the making
of the assignment "enjoin" creditor collection efforts against the assignor entity. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §362</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> In the revised statutes due to become effective July 1, 2001, this right will be found in §9-309. <a href="#4a">Return to article</a>

<a name="5">5</a> See California Code of Civil Procedure §1800. <a href="#5a">Return to article</a>

<a name="6">6</a> Many state versions of the UFTA contain an "insider preference" provision. See 14 Me.Rev.Stat.Am. §3576(2). <a href="#6a">Return to article</a>

Journal Authors

Geoffrey L. Berman

Robert J. Keach

Journal Date

Sunday, July 1, 2001 - 12:00

Bankruptcy Rule

2001