Bankruptcy Practitioners Get Your Guns Haberbush and Sherwood Partners Set the Stage for a Showdown between the Code and State ABC Law

Journal Issue

Jul/Aug 2006

Column Name

Feature

Citation

ABI Journal, Vol. XXV, No. 6, p. 32, July/August 2006

Topic Tags

Practice and Procedure

Preferences

Venue/Jurisdiction

Journal HTML Content

Anything you can do, I can do better.

I can do anything Better than you!1 
</blockquote></blockquote>In a judicial exchange reminiscent of the famous
repartee between Annie Oakley and Frank Butler, the Ninth Circuit
Court of Appeals last year in Sherwood Partners2
ruled that the Bankruptcy Code preempts California's preference
statute.3 Sherwood Partners expressed concern that
if an assignee may pursue preference actions in connection with an
assignment for the benefit of creditors (ABC)—a procedurally
streamlined and less-expensive alternative to a federal bankruptcy
case—creditors may be content to forego important procedural
protections afforded by the Code while a debtor avails itself of the
more economical ABC. In May 2006 the California Court of Appeals for
the Second Appellate District responded, by its decision in

Haberbush,4 holding that the Code does not preempt
the state preference statute. The California appellate court,
rejecting the notion that it might be bound by the Ninth Circuit
decision,5 stated that it could "discern no persuasive

reason to conclude that California's 'less-stigmatic, and less-costly,

voluntary assignment scheme'—which, like the federal bankruptcy
system, serves to ensure equality of distribution of a debtor's
assets—'stands as an obstacle to the accomplishment...of the
full purposes and objectives' of the federal bankruptcy
system."6 While these opinions raise interesting
questions of federalism and comity, and the U.S. Supreme Court may
ultimately be called on to reconcile the conflicting decisions,
Haberbush appears to revive California's ABCs. ABCs: A Long

and Venerable Pedigree as Alternative An ABC is a nonjudicial
alternative to a federal bankruptcy case whereby a debtor
contractually assigns all of its assets to a third party for the benefit

of its creditors. The assignee then has a fiduciary obligation to
liquidate the debtor's assets, maximize their value, ascertain
creditor's claims, and make a fair and equitable distribution to
creditors of the liquidation proceeds. While ABCs are often associated

with the wind-down of insolvent debtors, they also provide a swift and

cost-effective means to facilitate a going-concern sale of a debtor's
assets. Because ABCs are more efficient and less expensive than
bankruptcies and provide some similar benefits, distressed companies in

California—as well as their officers and directors,
professionals, potential asset-purchasers and
creditors—routinely opt for ABCs as an alternative to
bankruptcy.7 Assignments trace their origins at least to
the early Roman Empire, when the law provided for a debtor's property
to be impounded and equitably distributed among creditors without
discharge of the debtor's underlying obligations.8 The
right to make a voluntary assignment for the benefit of creditors later
developed under common law, where it was conceived of as a personal
right inherent in the ownership of property. While substantive rights
under assignments depend upon contract, many states have adopted
legislation to govern the execution and enforcement of the trusts by
which a debtor's property may be conveyed. A long line of U.S. Supreme

Court cases, dating back to at least 1877, recognizes that such
voluntary assignments, and the state laws that regulate them, are not
inconsistent with federal bankruptcy law.9 Sherwood
Partners Doubts the Viability of ABCs in the Ninth
Circuit Although the Ninth Circuit in Sherwood Partners

asserted that "we do not...question the validity of voluntary
assignments for the benefit of creditors, which have a venerable
common-law pedigree,"10 the court found that one
particular aspect of a voluntary assignment, California's preference
statute, is preempted by Code §547. Most bankruptcy practitioners
will be readily familiar with §547, the Code's preference
statute. The California preference statute likewise grants an assignee

the exclusive right to recover certain transfers of a debtor's
property to ensure an equitable distribution of assets, and the
elements required for such a preference action and the available
defenses mirror those of §547 before its amendment by the
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
(BAPCPA).11 In finding that California's preference
statute was preempted, the court reasoned that despite its substantive

similarities to §547, one of the essential goals of federal
bankruptcy law, equality of distribution of a debtor's assets among
competing creditors, is undermined by the less-stringent procedural
protections afforded to creditors in a nonjudicial
assignment.12 The court was not persuaded that a preference

defendant could protect itself against these procedural infirmities by

filing an involuntary bankruptcy petition, since the cooperation of at
least two other creditors is typically required—creditors who
likely stand to share in preference recoveries against the defendant,
and who therefore have little incentive to protect their fellow
creditor.13 Distinguishing prior cases that had validated
preference statutes in other states, the court concluded that state
statutes giving assignees avoidance powers—at least to the
extent they exceed powers that may be exercised by individual
creditors—"trench too close upon the exercise of the
federal bankruptcy power" and must yield to the regulation of
Congress.14 Haberbush Affirms Continued Validity

of ABCs in California The California Court of Appeals' decision
in Haberbush took a broader view, recognizing that preference
statutes are an integral part of a larger, collective process designed

to fairly and equitably marshal and distribute a debtor's assets.

Haberbush expressly rejected the Sherwood Partners
majority opinion, expressing concern that its reasoning casts doubt on
the validity not only of state preference statutes but of all
voluntary assignment statutes. Adopting the reasoning of Judge
Nelson's dissent in Sherwood Partners, the court in
Haberbush discounted concerns that CCP §1800, in giving to

an assignee powers beyond those available to individual creditors and
more akin to those of a bankruptcy trustee, is inconsistent with the
Code's essential goals. The court noted that voluntary assignments, by

definition, give an assignee more power than is provided to an
individual creditor. Tying a preemption analysis to whether an
assignee's powers exceed those of an individual creditor therefore
improperly threatens the validity of all voluntary assignment statutes
in contravention of long-standing Supreme Court precedent upholding
state assignment statutes.15 As for the possible
alteration of incentives to commence a federal bankruptcy
case—particularly in favor of a less-expensive and time-consuming
alternative—the court concluded that the only pertinent question

is whether the alteration of incentives somehow interferes with

or is an obstacle to the Code's objective of equitable distribution.
In the view of the California appellate court, the Sherwood
Partners majority provided no cogent explanation of how the
assignee's avoidance powers conflict with that objective, particularly
inasmuch as California's preference statute is, by design, virtually
identical to the Code's preference statute. If the same transfer can
be avoided in both the state and federal systems, the court concluded
that the state system cannot reasonably be said to interfere with the
Code's goals. No court has yet considered the impact of BAPCPA, which

amended §547 such that the federal and state preference statutes
are no longer identical. The California legislature originally enacted

CCP §1800, which took effect simultaneously with the Bankruptcy
Reform Act of 1978, with the intention that the state statute would
mirror §547.16 Under both CCP §1800 and pre-BAPCPA

§547, a transfer is insulated from recovery under the so-called
"ordinary course of business" defense if the defendant can
establish three elements: (1) the transfer was in payment of a debt
incurred in the ordinary course of business; (2) the transfer itself
was made in the ordinary course of business; and (3) the transfer was
made according to ordinary business terms. But BAPCPA amended
§547(c)(2) so that a defendant need establish only the first and
either the second or the third elements of the ordinary-course defense.
BAPCPA also established minimum dollar thresholds for preference
actions and requires that certain small actions must be brought in the

defendant's home district. If a difference between the state and
federal statutes now exists where there was no difference before, is
CCP §1800 now preempted in its entirety?17 CCP
§1800 might be defended on the grounds that states may provide
greater protection to individual rights than federal law
affords,18 but does CCP §1800 provide greater
protections to individual rights because it affords the creditor body
greater opportunities for recovery than are now available under the
federal preference statute? Or does it provide fewer protections
because, from the perspective of the individual preference defendant,
it will receive relatively fewer procedural protections under the
state preference statute? Preemption: Who Gets the Last Word?
 Haberbush and Sherwood Partners illustrate the
uncertainty surrounding the doctrine of federal preemption and the
power of the states to make laws "implicating" particular
aspects of the federal bankruptcy law, such as its equitable
distribution scheme. Whether the Code preempts CCP §1800 raises a

federal question, and one might wonder how the California appellate
court in Haberbush could disregard the decision of the Ninth
Circuit Court of Appeals in Sherwood Partners. Citing to
several prior California cases, the Haberbush court concluded
that "decisions of the lower federal courts on federal questions
are persuasive but not binding on state courts."19

While at least one decision by the U.S. Supreme Court lends
credibility to this position,20 the Ninth Circuit has
expressed "serious doubts as to the wisdom of this
view."21 The conflict between Sherwood Partners

and Haberbush on the substantive question of preemption, as
well as the question of comity that has been raised, may ultimately be

resolved by the U.S. Supreme Court.22 Meanwhile, whether an
assignee may bring a preference action under CCP §1800 will be
influenced by the venue in which the litigation is pending, and as
discussed below, this will create opportunities for forum shopping and

legal maneuvering for bankruptcy practitioners dealing with insolvent
California companies. This split in authority should be taken into
account by professionals who are representing distressed companies
within the Ninth Circuit considering whether to execute an ABC or
commence a federal bankruptcy case, potential buyers or others dealing

with these companies, and those pursuing or defending preference
actions in the Ninth Circuit. Implications for Insolvent Companies

and Potential Acquirers Before Sherwood Partners was
decided, preference recoveries were not a significant factor in
California to be evaluated in deciding whether an ABC or a federal
bankruptcy case was the better chouce for a borrower because the
preference statutes were identical. Today, however, one should consider
the impact of Haberbush and Sherwood Partners.
Commencing a federal bankruptcy case may be the only way to be certain

that preference actions may be pursued, and in some circumstances,
this could be a determinative factor in favor of a bankruptcy case.
However, preserving preferences may be a minor consideration where a
preference analysis indicates that these actions are unlikely to
enhance creditor recoveries, either because there are few potential
preferences or because the preferences at issue involve small amounts
that are not cost-effective to pursue. An asset purchaser that intends

to do future business with the debtor's former vendors might be
concerned that ongoing preference litigation will generate unwanted
disruption and costs, and it might condition the purchase on the
debtor's agreement not to pursue preferences. Alternatively, it might
be desirable to effect a sale of the debtor's business using an ABC,
leaving the assignee or creditors with the responsibility of
evaluating and preserving preferences, perhaps even through a
subsequent chapter 7 filing. Implications for Preference Litigants

An assignee seeking to pursue preference recoveries under CCP
§1800 will find a significant advantage in bringing the
preference actions in a California court because California trial
courts, even those outside of the Second Appellate District, will be
required to follow Haberbush.23 But in many cases,
the assignee under CCP §1800, or the preference defendant itself,

will be incorporated in states other than California, creating the
prospect of diversity jurisdiction. Defendants facing preference
litigation in a California court may consider whether diversity of
citizenship exists and whether the amount in controversy is such that
they have a basis to remove the preference action to a district court
in the Ninth Circuit, where Sherwood Partners will be binding
precedent. The additional litigation costs likely to be associated
with these tactics, and the risk that preference actions may be removed
to a federal district court, should be factored into any preference
analysis that is undertaken. Conclusion For those
involved with financially distressed companies, the cost-benefit
analysis that must be undertaken when evaluating different vehicles for
selling the company as a going-concern or liquidating its assets has
become more complex. Haberbush lends authority for the
proposition that California's preference statute is not preempted by
the Code, and in so holding, the California appellate court has
endorsed the state's ABC procedure as a "less-stigmatic, and
less-costly, voluntary assignment scheme" that, like the federal
bankruptcy system, serves to ensure equality of distribution of a
debtor's assets.
<blockquote> </blockquote><hr><h3>Footnotes</h3> 1 Berlin,
Irving, "Anything You Can Do, I Can Do Better," from Annie

Get Your Gun. 2 Sherwood Partners Inc. v. Lycos Inc.,

394 F.3d 1198 (9th Cir. 2005), cert. denied, 126 S.Ct. 397 (2005).

3 See California Code of Civil Procedure (CCP) §1800.

4 Haberbush v. Charles and Dorothy Cummins Family Ltd.
Partnership, 139 Cal. App. 4th 1630 (2006). 5 See
Id. at 1635, n.16. 6 Id. at 1640. 7 See
CCP §§493 and 1800; see, also, Crabbe, Deborah A.,
"Preemption and the Bankruptcy Code: Lessons from Sherwood
Partners Inc. v. Lycos Inc.," Am. Bankr. Inst. J.

(June 2005). 8 See Pobreslo v. Boyd, 287 U.S. 518, 519
(1933) (citing Radin, Max, Handbook of Roman Law, p. 314

(1927)). 9 See, e.g., id.; Stellwagen v. Clum, 245 U.S.
605 (1918); Burlingham v. Crouse, 228 U.S. 459, 473 (1913);
Hanover National Bank v. Moyses, 186 U.S. 181, 192 (1902);
Neal v. Clark, 95 U.S. 704, 709 (1877). 10 Sherwood
Partners, 394 F.3d at 1205, n.8. 11 See Nathan, Bruce
S., "Sherwood Partners Threatens Viability of State Law
Preference," Am. Bankr. Inst. J. (May 2005) (discussing
Code §547 as it existed pre-BAPCPA, and CCP §1800). 12

Id. at 1204-05. 13 Id. at 1205. 14
Id. at 1206. 15 Haberbush, 139 Cal. App. 4th at
1635-40 (citing Sherwood Partners, 294 F.3d at 1205; Pobreslo,
287 U.S. at 526; Stellwagen, 345 U.S. at 615). 16 Angeles
Electric Company v. Superior Court, 27 Cal. App. 4th 426, 430-431
(1994). 17 Silkwood v. Kerr-McGee Corp., 464 U.S. 238, 248

(1984) (state law preempted to extent it actually conflicts with
federal law). 18 Oregon v. Hass, 420 U.S. 714, 719 (1975)
(states may provide greater protection to individual rights than
federal law affords); accord, Dibella v. Hopkins, 403 F.3d 102,

111 (2nd Cir. 2005), cert. denied, 126 S.Ct. 428 (2005). 19

Haberbush, 139 Cal. App. 4th at 1635, n.16; accord, Walker v.

Kiousis, 93 Cal. App. 4th 1432, 1441 (2001) (citing Raven v.
Deukmejian, 52 Cal. 3d 336, 352 (1990); Tully v. World Savings
& Loan Assn., 56 Cal. App. 4th 654, 663 (1997)). 20
See Arizonans for Official English v. Arizona, 520 U.S. 43, 66
n.21 (1997) (stare decisis effect of a U.S. district court's ruling is

distinctly limited because it is not binding on Arizona state courts).

21 Yniguez v. Arizona, 939 F.2d 727, 736 (9th Cir. 1991).
22 The U.S. Supreme Court previously denied a petition for writ
of certiorari in the Sherwood Partners case. But the
U.S. Supreme Court could now consider the conflict between the
California and Ninth Circuit appellate courts should the defendants in

Haberbush elect to appeal that decision to the California
Supreme Court, and ultimately, to the U.S. Supreme Court under 28 U.S.C.

§1257 (final judgments rendered by the highest court of a state
in which a decision could be had may be reviewed by the Supreme Court
where the validity of a statute of any state is drawn into question on

the ground of its being repugnant to the Constitution or laws of the
United States). 23 Gwartz v. Superior Court, 71 Cal. App.
4th 480, 481 (1999); Auto Equity Sales v. Superior Court, 57
Cal. 2d 450, 455 (1962).

Journal Authors

Mette H. Kurth

Theodore A. Cohen

Journal Date

Saturday, July 1, 2006 - 12:00

Bankruptcy Rule

2006

none