California Code of Civil Procedure allows an assignee under a general assignment for the benefit of creditors to recover what under the Bankruptcy Code would be called preferential transfers. However, the U.S. Court of Appeals for the Ninth Circuit called the validity of this statute into question (at least when it arises in federal court) when, in a 2-1 decision issued in early 2005 in Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198 (9th Cir. 2005), it held that Section 1800 is preempted by the federal Bankruptcy Code.
On May 31, 2006, the California Court of Appeal for the Second Appellate District took the first step in reviving the allegedly preempted statute (at least in state court), when it issued its opinion in Haberbush v. Charles and Dorothy Cummins Family Ltd. Partnership, Case No. B175947. Noting that "[d]ecisions of the lower federal courts on federal questions are persuasive but not binding on state courts," the California Court in Haberbush took advantage of its freedom by disagreeing with the Ninth Circuit, and holding that Section 1800 is not preempted.
The central issue in both cases was the doctrine of field preemption, which generally means that where Congress has not expressly displaced state regulation in a certain area, that state regulation may nevertheless be preempted where it "stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." The Congressional purpose allegedly encroached upon by Section 1800 is the Bankruptcy Code's goal of equitable distribution of a debtor's limited assets among its many creditors, where those assets may be insufficient to satisfy all creditors' claims in full.
After reviewing the ways in which the Bankruptcy Code seeks to accomplish an equitable distribution, and the ways in which the Sherwood Partners Court found that Section 1800 interfered with that goal, the Court in Haberbush found that it was "impossible to conclude that Code of Civil Procedure section 1800 is inconsistent with 'the essential goals and purposes of federal bankruptcy law. . . .'" (Ironic, given that two out of three judges on the Ninth Circuit Court of Appeals had just done so in Sherwood Partners.)
Responding to the Sherwood Partners decision on many of the same grounds cited in that decision's dissenting opinion, the Court in Haberbush first noted, as the Ninth Circuit had, that Congress intended for state laws governing voluntary assignments for the benefit of creditors (which sport a "venerable common-law pedigree") to coexist with the Bankruptcy Code. Second, the Court in Haberbush stated that where such state laws are permitted to coexist, the fact that they implicate the Bankruptcy Code's goal of equitable distribution is not sufficient to conclude that the state law "stands as an obstacle" to that goal. That conclusion was especially confounding to the Haberbush Court, which raised the same question asked by the dissenting judge in Sherwood Partners: How does the Section 1800 assignment law, which is virtually identical to the Bankruptcy Code's preferential transfer statute, stand as an obstacle to the goal of equitable distribution?
Where the statutes are virtually identical, it would seem that the Ninth Circuit's problem with Section 1800 is not what it does (equitably distribute a debtor's limited assets), but who does it (a debtor's hand-picked assignee, as opposed to a chapter 7 trustee appointed by the Office of the United States Trustee and subject to the disinterestedness and supervisory requirements imposed by the Bankruptcy Code).
The question now will be whether the U.S. Supreme Court steps in to resolve this turf war between the federal and state courts.
For more information or if you have a question about this Alert, please contact Rudolph J. Di Massa, Jr. of our Business Reorganization and Financial Restructuring Practice Group or the attorney in the firm with whom you are regularly in contact.
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