California State Courts Continue to Validate Assignments for the Benefit of Creditors

In 2005, in a blow to assignments for the benefit of creditors ("ABC") in California, the Ninth Circuit in Sherwood Partners Inc. v. Lycos ("Sherwood I"), 394 F.3d 1198 (9th Cir. 2005), held that an assignee in an ABC cannot bring preference actions under California law because the Bankruptcy Code preempts state preference law. Since Sherwood I, two California state courts of appeal have reached the opposite conclusion and held that assignees can bring preference actions under California law because the Bankruptcy Code does not preempt state preference law. Credit Managers Assn of California v. Countrywide Home Loans, Inc., 144 Cal. App. 4th 590 (2006), review denied; Haberbush v. Cummins Family Ltd. Partnership, 138 Cal. App. 4th 1630 (2006). While Sherwood I leaves uncertain an assignees ability to bring preference actions under state law, California state courts have resoundingly shown approval for ABCs in California in rejecting Sherwood I.

In a recent case also involving Sherwood Partners as an assignee, Sherwood Partners v. EOP Marina Business Center ("Sherwood II"), which was decided July 27, 2007 by the California court of appeal, a California state court once again has shown support for ABCs. In Sherwood II, a real property tenant made an ABC to Sherwood ("Assignee") after being served with a 3-day notice by the landlord for failing to pay rent. The Assignee sued the tenants landlord to recover the tenants security deposit. The Assignee lost.

Under the lease, the successful party in litigation between the landlord and the tenant was entitled to recover attorneys fees from the losing party. The trial court concluded that both the tenant and the Assignee were liable for the landlords attorneys fees under the lease since the Assignee did not succeed in suing for return of the security deposit.

Concluding that the Assignee as part of the ABC did not assume the tenants liabilities under the lease, the appellate court held that the Assignee was not liable for the landlords attorneys fees. "The procedure of an assignment for the benefit of creditors would be eviscerated if an assignee were required to assume the underlying liabilities of the assignors insolvent business."

In considering an ABC as an alternative insolvency proceeding to Chapter 11, this case is good for assignees, insolvent companies, and potential purchasers. Together with Credit Managers and Haberbush, Sherwood II gives assignees comfort in accepting ABCs, which in many situations can be the most efficient and economical way to effectuate a sale of a distressed company.

Landlords and other non-assignor parties with attorneys fees provisions in their contracts may feel differently. After all, the Assignee sued the landlord, lost the lawsuit, and was not obligated to pay the landlords attorneys fees. All hope for the landlord, however, might not be lost. The landlord still would have a claim against the ABC estate (as opposed to the Assignee personally) for the attorneys fees. In Sherwood II, the Assignee did not appeal the trial courts award of attorneys fees to the landlord against the assignor. While that claim typically would be worth only cents on the dollar if treated as an unsecured claim, the landlord might have an argument that the claim is entitled to administrative priority, which could make the claim more valuable. Sherwood II did not address the priority of the landlords claim for attorneys fees against the ABC estate.  In any case, in Sherwood II, the California state courts have again shown approval for ABCs in California.

By: Theodore A. Cohen

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