Federal Bankruptcy Code Preempts a State Statute Giving an Assignee for the Benefit of Creditors Power to Recover Preferential Transfers
 
May 16, 2005
 
Michael Weissman - Chicago

Thinklink Corp. (Thinklink) had an agreement with Lycos, Inc. (Lycos), the operator of a network of Web sites. Lycos agreed to promote Thinklink’s messaging services exclusively for two years. Thinklink defaulted on a payment due Lycos, but Lycos continued to provide links to Thinklink’s messaging services. The agreement was renegotiated shortening the exclusive period to 90 days and reducing Thinklink’s remaining payments from $17 million to $1 million but no stock.

Two months later, Thinklink made an assignment for the benefit of creditors to Sherwood Partners (Sherwood). Sherwood shut down Thinklink’s business and sued Lycos under the California assignment statute to recover the $1 million as a preferential transfer. Lycos argued that the section of the California statute authorizing recovery of preferential transfers was preempted by the federal Bankruptcy Code.

The court ruled that the section of the California statute allowing an assignee for the benefit of creditors to recover preferential transfers came too close to infringing upon the exercise of federal bankruptcy power and, therefore, was preempted by the federal Bankruptcy Code.

A strong dissenting opinion was written. The dissent cautions that the majority’s ruling “would preempt any number of state laws governing voluntary assignments for the benefit of creditors because those laws have the effect of altering the incentives of variously affected parties to initiate bankruptcy proceedings.” Indeed, the dissent said that the majority’s concerns about the California statute are not distinguishable from concerns about voluntary assignment provisions generally. But, said the dissent, it is “illogical that state laws that provide a forum for the equitable distribution of that property should be preempted by federal bankruptcy law.” The dissent also observed that “When the majority’s reasoning is carried to its logical extension, it has the effect of pushing corporations threatened with insolvency from the less stigmatic, and less costly, voluntary assignment scheme into the world of federal bankruptcy.” See, Sherwood Partners, Inc. v. Lycos, Inc., 394 F.3d 1198 (9^th Cir. 2005).

What’s the point?

Will this decision embolden certain creditors to challenge state assignment for the benefit of creditors’ statutes generally? Or, if there are challenges, will they be confined to powers purportedly granted to assignees by state law that are deemed to invade a field already occupied by federal law?

For more information, e-mail Michael L. Weissman at michael.weissman@hklaw.com or call toll free, 1-888-688-8500.