One Thing Wrong With ABC Laws: § 543(d)(2) Of The Bankruptcy Code (Global Safety Labs)

By: Donald L Swanson

“[T]he bankruptcy court— . . . (2) shall excuse compliance . . . if . . . an assignee for the benefit of the debtor’s creditors . . . was appointed or took possession more than 120 days before the date of the filing of the petition, unless . . . necessary to prevent fraud or injustice.”

11 U.S.C. § 543(d)(2) (emphasis added).[Fn. 1]

Interrelationships between the Bankruptcy Code and state laws on assignments for benefit of creditors (“ABC Laws”) is undeveloped, filled with ambiguity and fraught with uncertainty.

So, why does the Bankruptcy Code mandate a “120 days” deference to proceedings under ABC Laws?  And why is such deference subject only to the highly-exacting “fraud or injustice” exception?

You’d assume, from § 543(d)(2)’s mandated deference, that ABC Laws require high levels of disclosure in the earliest portions of an ABC Laws case—similar to what’s required in schedules and statements of financial affairs in bankruptcy cases.   

But such an assumption is far from reality.

Reality

The reality of ABC Laws warrants no such deference.

A recent opinion from Delaware’s Chancery Court [fn. 2] explains reality in Delaware like this:

• Global Safety Labs, Inc., is a dissolved Delaware corporation that is, (i) winding up its affairs, and (ii) petitioning the the court for the amount of a bond it must post as security for claims;
• Global’s Petition is a bare-bones four-page document consisting of conclusory averments;
• Global’s Petition is not an outlier—it’s like petitions the court sees regularly in various types of cases, including those under Delaware’s ABC Law; and
• Many of such proceedings are handled ex parte, without any interested party providing a different perspective or asking probing questions.

In other states, by contrast, ABC Law reality is this: there is no court involvement, whatsoever.

Questions

So, again, why would the Bankruptcy Code mandate deference to ABC Laws after only 120 days?  And why would the only deference exception be a high and probably-unattainable standard?  

Answer

The answer is this:

• there should be no such 120 days deadline at all.

Congress should excise § 543(d)(2) from the Bankruptcy Code, leaving this § 543(d)(1) language [see fn. 1] as the sole-applicable standard:

• “the bankruptcy court . . . may excuse compliance . . . if the interests of creditors . . . would be better served by permitting a custodian to continue in possession, custody, or control of such property” (emphasis added).

The § 543(d)(1) standard properly places discretion on the post-petition role of an ABC Law assignee where it should lie: with bankruptcy judges.

Mandating the assignee’s role as nearly absolute after 120 days makes no sense.

[Historical Note: The 120 days rule existed, from the beginning, in both the Federal Bankruptcy Act of 1867 (repealed in 1878) and the Federal Bankruptcy Act of 1898 as either a four months or a six months rule. The theory, back then, is that “(t)ransactions anterior to these periods are presumed to have been acquiesced in by the creditors” (Mayer v. Hellman, 91 U.S. 496 501 (1875)). Initially, the Bankruptcy Code excluded the 120 days rule, but Congress added it back in by including § 543(d)(2) in a 1984 amendment.]

Problems

The 120 days mandated deference, in §543(d)(2), to assignees under ABC Laws is problematic on several fronts:

• It subordinates, automatically, the Bankruptcy Code’s full-disclosure policy to ABC Laws’ informality;
• It fails to recognize that uninformed creditors often have no way to know, within 120 days, whether they should be pursuing an involuntary bankruptcy—or not;
• It encourages debtors and their insiders to pursue clandestine strategies—such strategies just-might succeed, given the informalities of ABC Laws and § 543(d)(2)’s 120 days mandate; and
• It forces state courts to require bankruptcy-level disclosures at the earliest stages of proceedings, even when not required by ABC Laws.  

Solution

As noted above, Congress should repeal § 543(d)(2), with its mandated deference, leaving discretion at all times with bankruptcy courts (under § 542(d)(1)) on the post-petition role of assignees under ABC Laws.

Conclusion

Bankruptcy Code’s 120 days mandated deference to assignees under ABC Laws creates problems, on multiple levels, and should be repealed. 

Such a repeal would be in the best interests of both, (i) the bankruptcy system, and (ii) ABC Laws everywhere.

——————

Footnote 1.  11 U.S.C. § 543(d) says:

“(d) After notice and hearing, the bankruptcy court—(1) may excuse compliance with subsection (a), (b), or (c) of this section if the interests of creditors and, if the debtor is not insolvent, of equity security holders would be better served by permitting a custodian to continue in possession, custody, or control of such property, and (2) shall excuse compliance with subsections (a) and (b)(1) of this section if the custodian is an assignee for the benefit of the debtor’s creditors that was appointed or took possession more than 120 days before the date of the filing of the petition, unless compliance with such subsections is necessary to prevent fraud or injustice.”

Footnote 2.  The opinion is In the Matter of Global Safety Labs, Inc., Case No. 2022-0309, Delaware’s Court of Chancery (issued May 12, 2022).

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