Evolution of California’s ABC Laws: Illustrating Why Change Is Needed In Other States

By: Donald L Swanson

A common malady, in many states, afflicting assignments for benefit of creditors (“ABC”) is this:

• many states have statutory ABC schemes enacted in the late 1800s that require court supervision, a bond, and other bells and whistles;
• such requirements render ABCs in those states inefficient and unworkable; and
• the result is that ABCs are rarely used in such states.

By contrast, ABCs are frequently and effectively used in other states where ABCs are governed by the common law.

The obvious conclusion is this:

• states with statutory ABC schemes enacted in the late 1800s need to, (i) repeal those statutes, and (ii) enable ABCs by enacting the Uniform Assignment for Benefit of Creditors Act (which updates and codifies the common law of ABC).

California Illustration

The State of California provides a clear illustration of the contrast between:

• non-utilization of statutory ABC schemes enacted in the late 1800s; and
• frequent and effective utilization of ABCs under the common law.  

Until 1980, California law authorized two types of ABCs:

1. ABCs under a statutory scheme enacted in the late 1800s; and
2. ABCs under the common law.

On February 13, 1979, the California Law Revision Commission issues its “Memorandum 79-8,” which reports on its study of ABCs in California.  Such Memorandum provided the basis for the Commission’s recommendation, dated September of 1979, for repealing California’s statutory ABC scheme so that ABCs in California would proceed, exclusively thereafter, under the common law.[Fn. 1]

The California legislature did what the Commission recommended.  And, now, ABCs in California proceed exclusively under the common law, as clarified by a smattering of California statutes (see this linked article).

The result is that ABCs under the common law are flourishing, today, in California – and have been flourishing in California for a very long time.  As the California Supreme Court has declared about ABCs under the common law:

• in a 1935 opinion—“Experience has shown that this practice has much to commend it”;[Fn. 2] and
• in a 1991 opinion—it is a “beneficial procedure.”[Fn. 3]

Memorandum 79-8

What follows is a summary of the analysis and findings in said Memorandum 79-8.

–Common Law ABCs

ABC is historically a common law rather than a statutory creation.   

Despite the rise of federal bankruptcy laws, ABCs continued to play a role as a liquidation device. The primary reasons for the tenacity of ABCs appear to be their simplicity, quickness, and cheapness. An ABC can be conducted efficiently and without the expense and delay of the bankruptcy machinery and bureaucracy.

The business community feels that ABCs are a useful nonjudicial means of liquidating the debtor’s assets for creditors. The ABC can only realistically function in an atmosphere of trust among debtors, creditors, and assignee. But if that atmosphere is present, the business community sees no need to go into bankruptcy, which is harmful to the debtor as well as to the creditors.

–California Law

Most states have enacted statutes that attempt to regulate ABCs. California is no exception.

Civil Code §§ 3448 – 3473 prescribe detailed requirements for assigning the debtor’s assets first to the sheriff, who calls a meeting of creditors. The creditors elect a successor assignee, and the sheriff makes a second assignment to the successor. There are detailed recording requirements, provisions for court supervision, etc. 

As a consequence of these provisions and the inflexibility, time, and cost, the “statutory” ABC has fallen into total disuse. Debtors and creditors have simply ignored the statute and have made “common law” ABCs.

The California Supreme Court has held that California’s ABC statutory scheme does not affect common law ABCs, thereby making the statute a dead letter.

–Regularly Used

The net result is that common law ABCs are made regularly in the business community in California.

–Problems & Solutions

Problems may arise in ABCs, such as:

• a debtor might make a bad faith assignment–concealing assets, fabricating debts to friends and relatives, making preferential transfers or preferences in the assignment; or
• a debtor might make a collusive assignment to an assignee who is committed not to the best interests of the creditors but rather to the assignee’s own interest or the interest of the debtor.

The only practical solution in many of the problem cases is for the disgruntled creditors to force the debtor into bankruptcy, if possible. This is not wholly satisfactory, but it recognizes that only a basically friendly assignment is satisfactory.

The common law ABC is not a creature of legislature. It is not even a creature of the courts, although a substantial number of ABC problems are presented to trial and appellate courts. ABCs have been developed by the business community to fill a gap in existing insolvency procedures.

The beneficial administration of an ABC estate is not advanced by resort to judicial supervision, and it is doubtful, from past experience, that the legislature will contribute any useful assignment legislation in the near future.

The most salutary ABC, therefore, is one where all of the parties cooperate to encourage and to aid the assignee in obtaining the maximum return at the lowest reasonable cost.

–General Philosophy

Any statutory regulation in this area should be modest. The concepts are expressed well in Professor Hanna’s study for the New York Law Revision Commission:

• state legislation regarding insolvent estates . . . must avoid a degree of regulation which will make general assignments too costly;
• state supervision of general assignments . . . may well be misguided enthusiasm for law administration;
• an attempt to compete with bankruptcy courts, even within permissible limits, would be mistaken policy;
• what the states should do is facilitate mutually voluntary adjustments and then keep hands off; and
• bankruptcy is always in the background—it can take care of debtors who are a menace to creditors.

[N.Y. L. Revision Comm’n Report 328-342 passim (1950).]

–Judicial Supervision

Because common law ABCs are private arrangements between debtor and creditors, judicial supervision is nonexistent except in the unusual case where a party seeks to invoke a court’s equitable power.

The lack of judicial involvement, and the corresponding quickness, efficiency and cheapness of the procedure, appears to be the single major advantage of the ABC.

The regulatory statutes of all jurisdictions impose a judicial framework on the ABC for dissatisfied persons to seek relief. A good example is in Arizona–the ABC is filed with the probate court which thereupon has jurisdiction to hear contested matters on motion. [Editorial Note: Arizona recently enacted the Uniform Assignment for Benefit of Creditors Act.]

But the advantages of having judicial supervision must be weighed against its cost and the possibility that the availability of a forum will tend to breed litigation.

After a weighing analysis, the Commission believes that protections for creditors should not rely on the judicial process.  Alternative protections include, (i) filing an involuntary case in bankruptcy, and (ii) seeking to hold the assignee liable for violation of the trust.

–Assignee

The key to a successful assignment is a good and competent assignee.

The debtor selects the assignee, but unless the creditors have confidence in the assignee there will be problems. How can we ensure that the assignee will be satisfactory? Here are two suggestions:

• the assignee should be a disinterested person (i.e., a person other than the spouse, a relative, agent, etc. of the debtor); and
• if creditors are concerned about the assignee, they could require the assignee to post a bond, which would provide a source of funds in case of malfeasance

The ultimate protection of the parties against maladministration by the assignee is (i) the fiduciary duties of the assignee, and (ii) the assignee’s liability for breaching such duties.

Conclusion

Very interesting!

Based upon the analysis, findings and recommendations on ABCs in California from back in 1979, states with unused ABC statutory schemes from the late 1800s should:

• revoke those statutes; and
• enact the Uniform Assignment for Benefit of Creditors Act, which updates and codifies the ABC common law.

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Footnote 1.  The Commission’s Report appears at pages 1117-35 on this linked website.

Footnote 2.  The quotation is from Brainard v. Fitzgerald, 3 Cal. 2d 157, 163, 44 P.2d 336, 339 (1935).

Footnote 3.  The quotation is from Credit Managers’ Association of Southern California v. Brubaker, 233 Cal. App. 3d 1587, 1594, 285 Cal. Rptr. 417, 421 (1991).

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