Wisconsin Lawyer: As I See It Chapter 128: A Change Will Do Us Good:

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    As I See It
    Chapter 128: A Change Will Do Us Good

    Wisconsin Statutes chapter 128 provides for an assignment for benefit of creditors as a solution for businesses facing financial trouble. It's time the Wisconsin Legislature updated the law to provide real guidance to debtors, creditors, and state court judges.

    Hon. Catherine J. Furay

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    Collectively, small businesses are an integral part of the national economy. When these businesses face financial trouble, alternatives considered by debtors and their creditors may include bankruptcy reorganization or liquidation, assignments for the benefit of creditors (an “ABC”), closure, or replevin and collection actions.

    An ABC is a transfer “of a debtor’s property to another person in trust so as to consolidate and liquidate the debtor’s assets for payment to creditors, any surplus being returned to debtor.”1 It is the functional equivalent of a Chapter 7 bankruptcy,2 but it is subject to state law rather than a uniform federal statute.

    Wisconsin Statutes chapter 128 contains the state’s ABC statute. There have been only nine minor revisions to chapter 128 since 1977.3 Chapter 128 receiverships are increasingly occurring in Wisconsin for small businesses. Secured creditors start most involuntary filings. While many states have updated their ABC statutes, Wisconsin has not.

    The failure to update chapter 128 has caused several problems. Many statutory terms remain undefined, leaving procedure to the imagination of lawyers and judges. Most cases adopt what is referred to as a “Case Management Order” designed to fill in some gaps left open by chapter 128. Some provisions are at risk of legal challenges including potential territorial and constitutional issues. There are also concerns for the protections afforded debtors and unsecured creditors. For these reasons it is time to look critically at the statute, modernize it, and provide real guidance to parties and state court judges.

    Understanding the source of chapter 128, the material differences in the types of state court receivers, and the similarities and differences between ABCs and bankruptcy creates a backdrop for understanding the limitations of and conflicts in chapter 128. Revisions to the Wisconsin ABC law are long overdue. There is a lack of clear procedure and guidance in the current statute for state court judges. It is also appropriate to examine whether an involuntary ABC is necessary or appropriate for a secured creditor to protect its rights and interests.

    Roots of the Wisconsin Statute

    Trust law is the basis for ABCs. In a voluntary case, a debtor assigns its assets to an assignee to liquidate for the benefit of creditors.4 The assignee is called a “receiver.” Under both common law and the original statutes, all assignments were voluntary acts of a debtor.

    Catherine J. Furayuscourts cate_furay wiwb gov Catherine J. Furay, U.W. 1980, is a U.S. Bankruptcy Court judge, Madison.

    Wisconsin first codified its ABC law in the late 19th century. In 1926, the U.S. Supreme Court declared state insolvency laws were superseded for all matters comprehended within the Bankruptcy Act. It then suspended ABC statutes on those subjects.5

    Acting to remedy the suspension of statutes, Wisconsin revised and updated its statute in 1929. There have been few changes to Wis. Stat. chapter 128 since then, although amendments did include a provision for an involuntary ABC.6 Unlike bankruptcy, for which three unsecured creditors are required in most cases, a single secured creditor can now use the Wisconsin ABC involuntary provisions. The involuntary provisions under the Bankruptcy Code allow a filing only by unsecured creditors. An involuntary receivership or bankruptcy was intended as a remedy for unsecured creditors who, unlike secured creditors, had no other alternative to obtain the appointment of a receiver.

    Current Wis. Stat. chapter 128 was established in 1937 and is modeled on selected provisions of the federal Bankruptcy Act of 1898, as amended through 1928.7 The Bankruptcy Code, however, replaced the Bankruptcy Act in 1978.

    Unlike other ABC states, Wisconsin has generally failed to update its ABC law to reflect current bankruptcy provisions. This creates a major statutory construction problem. To determine the meaning of Wis. Stat. chapter 128, Wisconsin courts must look to the repealed and replaced Bankruptcy Act.8 Despite this rule, secured creditors who seek the appointment of a chapter 128 receiver often ask state courts to enter case management orders and adopt procedures using current provisions or procedures of the current Bankruptcy Code, not the Bankruptcy Act. Because actual practice already mimics the Bankruptcy Code and procedures, the need for and utility of an updated statute is manifest.

    Different State Court Receivers

    Despite the existence of remedies and tools that include appointment of receivers under Wis. Stat. section 813.16, secured creditors have increasingly turned to Wis. Stat. chapter 128 for the appointment of a receiver. The reason for this trend may be the differences between the authority of each type of receiver.

    In both a replevin and a foreclosure, the creditor may seek the appointment of a receiver prejudgment.9 A receiver under Wis. Stat. chapter 813 can take possession of the property to preserve it. Such a receiver is not entitled to sell the property. Instead, the receiver protects the property pending a judgment of replevin or foreclosure and the later disposition of property under the appropriate statutes after the applicable redemption period.

    Contrast this with a receiver under Wis. Stat. chapter 128. The chapter 128 receiver typically takes control of the business and assets. The receiver almost always does so with an expectation of selling the assets before there is any judgment against the debtor and without regard to applicable redemption rights. Although the chapter 128 receiver is a fiduciary with duties owed to all creditors, the actions of the receiver are not unfettered. The receivership does not bind secured creditors unless they consent. The receiver needs the cooperation of secured creditors because most receivership assets are fully encumbered.

    Need for Reform

    Secured creditors who seek a chapter 128 receiver often do so in the context of another cause of action in a replevin or foreclosure action. Rather than pursue the appointment of a prejudgment receiver under Wis. Stat. chapter 813, the secured creditor asks for the involuntary appointment of a chapter 128 receiver.

    While there are likely many legal infirmities with such a request, the motion for such an appointment often goes unchallenged for one of two reasons: 1) the debtor typically lacks the funds to hire counsel to prosecute the objections, or 2) unsecured creditors are unlikely to receive any substantial distribution from the receivership so expending money on hiring a lawyer to challenge the proceeding is not in their financial interest. Thus, there are few reported cases relating to challenges to involuntary chapter 128 cases, underscoring the need for reform.

    Chapter 128 is short. It does not 1) outline the authority of the receiver, 2) identify the limitations on the actions of a receiver, or 3) provide any definition for the process or procedures to be applied by state courts to requests by the receiver. This is likely because the statute began as a copy of the Bankruptcy Act. This assumed secured creditors and an ABC receiver would select procedures that were or are applied in bankruptcy cases and would ask state court judges to adopt those procedures. While some procedures may be appropriate, as discussed below, others are not.

    Bankruptcy or an ABC

    Some people view an ABC as more efficient, less costly, and of shorter duration than a Chapter 7 liquidation under the Bankruptcy Code.10 They think that the value received for the assets and amounts paid to creditors could be higher in an ABC. In an ABC, the debtor alone (or the petitioning creditor if it is an involuntary case) chooses the receiver. Some people think an ABC is advantageous because, although the assignee is a fiduciary for the creditors, a particular assignee – one, for example, who is familiar with the debtor’s industry – may be more helpful to a particular debtor or creditor.

    In bankruptcy matters, the U.S. Department of Justice U.S. Trustee Program appoints a trustee. The trustee must ask the court for authority to operate the debtor’s business if that is considered desirable. The trustee proposes a sale process to the court and creditors. The trustee must determine whether there is equity for unsecured creditors in various assets. If not, the trustee will abandon estate assets, or the secured creditor may obtain relief from stay to foreclose or replevin.

    Unlike other states, Wisconsin has generally failed to update its assignment for the benefit of creditors law to reflect current bankruptcy provisions.

    In both a Chapter 7 proceeding and an ABC, if the business of the debtor continues to operate, the receiver will likely seek permission to hire other professionals to help operate the business. This is not uncommon if a buyer for the business is being sought because the value of an operating (going-concern) business is likely higher than that of a business that has closed. Unlike in an ABC, however, the Chapter 7 trustee must decide early in the case whether there is value for anyone except the secured creditors. If the only creditor who will benefit from continued operation is the secured creditor, then the bankruptcy trustee will generally refuse to operate the business and will abandon any interest in the business to the debtor and the secured creditor.

    The advantages in duration and cost that may theoretically exist in ABCs are less apparent in Wisconsin. Both the receiver and a bankruptcy trustee must generally obtain court approval to operate the business,11 sell assets,12 hire professionals, and distribute estate funds. Adverse parties may be heard.13 Trustees and receivers may hire lawyers and other professionals. Both proceedings may become protracted and costly.14 Thus, the time and money spent administering the assets may not be less in an ABC than they would be in a bankruptcy. It is by no means manifest that ABCs are faster, cheaper, or provide better results.

    The Need for Speed

    While proposed sale procedures and timing may be heard as early as the first day of hearings in a chapter 128 proceeding, consideration of those items could take more time in a bankruptcy. This is certainly a consideration if the debtor is hemorrhaging cash. On the other hand, if factors are present that would support expediting a hearing in bankruptcy, that is possible and happens often. A sale procedure motion can be decided very early in a bankruptcy if the facts support the need to do so.

    It is not uncommon for the plaintiff creditor to request that the proposed receiver hire consultants of his or her choice. Typically, at the same time the petition is filed, an emergency motion is made to authorize the receiver to borrow, approve the terms of borrowing, and grant mortgages and security interests. The lender in those transactions is almost always the plaintiff creditor and, not surprisingly, the terms requested may include an agreement that all the plaintiff’s pre-receivership documents are valid and enforceable and not subject to any defense or attack. Such terms may go so far as to release the lender from all claims of the debtor. Copies of the full agreement are not always part of the court record.

    The debtor or a trustee in bankruptcy also can hire professionals, subject to the court examining potential conflicts of interest. They can negotiate for financing subject to notice requirements and full disclosure of all terms and conditions of that financing. Sometimes the lender is the same as the pre-bankruptcy lender, and sometimes it is not. Financing matters  often are heard on a preliminary basis within the first few days after a case is filed. Claims against secured creditors, however, cannot be released without complete disclosure and the debtor’s affirmative consent. Even with that consent, the trustee and other creditors have the opportunity to preserve such claims for the benefit of unsecured creditors.

    Limitations of the Current Statute

    As the use of ABCs has expanded in Wisconsin, so too have the actions of receivers and the reach they try to exercise. This raises important questions about the interaction of federal and state insolvency laws and creditor rights provisions. Rather than exercise the right to seek a Wis. Stat. chapter 813 or chapter 81615 receiver, repossess or foreclose and sell collateral, or file an involuntary bankruptcy, secured creditors are asking state courts to appoint a receiver under Wis. Stat. chapter 128. In most such cases, the reason is to allow secured creditors to exercise what is, in effect, a sanctioned self-help remedy undertaken – at least in part – almost exclusively for the benefit of the petitioning creditor and without the constraints of redemption and other debtor protections.

    In other words, the involuntary chapter 128 proceeding can have the effect of avoiding statutory or judicially imposed debtor and creditor safeguards. This is the first reason that serious consideration to amending Wis. Stat. chapter 128 is important.

    The current approach to sales of real property in Wisconsin assignment for the benefit of creditors actions threatens fundamental rights of debtors.

    Are receivers extending their reach beyond the breaking point? Receivers now routinely argue the ABC creates a stay applicable to all creditors – both within and outside the state. They argue that any order entered by a Wisconsin court in a chapter 128 proceeding has extraterritorial effect. Receivers ask for, and state courts routinely grant, orders that sales of assets are “free and clear of all liens, claims, and encumbrances,” despite the lack of that language in Wis. Stat. chapter 128. Such orders include sales of real estate within and outside Wisconsin.

    The legitimacy of ABC procedures are seldom challenged. Even so, the U.S. Constitution imposes at least some restraint on the ability of state courts to exercise bankruptcy-like powers. It is simply a matter of time before someone with financial incentive raises these challenges. Rather than waiting for a court to strike down portions of Wis. Stat. chapter 128 as unconstitutional, lawyers should consider asking the legislature to address the issues now by balancing various interests and drafting statutory amendments that correct the laws’ infirmities.

    Some Infirmities to Be Addressed

    Territorial Limits. One infirmity of Wis. Stat. chapter 128 is its geographical limit. To be effective, the law must be able to bind all estate creditors and administer all estate assets. A state law does not have the national reach of bankruptcy law and never will. Enforcing orders and reaching creditors under the authority of a state law requires the cooperation or assistance of other states’ courts. It has been a longstanding holding that a receiver appointed by a state court “has no extraterritorial power of official action; none which the court appointing him can confer, with authority to enable him to go into a foreign jurisdiction to take possession of the debtor’s property.”16 The reasoning underlying this holding has long been adopted and acknowledged in Wisconsin.17

    Sales by Wisconsin receivers raise another potential territorial issue. Although title companies have been persuaded to treat ABC orders for sales “free and clear” on the basis they are the equivalent of bankruptcy court orders, the orders are not legally equivalent. But insuring based on such orders may pose material legal risks. Wisconsin courts do not have the national reach of federal bankruptcy law or bankruptcy courts. There is no guarantee that the order of a Wisconsin judge will affect liens, encumbrances, or mortgages that are of record in another state nor that a Wisconsin court’s order can bind an out-of-state creditor with no presence or ties to Wisconsin. Enforcing sale orders out of state can be difficult.

    U.S. Constitution Preemption. Second, the U.S. Constitution’s Contracts Clause and Supremacy Clause preempt conflicting state laws.18 The Contracts Clause prohibits states from passing any law impairing the obligation of contracts. The “obligation of contracts” includes the state enforcement of mechanisms for contracts including the rights related to security interests, mortgages, and other securities.19 Orders by state courts to sell property “free and clear” may be subject to challenge under the Contracts Clause in the appropriate set of circumstances.

    Federal Statutory Preemption. Third, the enactment of federal bankruptcy laws adds another restraint on state ABC laws by preempting conflicting state laws.20 So long as the Wisconsin ABC law does not provide for discharge of debts, it might fall outside this preemption scope, but the issue was last visited in 1933.21

    Another major preemption challenge has been raised in California although not yet in Wisconsin. The U.S. Court of Appeals for the Ninth Circuit found that California’s ABC law was preempted if it provided for the receiver’s authority to recover preferential payments to creditors.22 So far, this is the only federal preemption limitation on state ABC laws other than the discharge restriction. This rationale could, however, easily be extended to strike down ABCs more broadly.23

    Lack of Protection for Debtors’ Rights. Fourth, the current approach to sales of real property in Wisconsin ABCs threatens fundamental rights of debtors. Governed by state law, “[t]he right of redemption is an inherent and essential characteristic of every mortgage.”24 The right of redemption is a right “to redeem the property by repaying the debt at any time until the foreclosure has been completed.”25

    Historically, the right to redeem has been a rule that cannot be impaired, cut off, or surrendered. “Any agreement which does so is void and unenforceable as against public policy,”26 and “[a]ny agreement in or created contemporaneously with a mortgage that impairs the mortgagor’s right … [to redeem] is ineffective.”27

    Wisconsin has codified three statutory rights of redemption.28 Read together, these statutes evidence Wisconsin’s efforts to preserve a mortgagor’s right of redemption.

    As explained by the Wisconsin Supreme Court in Barr, without a statutory provision to the contrary, “any contract by which the mortgagor sells or conveys his interest to the mortgagee is viewed suspiciously … in a court of equity.”29 An ABC that enables a creditor to have a receiver appointed who can then sell the debtor’s real estate “free and clear of liens, claims, and encumbrances,” thus enabling the creditor to realize sale proceeds while circumventing any right of redemption, is likely subject to challenge under Barr and applicable statutes.

    Limiting Chapter 128 to Voluntary Cases or Unsecured Creditor Petitions

    If the only beneficiary of administering assets is a secured creditor, a bankruptcy trustee files a report that there are no assets to be administered. This leads to a closure of the bankruptcy case, and secured creditors are left to their in rem remedies of foreclosure or repossession of their collateral. A trustee will administer assets only when there will be a benefit to the bankruptcy estate and thus to unsecured creditors. This markedly differs from current chapter 128 practice in which a receiver may administer assets mainly, if not exclusively, for the benefit of the secured creditor.

    No state court receiver under Wis. Stat. chapter 813 has the right to take possession of assets that are not collateral of the petitioning secured creditor in that case. This saves time and money for the court and all other parties in interest. It also makes clear that any receiver of collateral is acting solely in the interests of the petitioning secured creditor. Because a chapter 813 receiver takes possession only of the specific secured creditor’s collateral, that receiver has no authority to release claims the debtor or other creditors may have against the secured creditor. Thus, there is no need to consider whether – as often occurs in an involuntary chapter 128 receivership – a release of those claims by a receiver is in the best interests of all creditors or whether it is really only in the best interest of the petitioning secured creditor.

    Remedies are available for secured creditors without the need to resort to an involuntary chapter 128 proceeding. Secured creditors can repossess personal property or foreclose on real property. A “selfish receiver” can be appointed under Wis. Stat. chapter 813 to protect and preserve that secured creditor’s collateral. There is no justification for an involuntary chapter 128 receiver to be appointed to enforce any of those rights or remedies.

    The bankruptcy procedures ensure due process to all parties in interest. They provide specific notice requirements and balance the interests of the debtor, any primary secured creditor, and all other creditors. All parties’ rights are protected.30 Copies of proposed financing agreements are part of the public record. By using a trustee appointed by the U.S. Trustee Program in a Chapter 7 proceeding, all parties are guaranteed of the trustee’s neutrality, independence, and fiduciary capacity to the debtor, creditors, and all parties in interest. This neutrality can be uncertain when the receiver in a chapter 128 proceeding is hand-picked by either the debtor or its primary secured creditor.

    A final consideration is the quality of administration of an insolvency case by the court. State court judges regularly handle civil cases. State courts are courts of general jurisdiction, handling various types of cases including criminal matters, family matters, and civil disputes.

    A Wis. Stat. chapter 128 case filed may represent a case of first impression for a state court judge. The number of chapter 128 proceedings filed in Wisconsin in total does not approach the volume of bankruptcy cases filed each year. As courts of special jurisdiction, bankruptcy courts have far more experience handling all the issues of insolvent debtors, including liquidating assets and safeguarding the balance of the interests of all parties in the proceeding.

    These factors all support the need for a revision to Wis. Stat. chapter 128.

    Conclusion

    Wisconsin Statutes chapter 128 provides a tool to address orderly liquidation of assets of an insolvent debtor. It creates a distribution scheme that might equitably distribute any proceeds remaining after paying the secured creditor and receiver. The current statute is, however, lacking in detailed guidance for courts. This results in chapter 128 practice that looks more like proceedings under the current Bankruptcy Code (rather than the Act) and in exercises of jurisdiction well beyond what the statutes allow. Chapter 128 includes outdated provisions based on the Bankruptcy Act replaced in 1978 but practice has evolved to try to fill the inadequacies. Chapter 128 contains infirmities in balancing the rights and interests of all parties. Revisions are long overdue.

    Meet Our Contributors

    What has been your greatest professional accomplishment to date?

    Catherine J. FurayBeing appointed a United States Bankruptcy Court judge is, in my estimation, the greatest honor and professional accomplishment I could achieve. It gives me the privilege of serving the public and profession on a broader scale than was possible as an attorney.

    More than 4,000 cases were filed in the Western District of Wisconsin Bankruptcy Court in 2018, affecting not only the debtors but scores of creditors. Having a debtor thank me when I decided the case adversely to her confirmed that, at least sometimes, I am able to explain the reasons for the decision to the parties and not just the lawyers or for posterity. That is a great accomplishment.

    The opportunity to have term law clerks and to teach is rewarding because it is a way to help shape at least a few of our future or new lawyers’ skills and their perspective on the practice of law. If I can follow in the footsteps of other judges, elevating the practice and encouraging civility in the profession, I will have achieved another goal.

    Perhaps my greatest accomplishment – although not professional – is to have been lucky enough to find a husband who puts up with me and has been my best friend for decades.

    uscourts cate_furay wiwb gov Catherine J. Furay, U.S. Bankruptcy Court, Madison.

    Become a contributor! Are you working on an interesting case? Have a practice tip to share? There are several ways to contribute to Wisconsin Lawyer. To discuss a topic idea, contact Managing Editor Karlé Lester at (800) 444-9404, ext. 6127, or email org klester wisbar wisbar klester org. Check out our writing and submission guidelines.

    Endnotes

    1 Black’s Law Dictionary (10th ed. 2014).

    2 11 U.S.C. §§ 701-727.

    3 The most recent amendments were in 1999. Bills were simultaneously introduced in 2018 that would have addressed some issues with involuntary use of Wis. Stat. chapter 128 but those bills failed to pass. See 2017 Wis. S.B. 862; 2017 Wis. A.B. 1049.

    4 Melvin G. Shimm, The Impact of State Law on Bankruptcy, 1971 Duke L.J. 879, 888 (1971); see Cribb v. Hibbard, Spencer, Bartlett & Co., 77 Wis. 199, 46 N.W. 168 (1890).

    5 In re Tarnowski, 191 Wis. 279, 210 N.W. 836 (1926); Hazelwood v. Olinger Bldg. Dep’t Stores, 205 Wis. 85, 236 N.W. 591 (1931).

    6 Wis. Stat. section 128.08 provides that a court may sequester a debtor’s property and appoint a receiver if an execution was returned unsatisfied or a corporation is dissolved, insolvent, or in danger of insolvency.

    7 Wis. Stat. §§ 128.19-29 (1925).

    8 Capitol Indem. Corp. v. Hoppe (In re Bossell, Van Vechten & Chapman), 30 Wis. 2d 20, 26, 139 N.W.2d 639 (1966).

    9 In a replevin, the creditor seeks to have property turned over prejudgment in compliance with Wis. Stat. section 810.02. Most mortgages also contain provisions for the appointment of a receiver. The same basis in a replevin or foreclosure – an interest in the property and possible loss or impairment of the property or its value – entitles the creditor to ask for appointment of a receiver under Wis. Stat. section 813.16.

    10 11 U.S.C. §§ 701-727.

    11 11 U.S.C. § 721.

    12 11 U.S.C. § 363.

    13 Fed. R. Bankr. P. 7001.

    14 As an example, a review of open chapter 128 cases of three of the common Wisconsin receivers indicates open cases from as long ago as 2013. The open cases for those receivers by year are the following: 2013 – 1; 2014 – 1; 2015 – 2; 2016 – 1; 2017 – 3; and 2018 – 9. By comparison, there are 10 open Chapter 7 cases in the Western District of Wisconsin dating from 2013. Eight are individual consumer cases. Seven of those cases were closed but have been reopened because additional assets have been discovered. Two were appealed.

    15 A receiver may be appointed under Wis. Stat. section 816.04 after a judgment has been entered.

    16 Booth v. Clark, 58 U.S. 322, 338 (1855); Hale v. Allinson, 188 U.S. 56, 68 (1903).

    17 Filkins v. Nunnemacher, 81 Wis. 91, 93, 51 N.W. 79 (1892).

    18 U.S. Const. art. I, § 21, art. VI, cl. 2.

    19 David A. Skeel Jr., Rethinking the Line Between Corporate Law and Corporate Bankruptcy, 72 Tex. L. Rev. 471, 546-47 (1994); see also International Shoe Co. v. Pinkus, 278 U.S. 261, 265 (1929).

    20 International Shoe, 278 U.S. at 265.

    21 Johnson v. Star, 287 U.S. 527 (1933); Pobreslo v. Joseph M. Boyd Co., 287 U.S. 518, 525-26 (1933).

    22 Sherwood Partners Inc. v. Lycos Inc. 394 F.3d 1198, 1206 (9th Cir. 2005).

    23 Id. at 1206-08.

    24 Barr v. Granahan, 255 Wis. 192, 195, 38 N.W.2d 705 (1949); see also Farm Credit Bank of St. Paul v. Lord, 162 Wis. 2d 226, 236, 470 N.W.2d 265 (1991).

    25 Marshall E. Tracht, Renegotiation and Secured Credit: Explaining the Equity of Redemption, 52 Vand. L. Rev. 599, 606 (1999).

    26 Humble Oil & Refining Co. v. Doerr, 303 A.2d 898, 905 (N.J. Super. 1973).

    27 Restatement (Third) of Property (Mortgages) § 3.1(b) (1997).

    28 Wis. Stat. §§ 846.103, 846.13, 846.30.

    29 Barr, 255 Wis. at 196.

    30 Tulsa Prof’l Collection Servs. Inc. v. Pope, 485 U.S. 478, 484 (1988).




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