Delaware Bankruptcy Court Rules State Property Law Inapplicable in Preference Action
Written by David B. Wheeler
Moore & Van Allen, PLLC

Judge Peter Walsh of Delaware issued a controversial decision setting aside the application of a state construction lien trust act in Hechinger Investment Company of Delaware, Inc. v. MGH Home Improvement, Inc. (In re Hechinger Investment Company of Delaware, Inc.)¹ . In Hechinger the debtor brought a preference action against MGH arising out of payments made to MGH as its subcontractor. MGH asserted it was entitled to protection as a recipient of trust funds under the Michigan Construction Lien Act and, therefore, beyond the reach of Bankruptcy Code §547.

Citing the Supreme Court case Butner v. United States² and the applicability of state property law in the bankruptcy context, MGH sought dismissal of the Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). The Court first noted – and this may serve as a basis for distinguishing this case – that under the applicable standard for consideration of a 12(b)(6) Motion to Dismiss, a court is required to “accept as true all the allegations in the complaint and all reasonable inferences that can be drawn therefrom and view them in the light most favorable to the plaintiff.” ³ The Court then noted that the Estate had properly plead the elements of a preference⁴ and the Court was therefore compelled to accept the matters plead in the light most favorable to the Estate.

Once it concluded the Estate had properly plead a cause of action under Bankruptcy Code §547, the Court was then called upon to determine the applicability of State Law (Michigan) as a defense to the Preference Complaint. MGH asserted the applicability of property rights under state law; in this case, Michigan’s Construction Lien Act. The Estate on the other hand argued that to the extent state law conflicted with the Bankruptcy Code, its applicability would be negated by the Supremacy Clause of the U.S. Constitution.

Preemption of state law under the Supremacy Clause may occur under three circumstances. First, Congress may expressly preempt state law.⁵ Second, preemption may be inferred where the scheme of regulation is sufficiently comprehensive to make reasonable the inference that Congress left no room for supplementary state regulation.⁶ Third, federal preemption may take place to the extent state law actually represents a conflict with federal law, either due to inconsistency or because state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.⁷ Reasoning that the application of the Michigan law would potentially preclude the Estate’s recovery of an otherwise preferential transfer under bankruptcy law and therefore serve as an obstacle to the accomplishment and execution of the purposes of the Bankruptcy Code, the Court denied the MGH Motion to Dismiss.⁸

Again, the impact of this decision must be measured against the applicable standard of review for a motion to dismiss, versus that arising for a full hearing on the merits. Keep in mind also that the great majority of opinions uphold the applicability of state property law in issues related to whether a property interest belongs to the debtor/estate. Nonetheless, the import of this decision may not be dismissed as a mere unpublished opinion or one issued by a visiting judge. There is no question this ruling will have an impact on the incredible volume of preference claim negotiations and actions pending in Delaware.

¹ 288 B.R. 398 (Bankr. D Del. 2003) [Back to text]
² 440 U.S. 48, 59 L.Ed. 2d 136 99 S. Ct. 914 (1979) [Back to text]
³ 288 B.R. @ 400 [Back to text]
⁴ Id @ 401 [Back to text]
⁵ Id [Back to text]
⁶ Id [Back to text]
⁷ Id [Back to text]
⁸ Id @ 402 [Back to text]

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