Sales “Free and Clear”: What is an “Interest”?

In re Mundy Ranch, Inc., 484 B.R. 416 (Bankr. D. N.M. 2012)

In Mundy Ranch, a corporate debtor moved to sell real estate that it owned free and clear of interests under Section 363(f) of the Bankruptcy Code.  A minority shareholder that had been seeking dissolution of the corporation and partition of its assets prior to the bankruptcy objected.

Mundy Ranch was a family-owned corporation that generated revenue primarily by developing and selling parcels of land.  It owned ~6,000 acres of land, including a 5,500 acre parcel of land that it listed in its bankruptcy schedules as having a value of $17 million, subject to secured claims of ~$2 million.

Prior to the bankruptcy, the minority shareholder (Father Mundy) became dissatisfied with the management of Mundy Ranch and filed a state court action seeking dissolution of the corporation and partition of its property.  His claims were contested, and he filed a notice of lis pendens in the county land records to provide notice of the partition claim.

After Mundy Ranch filed a voluntary chapter 11 proceeding, it negotiated a purchase agreement to sell 32.25 acres of vacant land for $146,125, payable with a down payment and 3 annual payments of $36,281.25 each, in order to raise cash to pay its operating expenses.

Father Mundy raised a series of objections to the proposed sale, including a contention that he did not have an “interest” within the meaning of Section 363(f) of the Bankruptcy Code, and thus Mundy Ranch could not sell the property free and clear of his partition claim or the lis pendens.  Alternatively, if he had an interest, then he was entitled to adequate protection.  In particular, he requested that all or his portion of the sale proceeds be sequestered.

Section 365(f) provides that a chapter 11 debtor “may sell property… free and clear of any interest in such property of an entity other than the estate,” if one of a list of conditions is met.  Thus, the threshold question was the scope of the term “interest.”

There is no definition in the Bankruptcy Code.  Some courts have narrowly construed the term to mean an in rem interest.  In other words, they require some specific interest in the property, such as a lien.  On the other hand, at least three Circuit Courts (Second, Third and Fourth) have taken a more expansive reading that includes claims if there is a “sufficient relationship” between the claim and the asset to be sold.

The Mundy Ranch court joined the broader view that “interest” in property is not limited to in rem interests, and in this case was sufficiently broad to include Father Mundy’s partition claim.  Otherwise, any shareholder that brought a dissolution and partition lawsuit could block any sale by the corporation in a subsequent chapter 11 case, since buyers would have to take a risk that the property would be subject to a later partition.

Given that the partition claim constituted an interest, the court found that the sale could proceed free and clear of that claim under Section 363(f)(4), which permits a sale free and clear if the interest is in bona fide dispute.

The court did not find that the sale was “free and clear” of the notice of lis pendens.  Its reasoning was that the notice was not an interest itself, but simply provided notice of the partition claim.  It would have no further legal effect since the sale would be sold free and clear of the partition claim.

Finally, the court considered Father Mundy’s request for adequate protection of his interest.  Section 361 indicates that adequate protection may include making a cash payment, providing additional and replacement liens, or giving the “indubitable equivalent” of the entity’s interest.  However, additional protection is not required if the interest is already adequately protected.

The court objected to providing special protection to Father Mundy, since this would effectively give him priority over other shareholders.  In addition, he did not have a present interest in the property, but only a disputed, contingent interest that depended upon whether a court would agree to grant his dissolution and partition requests.  The bankruptcy court found that this type of interest did not warrant additional adequate protection, and normal bankruptcy procedures were sufficient to protect Father Mundy’s interest against mismanagement and waste.

Consequently, the court approved the sale of the property free and clear of the partition claim, and held that the notice of lis pendens did not constitute an interest subsection to Section 363(f), but also did not cloud title to the property since it only gave notice of the partition claim.

There is a tendency to assume that a bankruptcy sale is free and clear of everything.  However, as illustrated by the case, it may be important to take a closer look at whether something is an interest and whether one of the criteria in Section 363(f) has been met.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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