Sale Contract for Mineral Interests: Speak Early and Often, Or Forever Hold Your Peace

Davis v. Dunmore Properties, Inc. (In re Davis), 503 B.R. 609 (Bankr. M.D. Pa. 2013) –

After confirmation of their chapter 13 plan, two chapter 13 debtors filed motions for summary judgment seeking to reject a contract for sale of their mineral rights and disallowance of the buyer’s proof of claim.  The buyer argued that the agreement was not an executory contract, and so could not be rejected.  Alternatively, if the agreement was considered an executory contract, the buyer argued that it was entitled to damages as provided in Section 365(i) of the Bankruptcy Code.

The buyer (Dunmore) entered into a contract with the debtors to (1) purchase a 33% ownership interest in mineral rights relating to property owned by the debtors and (2) obtain a right of first refusal as to the remaining 67% interest.  Dunmore paid a $10,000 deposit.  The sale did not close by the contract deadline,  so Dunmore sued in state court for specific performance or monetary damages of ~$595,000 and recorded a lis pendens.  Subsequently the debtors filed a chapter 13 bankruptcy.

The debtors filed several plans.  The final plan contained provisions relevant to Dunmore’s
claims as follows:

  • The plan included a proposed sale of the debtors’ real property for $1.1 million, with the proceeds to be applied to (1) real estate taxes, (2) satisfaction of mortgage claims, and then (3) to all creditors with allowed claims.  There was no provision for paying any portion of the proceeds to Dunmore in connection with its claim relating to the mineral rights.
  • The section of the plan dealing with executory contracts listed the Dunmore agreement as “Executory contract for sale of mineral rights, subject to consent of AgChoice per mortgage dated 12/7/2007 and prior gas lease to Oil and Gas.”  This item was identified as “reject.”
  • In the lien avoidance section of the plan, Dunmore was listed as a creditor with a “Judicial lien by virtue of Lis Pendens.”
  • The section of “other” plan provisions included statements that the debtors rejected the executory contract with Dunmore and that they stripped the judicial lien of Dunmore.

Dunmore objected to the second amended plan, asserting (1) the debtors were not entitled to avoid the lis pendens, (2) they were not entitled to reject the sale of mineral rights, and (3)  general statements that the plan was not proposed in a manner consistent with the Code,  it was not proposed in good faith, and “Dunmore does not accept the plan within the meaning of the Bankruptcy Code.”  For reasons that are not explained in the opinion, Dunmore withdrew its objections, and the plan was confirmed two days later.

The day the plan was confirmed Dunmore filed a proof of claim for ~$595,000 based on “breach of real estate sales contract.”  The debtors filed an objection to the Dunmore proof of claim and Dunmore filed a motion for a determination regarding the status of its contract.  In both contexts, Dunmore argued that its agreement was not an executory contract under the Bankruptcy Code, and thus was not subject to rejection.  Alternatively, it argued that it was entitled to damages as provided under Section 365(i) of the Bankruptcy Code.

Dunmore lost on all counts – primarily because the court determined that the chapter 13 plan was binding, and thus it was too late for most of Dunmore’s arguments.  Section 1327(a) of the Bankruptcy Code specifically provides that a plan will be binding on “each creditor, whether or not the claim of such creditor is provided for the plan, and whether or not such creditor has objected, has accepted, or has rejected the plan.”  In addition, the court noted that a confirmation order is res judicata as to all issues that could have been decided in the confirmation hearing.  Dunmore had its opportunity to object to treatment of its contract and claim, but instead withdrew its objection.

With respect to the argument about whether the agreement was an executory contract, the court determined that characterization of the agreement as an executory contract in the plan was sufficient to resolve the issue.   Regardless of its classification outside of that context, Section 1322(b)(2) allows a plan to modify the rights of holders of claims, which includes modification of contract rights.  According to the court, this means that a plan may provide that a contract is subject to treatment as an executory contract under Section 365, and thus provide for assumption, rejection or assignment as an executory contract.

In addition, the debtors had included the Dunmore agreement in their bankruptcy schedules as an executory contract.  Dunmore failed to challenge this classification, and failed to object to this characterization in the plan.  Consequently, the court determined that the Dunmore agreement was an executory contract subject to rejection.

With respect to the lis pendens, the court acknowledged that it is not technically correct to characterize a lis pendens as a judicial lien.  Rather, it is clear under applicable state law that a lis pendens does not establish a lien but merely gives notice of an interest that may be acquired in pending litigation.  So, Dunmore could have challenged treatment of its lis pendens as a judicial lien.  However, it failed to do so.  The Chapter 13 model plan used in the court includes a section that incorporates lien avoidance procedures.  Since the debtors provided for avoidance of the lis pendens as a judicial lien and Dunmore did not object, it was avoided as a result of the confirmation order.

With respect to Dunmore’s proof of claim, the court first determined that the contract should be treated as an executory contract for the sale of real property.  Among other things, state law treats conveyance of mineral rights as a real estate conveyance.

Under Section 365(j) of the Bankruptcy Code, a purchaser under an executory contract for sale of real estate that is either (1) in possession, but elects to treat the contract as terminated under Section 365(i) or (2) is not in possession “has a lien on the interest of the debtor in such property for the recovery of any portion of the purchase price that such purchaser or party has paid.”  Thus, the court concluded that the highest amount that Dunmore could claim was $10,000 (the  amount of the deposit that it paid).  It rejected Dunmore’s argument that Section 365(i) was applicable, since that section applies only to purchaser’s in possession, and Dunmore was not in possession.  The court further concluded that the Section 365(j) lien was stripped from the property under the plan as confirmed.  Consequently, it held that Dunmore’s claim was entirely disallowed.

If there is any lesson to be learned from this case, it is that a creditor fails to diligently pursue objections at its peril.  There were several issues where it is possible that Dunmore’s should have prevailed on the merits, and it is not clear why avoiding the Section 365(j) lien meant that Dunmore did not even have an unsecured claim for rejection damages, but that didn’t matter.  The court’s decision can be summarized in the single sentence that “Dunmore sat on its rights and allowed the Second Amended Plan to be confirmed, thereby allowing all of its interests, including its §365(j) lien, to be avoided.”

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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