Abandonment: When Property Drops Out of the Bankruptcy Estate

In re Rich, 510 B.R. 366 (Bankr. D. Utah 2014)

In a case that was converted from a chapter 11 reorganization to a chapter 7 liquidation, the debtor sought an order directing the trustee to abandon certain real estate, arguing that there was no equity for the bankruptcy estate. A lender had already obtained relief from the automatic stay permitting it to foreclose on the property, and the debtor wanted to do a short sale with the consent of the lender. The chapter 7 trustee opposed the motion.

About a year and a half after an individual filed a chapter 11 petition, he voluntarily converted to a chapter 7 case. Six months later the debtor received a discharge and reached a settlement with the trustee releasing all claims (including the trustee’s claims that the debtor made unauthorized post‑petition transfers). Almost a year after the discharge, a bank filed a motion seeking relief from the automatic stay with respect to certain real estate. Neither the debtor nor the trustee objected, and the bank’s request was granted.

The debtor then filed a motion to compel the trustee to abandon the real estate. He advised that he had negotiated a short sale of the property with the consent of the bank. The real estate secured ~$520,000 in debt and the proposed sale was for $335,000. The debtor stated that he would not receive any proceeds from the sale, and argued that there was no equity in the real estate, and thus it had no value to the bankruptcy estate.

The trustee objected, contending that the motion for abandonment was equivalent to a motion for approval of a Section 363 sale. The trustee brushed aside his failure to object to the bank’s motion for stay relief and argued that the debtor’s failure to provide an appraisal should be fatal to his abandonment request. The trustee also raised allegations of continuing fraudulent and unauthorized post‑petition transfers, and contended that the debtor should have negotiated harder to increase the price.

Under Section 544(b) of the Bankruptcy Code, a court may order the trustee to abandon property that is “burdensome to the estate or that is of inconsequential value and benefit to the estate.” Once property is abandoned it is no longer part of the bankruptcy estate and reverts to the debtor as if no bankruptcy had been filed. The court no longer has jurisdiction, and the debtor is free to deal with the property without regard to the Bankruptcy Code.

While acknowledging that the debtor’s purpose was to effectuate a short sale, the court found that his motivation was irrelevant. The only question was whether the property was burdensome or of inconsequential value. The court did not view the abandonment motion as the equivalent of a request for approval of a sale under Section 363, and viewed the debtor’s purported lack of authority to negotiate the short sale as irrelevant.

While the trustee raised the specter of a pattern of fraudulent transfers, he did not commence an adversary proceeding to address them, provided no details, and gave the debtor a broad release in connection with their settlement.

Regardless, the only issue was (repeat after me) whether the property was burdensome or of inconsequential value. The court viewed the trustee’s failure to object to the bank’s request for relief from the stay as an implicit concession that there was no equity in the property.

Also, during the course of two and a half years the trustee did not make any attempt to market the property, nor did he allege that he was even attempting or intending to sell the property in the future. The trustee also did not allege that there was equity “or even the possibility of equity.”

The court summarized by stating: “Failure to administer property that is of value and benefit to the estate is not an acceptable option and failure to abandon property that is burdensome is not an acceptable option.” Not surprisingly, the court granted the debtor’s motion to abandon the property.

Abandonment is a wild card that people often overlook. As noted, property that is abandoned reverts to the debtor (although under some circumstances it is possible that possession of property might be abandoned to a third party). Once that happens, other parties with an interest in the property no longer have the benefit of any constraints that the bankruptcy might impose on the debtor.

It is interesting to see that the debtor followed the same strategy of seeking abandonment to permit a short sale for two additional properties. (In those cases the trustee did not object.) Presumably the bank agreed to the short sales because (1) they avoided the trustee fees and bankruptcy court oversight involved in a sale through the bankruptcy, and (2) they were quicker and produced a better result than foreclosures. Given that the debtor already obtained a discharge, it is less clear why he made the effort. Perhaps his cooperation with the bank helped reduce or eliminate liability for an affiliate guarantor?

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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