Foreclosed Property: Related Rights May Be Tricky

Cooper v. WPD Poplar Ridge, LLC (In re Poplar Ridge, LLC), 526 B.R. 147 (W.D. N.C. 2015) –

After a developer defaulted, the trustee under a deed of trust held a pre-petition foreclosure sale.  The issue was whether the developer debtor’s “declarant rights” were included in the property that was transferred in the sale.  The bankruptcy trustee contended that the rights should not have been transferred and sought to set aside the conveyance.

Poplar Ridge was a residential subdivision.  As required under a state Planned Community Development Act, the project was established under a Declaration of Covenants, Conditions and Restrictions (Declaration).  When the debtor acquired the project from the initial developer, it became the “Declarant” under the Declaration.

In particular, Declarant was defined in the Declaration to mean the initial developer and its successors in title and assigns, provided that (1) they “shall acquire for the purpose of development and/or sale all or substantially all of the remaining undeveloped or unsold portions of the Project” and (2) they shall be designated the Declarant in the conveyance instrument.

When the debtor acquired the project, it granted its lender a deed of trust on unsold lots to secure a $2.5 M loan.  The deed of trust covered the real estate “[t]ogether with all rights, easements, appurtenances… that may now, or at any time in the future, be part of the real estate.”

After the debtor defaulted, the lender initiated foreclosure proceedings.  The lender was the high bidder and assigned its rights to a limited liability company.  The trustee deed delivered in connection with the foreclosure sale conveyed the real property together with “all easements and appurtenances to any and all of the above-described property.”  It further designated the grantee as a successor declarant under the declaration.

The deed of trust trustee also executed a document titled “Transfer of Declarant’s Interest.”  The bankruptcy court deemed this transfer of interest to be “mere surplusage,” since any rights that the trustee had under the deed of trust had already been sold at the foreclosure sale and conveyed by the trustee deed.  In fact, the trustee deed both designated the purchaser as Declarant and conveyed all rights under the deed of trust.

The bankruptcy court granted the purchaser’s motion to dismiss the bankruptcy trustee’s case for failure to state a claim, and the bankruptcy trustee appealed to the district court.  The question before the district court on appeal was whether the deed of trust encumbered the debtor’s Declarant rights.

A significant portion of the court’s opinion was devoted to describing the standard to be applied in connection with a motion to dismiss under Rule 12(b)(6):

  • The Supreme Court has rejected the “no set of facts” standard because it would “improperly allow a wholly conclusory statement of claim” to survive.
  • Facts must be sufficient to “raise a right to relief above the speculative level.” A “naked assertion devoid of further factual enhancement” will not survive.
  • There must be “more than unadorned, the defendant–unlawfully–harmed–me accusation.”
  • The “plausibility standard” is “more than a sheer possibility that a defendant has acted unlawfully.”

As usual, the nature and extent of the debtor’s rights were evaluated under state law. Although there were no reported cases addressing declarant rights in the context of a foreclosure, the court found that it was “well settled that ‘a conveyance of land, in the absence of anything in the deed indicating a contrary intention, carries with it everything properly appurtenant to, that is, essential or reasonably necessary to the full beneficial use and enjoyment of the property conveyed.’”

Since, among other things, the declarant’s rights allow a developer to control a homeowner association, the court found that it was clear that they were an essential part of the rights necessary to complete work in developing a community.

The court noted recent amendments to the applicable statute that confirmed that declarant rights were included in deeds of trust dating back to 1999.  In addition, with the exception of a transfer pursuant to a foreclosure, by statute declarant rights must be transferred by an instrument recorded in every county where the planned community is located and must be executed by the transferee.  Since there was no such document in this case, the court concluded that the declarant rights had not been “unbundled” prior to the grant of the deed of trust, and consequently the deed of trust encumbered the declarant rights.

Based on that determination, the court made short shrift of the various fraudulent conveyance and other claims asserted by the bankruptcy trustee.  The purchaser was the lawful successor, and the transfer in the context of a regularly conducted foreclosure sale was deemed to be for reasonable equivalent value as a matter of law.  Thus, the court affirmed the bankruptcy court decision.

It is interesting to watch courts try to describe a standard that seems to be shrouded in mist.  Somehow descriptions such as “wholly conclusory,” “speculative level,” and “sheer possibility” do not give one a sense of certainty about what is required.  I suppose that is just the nature of the beast.

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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