In re Arch Hospitality, Inc., 530 B.R. 588 (Bankr. W.D.N.Y. 2015) –

A Chapter 11 debtor sought bankruptcy court approval to sell a hotel free and clear of liens in a Section 363 sale.  The issues before the court ultimately turned on whether creditors with liens on the hotel were required to affirmatively consent.

The debtor owned a hotel that was subject to the following liens: (1) real estate taxes in excess of $234,000, (2)  first mortgage of more than $2.9 million, (3)  second mortgage in excess of $477,000, (4)  state lien for unpaid sales taxes of more than $40,000, and (5) judgment of the state workers’ compensation board for $2,500.

The real estate taxes were senior in priority, and the first mortgage was next in line.  All parties agreed that the value of the property was insufficient to pay the first mortgage in full, much less the rest of the liens.

Under Section 363(f) of the Bankruptcy Code, property may be sold free and clear of interests if one of five tests is met.  With respect to the liens at issue in this case:

• Subsection (3) provides that property can be sold free and clear if the interest is a lien and the price is greater than the aggregate value of the liens on the property. The court concluded that this was adequate to address the real property taxes, since the sale price would be sufficient to pay the taxes in full.
• Subsection (2) allows a sale free and clear if the lienholder consents. Since the first mortgagee expressly consented, this section was applicable to its lien.
• As for the state lien for sales taxes, the state originally objected, but then withdrew its objection. The court concluded this was sufficient to demonstrate implied consent.

This left the second mortgage and the workers’ comp lien.  Neither of these creditors bothered to respond to the proposal to sell the hotel free and clear of their liens.

The debtor first argued that the second mortgage and state liens were wholly unsecured based on Section 506 of the Bankruptcy Code.  Under Section 506(a), an allowed claim of a creditor with a lien on property is treated as secured to the extent of the value of the property and unsecured with respect to any deficiency.  Then, under 506(d):  “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”

Thus the debtors argued that holders of the second mortgage and the workers’ comp lien should be deemed unsecured creditors based on Section 506.  However, Section 363(f) relates to all interest in property and the court concluded that the debtor was mistaken in the assumption that an unsecured creditor could not have an interest in the property.  Even if the court agreed that the two claims should be treated as unsecured, under Section 349(b)(1) if a case is dismissed then any lien voided under Section 506(d) would be reinstated.  In the court’s view, the possibility of lien reinstatement constituted an interest in property so that the debtor was required to meet one of the five tests under 363(f).

In that regard, the only argument the debtor advanced was that failure to object should be construed as implied consent.  The court disagreed.  In its view, a “failure to oppose, however, differs fundamentally from an affirmation of acquiescence.”  While acknowledging that there may be circumstances in which silence indicates consent, the court did not believe that the real estate liens in this case presented such circumstances.

The court acknowledged that the courts are split on whether consent can be implied from a failure to object.  However, it found the reasoning in cases requiring express consent to be more persuasive.  Consequently, the court concluded that the debtors could not sell the hotel free and clear of the second mortgage or the workers’ comp lien, and thus denied the motion for authority to sell the hotel.

Often a motion to sell free and clear will include a general conclusory statement that the property can be sold free and clear of liens based on Section 363(f).  Requiring express consent from everyone holding a lien on property as a condition of selling it free and clear of those liens can pose significant practical hurdles – particularly in a large case involving sale of property with numerous liens.  If pushed, counsel will typically argue that anyone who failed to object should be deemed to have consented.

In this case, both the U.S. Trustee and initially one of the state lien creditors objected, forcing the court to focus on the issue.  Add the fact that (1) the case had been pending for almost three years without any proposed plan of reorganization and (2) debtor’s counsel represented that it was unlikely the debtor would ever be able to present a confirmable plan (since it did not have the ability to pay priority claims), it is not surprising that the court was not particularly sympathetic to the debtor’s position.

The lesson to be learned is that while a judge does not need to address the issue of whether there has been consent in the typical case, once the question is before the court, there is a risk that the debtor will have to obtain affirmative consent from all secured creditors who do not meet any of the other criteria, even if they have not expressed any objections.

Vicki R. Harding, Esq.