Bankruptcy Sales: Free and Clear Could Be Clearer

In re Love, 553 B.R. 54 (Bankr. D. S.C. 2016)

Chapter 13 debtors filed a motion seeking authority to sell 5 acres of real property free and clear of a mortgage covering the property. The mortgagee objected.

The property that the debtors were seeking to sell was part of a larger 22 acre parcel consisting of 15 acres of vacant land and 7 acres that included the debtors’ principal residence, barn, pool, and two ponds. The mortgage was a first priority lien that covered the entire 22 acres and secured a debt of ~$500,000.

The debtors confirmed a chapter 13 plan that proposed to cure prepetition mortgage arrearages and to resume making regular monthly mortgage payments. The plan also provided that the debtors would sell either the 15 acre vacant parcel or the 7 acre improved parcel and applied the net non-exempt proceeds to the debt within 24 months after confirmation. If there was a prospect for a sale, the debtors would have an additional 12 months to sell the property. If they were unable to sell then the plan was to be amended to provide for monthly installments sufficient to adequately fund the plan.

Subsequently, after the debtors failed to comply with the terms of a settlement order by failing to make mortgage payments when due, the court granted the mortgagee relief from the automatic stay to permit it to pursue non-bankruptcy remedies against the entire property. Although the debtors attempted to obtain a loan modification, that effort failed. (The mortgagee advised that it denied the debtors’ request due to the failure to provide requested documentation.)

Against this background, the debtors filed a motion seeking authority to sell 5 acres to an adjacent land owner for $100,000. They proposed to tender the proceeds to the mortgagee to pay any past due amounts. In exchange they requested that the mortgagee be required to release its lien on the 5 acres while retaining its lien on the rest of the 22 acre parcel.

The debtors contended that proposed transaction would substantially reduce the arrearage, increase marketability of the remaining property and facilitate their efforts to sell, while leaving a sufficient equity question for the mortgagee. Although there was no evidence of the current balance of the debt, the exact amount in arrears or the value of the entire property, it appears that the debt was ~$500,000 and the parties agreed that there was equity in the property.

However, the mortgagee (1) disagreed with the contention that severance of 5 acres would increase the value and marketability of the property, (2) contended that the debt would still be delinquent after application of the proceeds, and (3) argued that it had obtained relief from the automatic stay and was entitled to continue to pursue its state law remedies against the entire parcel.

The first issue addressed by the court was whether it should approve the sale under section 363(b) of the Bankruptcy Code. The debtor was required to show a sound business reason for the sale, and the court was required to scrutinize the sale to ensure that it was fair and reasonable, a maximum value was being recovered, and “the decision to sell is made on an informed basis, in good faith, and in the honest belief that the sale is in the estate’s best interest.” The court was convinced that the debtors met their burden on this issue.

However, since the debtors wanted to sell the property free and clear of the mortgage, they were also required to comply with section 363(f). This section provides that property may be sold free and clear only if it meets one of the criteria laid out in that section. In this case the only option was subsection (5) which provides:

(5)    such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

Courts have had a difficult time interpreting this provision: “Competing constructions seem to render [paragraph 5] so specialized as to never be invoked, or all-powerful, subsuming all the other paragraphs of § 363(f).”

For example, some courts have concluded that “interest” does not include liens, while others take a more expansive reading. Similarly some courts interpret “could be compelled” to mean that all a debtor must do is show that it is theoretically possible to compel a party to accept money in satisfaction of its interest, while others hold that a debtor must prove there is a hypothetical proceeding that could be brought by the debtor.

The Love court subscribed to the view that at a minimum the hypothetical proceeding must be legally possible. It also agreed that the proceeding must be one that could be brought by a trustee or the debtor (as opposed to a third party).

Given this view, is not surprising that the debtors failed when they argued that the state foreclosure action satisfied subsection (5) since the mortgagee could be compelled to accept money satisfaction of its lien. The court rejected this argument noting that a bank’s voluntary foreclosure of its lien is fundamentally different from eliminating a lien over its objection. Further, the foreclosure proceeding was within the control of the mortgagee and lacked the element of compulsion.

The court also rejected an argument that the mortgagee had already agreed to release portions of the property or that the plan contemplated the proposed 5 acre sale. Thus, while not unsympathetic to the debtors’ request, the court denied the motion.

Often a motion to approve a sale free and clear of liens will contain only conclusory statements about compliance with section 363(f). As a result the details of this subsection are probably not litigated as often as one might guess. However, given that section 363(f) was enacted more than 35 years ago it is interesting that there is still such a wide variety of interpretations.

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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