Bankruptcy Estate: Would the Automatic Stay Protect a Squatter?

In re Castle Service, 560 B.R. 587 (Bankr. D. Utah 2016)

The debtor occupied but did not hold title to the real property where its business was located. A mortgagee seeking to foreclose on the property moved for a determination that the property was not an asset of the bankruptcy estate, and thus was not subject to the automatic stay.

The debtor operated an automotive service business on the property for more than 15 years. Originally two of the debtor’s owners acquired the land and obtained a construction loan to build the improvements for the business. Subsequently the debtor was formed and executed a replacement note. The debtor’s owners continued to hold title to the property. They guaranteed the debtor’s note, and the deed of trust securing the construction loan was modified to reflect the increased principal amount of the replacement note.

The property was the debtor’s sole business location. Although the debtor continuously occupied the property for operation of its business, there was no written lease. There was also no evidence that the debtor paid rent, although it made all payments on the replacement construction note.

The mortgagee argued that the property was not part of the debtor’s bankruptcy estate, and thus was not protected by the automatic stay, because the debtor did not hold title. However, the bankruptcy court noted that section 541 of the Bankruptcy Code provides that the bankruptcy estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” This means that “every conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative” is included.

In acknowledging that “mere possession alone” might not be sufficient to bring property within the bankruptcy estate, the court drew a distinction between a “possessory interest” and “possession.” Quoting Black’s Law Dictionary: “a possessory interest is a ‘[r]ight to possess property by virtue of an interest created in the property though it need not be accompanied by title …” In other words: “cases in which the debtor has some right to possess the property, for example, by virtue of the titleholder’s consent or permission.”

In this case the court noted that (1) the debtor was liable for the loan made for purposes of constructing the building used in its business, (2) the debtor possessed and operated its business out of the property for more than 15 years, (3) payments on the loan were made by the debtor and not the property owners, (4) the debtor’s use of the property was made with the full knowledge and express or implied consent of the property owners in the mortgagee, and (5) although title was held by two individuals and not the debtor, the only use of the property was for the debtor’s business.

Given the facts and legal framework as outlined by the court, it determined that the debtor had a valid interest in the property that was part of the bankruptcy estate. Consequently, although the mortgagee could sue the owners on their guarantee of the debtor’s note, the debtor had an interest in the property so that foreclosing on the property would violate the automatic stay.

The court then considered the mortgagee’s request for relief from the automatic stay for cause. However, the mortgagee did not contend that there was a lack of adequate protection, and it did not present any evidence regarding the debtor’s equity in the property. The court noted that the debtor’s schedules indicated that there was equity in the property, and since it was the sole location for the debtor’s business it was clear that the property was necessary for the debtor’s reorganization. So, the mortgagee did not establish that there was cause, and thus the court denied its request for relief from the automatic stay.

The potential scope of the bankruptcy estate and corresponding reach of the automatic stay is extremely broad. Simply characterizing a debtor’s interest as “merely possessory” will not win the day. However, courts are likely to draw distinctions based on the strength of the debtor’s right to be in possession. For example, courts are inclined find a way to grant relief in the case of a holdover tenant, and more likely than not a squatter would be out of luck.

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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