Brown v. Ellmann (In re Brown), 851 F.3d 619 (6th Cir. 2017) –

After a chapter 7 trustee sold mortgaged residential property that had been surrendered by the debtor, the debtor claimed an exemption in the sale proceeds based on her state law redemption rights. The bankruptcy court denied the exemption claim, and the debtor appealed – first to the district court and then to the Sixth Circuit. There was no stay pending appeal and the debtor had no equity in the property, so as a threshold mater the court addressed mootness and standing before considering the merits of the exemption claim.

In her initial filings the debtor listed a residence valued at $170,000 subject to mortgages totaling $219,000. She stated her intent to surrender the property and initially did not claim any exemption for redemption rights. The trustee later sold the property for $160,000. When the trustee sought to distribute the proceeds, the debtor objected and sought to amend her bankruptcy filings to claim exemptions for the value of redemption rights under state law.

The trustee began by arguing that the court lacked jurisdiction because the case was moot on constitutional, statutory, and equitable grounds. In particular, section 363(m) of the Bankruptcy Code provides:

The reversal or modification on appeal of an authorization … of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

According to the court, a majority of the Circuits construe this provision as a per se rule that appeals are automatically moot if the appellant fails to obtain a stay of the sale pending appeal. However, two other circuits (Third and Tenth) require that the party alleging mootness also prove that the court is not able to “grant effective relief without impacting the validity of the sale.” The Sixth Circuit chose this case to adopt the view that a party challenging on the grounds of mootness must prove no effective relief is available.

Thus, although it was clear that the debtor did not obtain a stay of the sale pending appeal, that was not the end of the matter. The court noted that redistributing sale proceeds would be consistent with section 363 because it would not modify or set aside the sale. Since the trustee did not indicate whether any proceeds from the sale remained accessible, there was a possibility that the court could grant effective relief. Accordingly, the court concluded the trustee did not demonstrate that the case was actually moot.

After disposing of the statutory mootness argument, the court concluded the trustee also failed on the narrower constitutional mootness argument and did not address equitable mootness since that issue was not raised in a timely manner.

Turning to standing, to appeal a bankruptcy order a party must be “directly and adversely affected pecuniarily by the order.” The trustee argued that the debtor had no standing because she did not have a claim to the sale proceeds since she had no equity in the property. However, that in effect put the cart before the horse. If the bankruptcy court had decided that the debtor was entitled to an exemption, she would have had an interest in the exempted share of the proceeds.

This left the substantive issue of whether the debtor was entitled to claim an exemption. Under section 522 of the Bankruptcy Code, an exemption is available for “The debtor’s aggregate interest [subject to a cap] in real property … the debtor uses as a residence …” The court concluded that any exemption based on the value of redemption rights must attach to some equity interest of the debtor, and an exemption cannot be supported if the sale proceeds are insufficient to satisfy secured claims.

Accordingly, the court ruled that the case was not moot and the debtor had standing, but the bankruptcy court properly denied the debtor’s exemption claim.

As the court noted, the good faith purchaser protection found in section 363(m) is intended to encourage participation in bankruptcy sales and increase value by protecting the interests of a good faith purchaser. A purchaser is looking for comfort that it can safely ignore any threatened disputes regarding the sale. It needs to be aware that this is more easily achieved in some Circuits (i.e. those applying a per se rule) than others.

Vicki R Harding, Esq.