Chapter 7 Sale: Debtor Out of Luck Unless Property Is Abandoned

In re Mejia, 576 B.R. 464 (Bankr. S.D.N.Y. 2017) –

A chapter 7 debtor sought bankruptcy court approval to sell property in a section 363 sale. The trustee filed an untimely objection on the grounds that a chapter 7 debtor must sell abandon property outside of bankruptcy and cannot use section 363 of the Bankruptcy Code.

The property was co-owned by the debtor and his non-debtor sister subject to a mortgage. The mortgagee obtained a judgment of foreclosure and sale but was stayed from proceeding further by the debtor’s bankruptcy filing. The property was valued at somewhere around $850,000 to $900,000. The outstanding mortgage balance was ~$770,000 and the debtor’s homestead exemption was $165,550 (for a total of a little more than $935,000).

The trustee considered the property to be abandoned because she (1) stated on the record at the 341 meeting that the property had no value to the bankruptcy estate since there was no equity beyond the amount of the debtor’s homeowner’s exemption, and (2) filed a report of no distribution. Consequently, the trustee argued that the property was no longer part of the bankruptcy estate. It could be sold by the debtor – but only outside of bankruptcy, not through a section 363 bankruptcy sale.

The court considered the trustee’s position flawed in one major respect: the property was never properly abandoned.

As an initial point, the court noted that in a chapter 7 bankruptcy only the trustee has the authority to use, sell or lease property of the bankruptcy estate under section 363. (This is in contrast to a chapter 11 case where the debtor in possession generally has the rights of a trustee pursuant to section 1107.) So, once a bankruptcy petition is filed, as long as property remains part of the bankruptcy estate the debtor has no power to sell. However, a debtor may sell property outside of bankruptcy if it has been abandoned.

In that regard, the court determined that property may be abandoned only in one of the three ways set forth in section 554:

  • After notice and hearing, the trustee may abandon property “that is burdensome to the estate or that is of inconsequential value and benefit to the estate.”
  • After notice and hearing, a party in interest may request that the court order the trustee to abandon property that is burdensome or of inconsequential value and benefit to the estate.
  • If property is scheduled and not otherwise administered at the time a case is closed, the property is abandoned to the debtor unless the court orders otherwise (a “technical abandonment”).

The court noted that if property is abandoned, it reverts to the party with a possessory interest. In this context, possessory interest “is defined as a ‘right to exert control over’ or a ‘right to possess’ property ‘to the exclusion of others.'” In a lien theory state, the mortgagor retains title in the mortgagee does not have a right of possession, so the property would revert to the debtor.

The court emphasized that unless there is a technical abandonment when a case is closed, abandonment requires notice to creditors with an opportunity for hearing in accordance with the bankruptcy rules. In this case, although all parties appeared to agree that the property was of inconsequential value to the estate – justifying abandonment, the court determined that the procedural requirements of section 554 (such as notice to creditors) were not met – so the property was not abandoned under the first two alternatives. In addition, the case remained open for an extended period of time – preventing automatic technical abandonment upon closing of the case.

Accordingly, the court denied the debtor’s motion since it had no authority to sell the property while the property was still part of the bankruptcy estate.

Eventually the debtor took the hint and filed a motion to compel the trustee to abandon property. In response the trustee filed a letter consenting to the debtor’s motion plus she filed her own application to abandon the property. The court commented that the trustee “would have saved time and expense for everyone if she had simply filed the application to abandon the Property instead of the untimely Objection.”

It seems people are sometimes confused about the limited role and powers of a debtor in a chapter 7 case (in contrast to a Chapter 11). In this context abandonment can be a useful tool, although as this case illustrates, there are formal rules that need to be followed.

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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