Automatic Stay Relief: Where Best to Untangle Joint Ownership Interests?

In re Guy, 587 B.R. 475 (Bankr. E.D.N.C. 2018) –

A chapter 7 debtor and his sister jointly owned real property as tenants-in-common. The sister moved for relief from the automatic stay in order to commence a state court action for partition by forced judicial sale.

The debtor and his sister inherited the property from their deceased mother. The tax value of the property was $135,000, and it was encumbered by two liens in favor of a bank totaling ~$65,000 (i.e. there appeared to be equity in the property).

A residential building was located on the property. The sister claimed that as a result the property could not be physically partitioned without substantial injury to value. Consequently, she contended she was entitled to seek judicial partition by forced sale. The sister lived next door to the property and apparently hoped that she could acquire full ownership of the property through this process.

She was preparing to file a state court action to partition the property when the debtor filed bankruptcy. So, her next step was to seek relief from the automatic stay so that she could proceed.

The debtor responded by noting that he filed a petition in part to stay a foreclosure sale by the bank in the belief that a private sale would produce more value. The siblings were estranged, and the debtor claimed that his sister was interfering with his sales efforts by damaging the property, removing “for sale” signs, and harassing potential buyers. The debtor said he did not oppose his sister purchasing his interest, but claimed she was unwilling to pay a fair price.

Given the circumstances, the debtor argued that the bankruptcy estate’s interest in the property would be better protected by a bankruptcy sale. The trustee suspected there was equity in the property and also was concerned that the sister’s proposed force judicial sale was not in the best interests of the estate.

The sister sought relief from the stay “for cause” pursuant to section 362(d) of the Bankruptcy Code. Because there is no definition of “cause,” the Fourth Circuit has held that the determination must be made on a case-by-case basis. According to the Fourth Circuit, the three factors to consider in deciding whether to lift the automatic stay to allow continuance of a prepetition judicial action are whether:

  1. issues in the litigation involve only state law so bankruptcy court expertise is not necessary;
  2. modifying the stay will promote judicial economy and if there would be interference with the bankruptcy case because matters would have to be litigated in bankruptcy court if a stay was not lifted; and
  3. the estate can be properly protected by requiring creditors to seek enforcement of any judgment in the bankruptcy court.

The court noted another bankruptcy court decision affirmed by the Fourth Circuit that lifted the automatic stay to allow continuation of an equitable distribution proceeding in state court that have been active for about five years prior to the petition (unlike this case where the proceeding had not yet been commenced). In the other case the proceeding was within the state court’s expertise and judicial economy weighed in favor of leaving the litigation to the state court given the long history. In addition, it was found that lifting the stay would not harm the estate or interests of other creditors.

The court also discussed an unpublished opinion offered by the sister. In that case a debtor and her nephew owned property as tenants-in-common. The debtor filed bankruptcy to prevent a tax foreclosure. She proposed a plan to pay creditors the equivalent of her non-exempt equity in the property over five years. In the meantime, the nephew entered into an agreement to sell his interests to a third party. It was a condition of the sale that the buyer acquire the rest of the interests in the property through negotiations or a state court partition action. The nephew and the third party buyer moved for relief from the stay to permit their sale and to pursue a state court partition action.

As in this case, the state court action had not been commenced prepetition. The bankruptcy court in that case found cause to grant the relief requested by the nephew because partition was a matter of state law and did not require bankruptcy court expertise, judicial economy favored granting the requested relief, and the hardship to the nephew and purchaser caused by waiting for the chapter 13 repayment plan outweighed hardship to the debtor. The court also found that the estate’s interest was adequately protected by requiring that sale proceeds due to the debtor as a result of the partition be paid to the chapter 13 trustee for distribution to the debtor’s creditors.

In considering what to do in this case the bankruptcy court noted that state law provided that a state court could order mediation whenever a partition sale is requested. It further noted that the debtor in this case did not oppose a partition through sale of the property. Consequently, a bankruptcy sale was a feasible alternative.

Further, the court concluded that under the Bankruptcy Code a bankruptcy sale of the property could include both the estate’s interest and the sister’s undivided interest as a tenant-in-common. It viewed the bankruptcy sale as comparable to the proposed state court procedure, except that the bankruptcy process was far more efficient.

Finally, the court shared the trustee’s concern that allowing the property to be dealt with in the state court was not in the estate’s best interests. It appeared to the court that the sister was attempting to sabotage sale of the property and that she preferred to obtain the property at a reduced cost through the forced judicial sale. Since the property appeared to have equity, ensuring an efficient and reasonable sale to the bankruptcy was in the best interest of the estate.

Accordingly, judicial economy and protection of the estate’s interest favored proceeding with the sale under the Bankruptcy Code. However, the sister was invited to renew her motion if the debtor delayed or was unsuccessful in his attempts to sell the property.

It appears that the critical factor in this case was the court’s mistrust of the sister’s motives, which led to a desire to retain supervision of the sale process to assure that the bankruptcy estate realized the benefit of any equity in the property. This suggests the importance of communicating the underlying “story” in addition to making strictly legal arguments.

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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