A chapter 7 trustee sought bankruptcy court authorization to distribute proceeds from the sale of a liquor license. The trustee proposed to distribute proceeds pro rata to creditors with “holds” against the license as contemplated by state regulatory requirements as opposed to distribution strictly in accordance with the priorities set forth in the Bankruptcy Code.
The debtor acquired a restaurant and bar business, including an associated liquor license. To secure repayment the seller took a security interest in some of the property purchased by the debtor, including the liquor license. Under the security agreement, upon a payment default the liquor license was to be “immediately” transferred back to the seller.
Under state regulations a seller could recover a liquor license through an involuntary transfer if (1) the sale contract was recorded and the seller filed a UCC financing statement claiming a security interest in the license, (2) all transfer documents were filed with AMCO (Alcohol and Marijuana Control Office), and (3) notice of the transfer was published. So, after the debtor defaulted and ceased operations, the seller took action to enforce its rights, including filing a license transfer application with AMCO to initiate an involuntary transfer of the liquor license back to the seller.
Apparently, the application was received by AMCO after the debtor filed bankruptcy and the seller continued to take steps to pursue the transfer before it eventually filed a motion for relief from the automatic stay. There were various disputes regarding whether the seller took the proper steps to perfect its interest in the license and whether it violated the automatic stay. But the day before the court was to hold a hearing on the stay relief request the trustee filed a motion for approval to sell the liquor license and other assets to the president of the seller for $175,000 “in large part to avoid the time, risk, and expense associated with litigating the issue of perfection of the License.”
Under the purchase agreement it was acknowledged that transfer of the liquor license was subject to AMCO’s approval, and upon deposit of the purchase funds the trustee was obligated to support reconveyance of the license to the seller.
Under the state liquor license regulatory process, a transfer required application to AMCO, notice to creditors and approval by AMCO. Creditors could place a “holds” on the liquor license by filing a statement that they are owed money by the holder of the liquor license arising from the conduct of the business involving the liquor license. Generally, AMCO did not approve a voluntary transfer of the license unless the holds are paid, but it was long-standing practice that this requirement would be met if creditors received a pro rata distribution on their hold amounts debt of a carveout for administrative costs related to the sale.
Accordingly, the trustee proposed to distribute proceeds pro rata to creditors with holds That of a carveout of $25,000. The debtor and its owners objected, arguing that an IRS debt should be treated as a priority and paid in accordance with section 507(a)(8) as opposed to pro rata with other creditors.
In analyzing the issue, the bankruptcy court characterized a creditor with a valid hold as the equivalent of a secured creditor, although not all creditors could qualify to assert a hold so the distribution in accordance with the liquor license regulatory process was not the same as distribution in a chapter 7 under section 726(a) of the Bankruptcy Code. Notwithstanding this difference, the bankruptcy court noted that historically courts have approved liquor license sales permitting payment of holds from the proceeds, finding that the altered distribution scheme did not violate federal bankruptcy law.
However, the court went on to state that subject to any creditors’ property rights created under state law, distribution of proceeds was still governed by the Bankruptcy Code. In particular, the court noted that only creditors who responded to the notice of transfer or who had previously filed a written claim against the license were entitled to a hold. In this case the trustee submitted an unsigned affidavit identifying potential holds. But the only claims actually filed were a claim for ~$1.5 million filed by the seller and a claim for ~$425,000 filed by the IRS, and in both cases the claims are filed well after the license transfer was approved.
Accordingly, when the sale order provided that claims attached to proceeds from the sale of the license to the same extent and with the same priority as to the license, that meant that no holds attached to the proceeds since they were no valid holes filed before the license was transferred. Thus, the court denied the trustee’s request for authorization to distribute proceeds pro rata to creditors with holds.
Rather than treating this as a question of conflicting distribution schemes, the court reconciled the state liquor license and Bankruptcy Code procedures by characterizing the state liquor license regime as creating property rights and then applying the bankruptcy distribution rules taking into account those rights. The opinion suggests that the result would have been different if creditors had asserted valid holds since their rights would have been respected. However, the opinion describes hold rights applicable in the context of a voluntary transfer, while the footnotes indicate that the retransfer of a license upon default is an involuntary transfer and the right to protest an involuntary transfer may be more limited. So, who knows?
Vicki R Harding, Esq.