Selling Real Estate Free and Clear: The Trustee Does Not Always Win

Belfance v. Shelton (In re Shelton), 593 B.R. 755 (Bankr. N.D. Ohio 2018) –

A chapter 7 trustee sought a determination of rights in connection with seeking authority to sell property free and clear of other interests using its power of a hypothetical bona fide purchaser of real property under section 544(a)(3) of the Bankruptcy Code. The court addressed both the interests held by the bankruptcy estate and the impact of constructive notice on the rights of a hypothetical bona fide purchaser.

The debtor’s mother executed a durable power of attorney (POA) appointing the debtor as her attorney-in-fact. The POA give the debtor broad powers to take action with respect to the mother’s interest in real estate. Among other things:

The POA authorized the Debtor “to sell, lease, convey, and to deliver possession and control of [the mother’s] real property, on such terms and conditions, and under such covenants, as said attorney in fact shall deem proper and in my name execute, acknowledge, and deliver such instruments necessary to effect such sale, conveyance, lease, or agreement.”

The POA did not include a specific provision authorizing the debtor to transfer her mother’s property to herself.

Using the POA, the debtor executed a warranty deed conveying her mother’s interest in certain real estate to the debtor. The deed and POA were recorded. Although the deed stated that $10,000 was paid for the property, all parties agreed that the debtor did not pay any consideration.

A property title report obtained by the trustee in 2016 stated:

The deed is executed by [the debtor] as attorney in fact for [her mother] pursuant to an improperly acknowledged power of attorney …. The recorded Power of Attorney does not give the attorney in fact the power to convert assets to her own use and is not valid upon the incompetency of [her mother].”

(An earlier title report obtained in 2015 by the trustee did not raise any questions regarding the sufficiency of the POA or the validity of the deed.) Although interesting, ultimately the title reports were not relevant to the court’s analysis since they were not part of the record title and thus could not provide constructive notice of issues.

The court began its analysis by discussing the rights of a bona fide purchaser. Under applicable state law a purchaser takes subject to prior claims and interests if it has actual or constructive knowledge. However, under section 544(a)(3) of the Bankruptcy Code a trustee may exercise rights of a bona fide purchaser without regard to actual knowledge, although the trustee is still charged with any constructive knowledge that would be imputed to a purchaser under state law.

Under applicable state law, an attorney-in-fact does not have the power to transfer a principal’s real property to the attorney-in-fact unless the POA expressly grants the power to do so. Further, under state case law a deed that improperly transfers property to the attorney-in-fact is void, not avoidable.

In this case the POA did not authorize the debtor to transfer her mother’s property to herself, so the deed was void. Consequently a purchaser would not be able to obtain good title from the debtor and it would not be a bona fide purchaser. In addition, a bona fide purchaser would be charged with constructive knowledge of the problems with the POA and deed. Further, the court concluded that the simple fact that a deed by itself purported to transfer title to the person executing on behalf of the grantor under a power of attorney was sufficient to put a purchaser on notice that it should make further inquiry about the attorney-in-fact’s authorization to execute the deed.

In this case since the deed was void, the bankruptcy estate did not have any interest in the property in the first place. Even if the deed was voidable (as opposed to void) the recorded deed and POA would have given a purchaser constructive notice of the mother’s interests and the fact that the debtor did not have valid title to the property.

The trustee also argued that it had a right to sell the property free and clear of the mother’s interests under section 363(f) because the interests were the subject of a bona fide dispute. The court rejected this argument on the grounds that section 363 applies only to property of the bankruptcy estate, and the debtor did not have an interest that could become property of the estate.

Consequently, the court determined that the trustee could not exercise the rights of a bona fide purchaser of real estate and could not sell the property free and clear of the mother’s interests.

Once again, the outcome of a case is determined by the specifics of local real estate law. Since real estate law can be far from uniform across jurisdictions, the assistance of local counsel can be critical to assure that a real estate transaction will not be subject to future attack.

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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