Chapter 7 Sales: The Debtor May Be Pretty Much Irrelevant

Pasley v. Keats (In re Pasley), 603 B.R. 6 (6th Cir. BAP 2019) –

A chapter 7 trustee sought to sell real estate owned by the debtor’s limited liability company (LLC). When the bankruptcy court entered an order approving the sale over the debtor’s objection, the debtor appealed to the Bankruptcy Appellate Panel (BAP).

After the debtor filed a chapter 7 bankruptcy, he submitted bankruptcy schedules that included a 100% ownership interest in an LLC. The trustee discovered that the LLC owned real estate. So, he sought authority to (1) list the property with a realtor or sell it privately, (2) pay closings costs as an administrative expense of the estate, and (3) hold the net sale proceeds pending further order of the court.

The debtor objected. The trustee’s response was to reaffirm his position that (1) upon filing bankruptcy the debtor was deemed to have assigned his LLC membership interests to the trustee, and (2) this gave the trustee the right to liquidate the LLC’s assets.

The bankruptcy court agreed with the trustee, holding that since the trustee stepped into the shoes of the debtor, he could sell the LLC’s real estate if he wanted to. However, the court was concerned about the LLC’s creditors. So, the trustee was instructed to identify LLC creditors that would have to be satisfied before sale proceeds would flow through to the debtor’s bankruptcy estate.

After the trustee addressed the court’s concern about the LLC creditors, he advised that he was ready to list the property, but first asked for a comfort order from the court to avoid issues with title companies and closing attorneys. In response, the debtor objected that the LLC’s property was not part of the bankruptcy estate.

The court acknowledged that although the LLC ownership interests were part of the bankruptcy estate, the real estate itself was not (and consequently was not being sold in a section 363 sale). However, since the trustee could exercise the rights of the debtor as the sole owner of the LLC, the trustee nevertheless had the authority to sell the real estate. Thus, the court entered the requested sale order.

On appeal, the BAP considered the debtor’s standing to appeal sua sponte. Although the parties did not raise the issue, the court advised that it had an obligation to consider standing since it is a jurisdictional requirement. As a preliminary matter, the court noted that standing in bankruptcy cases is more limited than Article III standing. Quoting Sixth Circuit precedent:

“[T]o have standing to appeal a bankruptcy court order, an appellant must have been ‘directly and adversely affected pecuniarily by the order.'” … “[A] party may only appeal a bankruptcy court order when it diminishes their property, increases their burdens or impairs their rights.”

In most cases, a chapter 7 debtor is not going to have the required interest because no matter how estate assets are distributed nothing will revert to the debtor. There is an exception if a debtor can demonstrate that the appeal will generate assets in excess of liabilities so that there will be a surplus that can be distributed to the debtor.

In this case the debtor did not claim that the membership interests were exempt from the bankruptcy estate and failed to make the required showing that the sale would diminish his property, increase his burdens, or impairs his rights. Accordingly, the debtor did not have standing and the appeal was dismissed.

It can be frustrating to a chapter 7 debtor – particularly an individual who will carry on after the case is closed – to discover that it has only limited rights that will be recognized in a bankruptcy.

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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