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Home | Commentary | Lenders: Beware of the ‘Forced’ Short-Sale in Bankruptcy
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Lenders: Beware of the ‘Forced’ Short-Sale in Bankruptcy

Historically, Chapter 7 Trustees rarely seek authorization to sell over-encumbered real property of the estate free and clear of liens because such a sale is authorized only under very limited circumstances. Based upon the rarity of motions to sell over-encumbered property and the assumption that a Court would never grant such a motion, creditors have generally been complacent about monitoring bankruptcy cases for such motions. However, in the current climate, this assumption is dangerous and may lead to catastrophic results.

In Illinois, Florida, and Nevada, Bankruptcy Courts have granted motions to sell over-encumbered property free and clear of liens based upon a lack of opposition. Such sales result in partial payoffs to senior lienholders and oftentimes the extinguishing of junior liens without compensation. This practice appears to have begun in late 2011.

The Trustees’ primary argument in support of the motions was that a lack of opposition constituted consent, thus satisfying § 363(f)(2). Trustees have also argued that the sales benefit the real estate market by circulating properties that were not being foreclosed quickly enough. Unfortunately, based upon the logistical dilemma posed by the deluge of bankruptcy filings, the foreclosure holds caused by newly enacted legislation, and the lack of familiarity with regard to the Trustees’ tactic, many creditors were rendered ill-prepared to timely oppose the motions.

§ 363(f) authorizes a Trustee to sell property of the estate free and clear of liens only under limited circumstances. Without dispute, this is to effectuate the Trustee’s duty to liquidate the property of the estate[1] as is compatible with the best interests of parties in interest.[2]   According to the Supreme Court, a Trustee’s role is to "maximize the value of the estate,"[3] but, "by the settled practice, a sale free of liens will not be ordered by the Bankruptcy Court if it appears that the amount of the encumbrance exceeds the value of the property."[4] Thus, "the bankruptcy court should not order property sold free and clear of liens unless the sale proceeds will fully compensate secured lienholders and produce some equity for the benefit of the bankrupt's estate."[5] 

A Trustee may certainly seek a lienholder’s voluntary 'consent' to a short payoff through negotiation.[6] Such negotiation appears consistent with a Trustee’s duty to ‘maximize the value of the estate.’ However, ‘consent’ must involve an affirmative and unequivocal manifestation of assent.[7] [8] Several Courts have reached similar conclusions.[9]

The non-consensual sale of over-encumbered property eviscerates the purpose of § 363(f) and leads to an inconsistent result because Courts have held that if over-encumbered property is sold free of liens, the bankruptcy estate must bear the costs of sale.[10] Furthermore, Courts have routinely held that Chapter 7 Trustees are not entitled to expenses that were incurred during periods when property is over-encumbered and could have been abandoned, as such expenses are not "necessary" within the meaning of § 506(c).[11] Similarly, with respect to compensation under § 330, the Bankruptcy Code forbids reimbursing Trustees for expenses incurred in actions not reasonably likely to benefit the estate.[12]

In analyzing a Trustee’s non-consensual sale of over-encumbered property, Judge William A. Clark explained: "Under these circumstances the court does not understand how the trustee could conclude that a sale would produce any benefit for the bankruptcy estate. Once the lack of equity for the estate became apparent to the trustee, he should have abandoned the property or at least have ceased his efforts to complete the sale of the property. In short, this sale was completely unnecessary."[13]

Creditors need to be careful when it comes to Bankruptcy Court sales. They need to file written opposition if they do not explicitly consent. Moreover, a creditor should not be lulled into a false sense of security simply because the creditor obtained relief from stay. A Bankruptcy Trustee can still sell an estate asset until the estate has been divested of ownership by the creditor’s foreclosure, the Trustee has abandoned the property, or the case has been dismissed or otherwise closed.

Footnotes

[1] Property of the estate consists of all legal and equitable interests of a debtor in property as of the commencement of the case, and also includes certain community property rights and certain future or expectancy interests.  See 11 U.S.C. § 541.

[2] § 704(a)(1)

[3] Commodity Futures Trading Com’n v. Weintraub, 471 U.S. 343, 352 (1985)

[4] Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 584 (1935).

[5] Matter of Riverside Investment Partnership, 674 F.2d 634, 640 (7th Cir. 1982) (emphasis original).

[6] See, e.g., In Re A.G. Van Metre, Jr., Inc., 155 B.R. 118, 120 (Bankr. E.D. Vir. 1993) (finding that § 363(f)(3) was satisfied where "as a result of negotiations by the trustee [secured creditor] agreed to reduce its lien to $700,000.00 in order to consummate a sale of the property.")

[7] In Re Roberts 249 B.R. 152, 155 ["There is no indication within § 363 itself or its underlying legislative history that Congress intended “consents” to have any meaning other than that which it is commonly understood to have. Consent, when used as a verb, means to give assent or approval." (citing Webster's Third New International Dictionary (unabridged) [1986]) (internal quotations omitted)

[8] See also In Re East Airport Development, LLC, 443 B.R. 823, 831 (9th Cir. BAP 2011) (citing positively, in dictum, In Re Roberts, supra, 249 B.R. at 155: "§ 363(f)(2) requires unequivocal manifestation of the lienholder's affirmation.").

[9] See In Re DeCelis, 349 B.R. 465, 474 (Interest holder's silence is not consent); In Re Silver, 338 B.R. 277, 280 (Bankr. E.D. Vir. 2004) (in rejecting the trustee's contention that failure to object constitutes "consent": "However, I am reluctant to accept silence as consent where, as here, the proceeds are not sufficient."); In Re Penniston, 206 B.R. 948, 950 (Bankr. D. Minn. 1997) (The Court, in reviewing whether a lien holder consented under § 363(f)(2): "the record does not reflect any such consent nor do I think its failure to object can necessarily be construed as consent."). "Consent" obligates the trustee to approach the lienholder and secure the lienholder's assent if the trustee wishes to sell the property free and clear of the lien.  In Re Roberts, surpa, 249 B.R. at 155.

[10] Louisville Joint Stock Land Bank, supra, 295 U.S. at 585 (FN 14; internal citation omitted).

[11] In Re Williamson, supra, 94 B.R. at 962-963; In Re Crutcher Concrete Const., Crutcher Concrete Const., 218 B.R. 376, 380; The Matter of Combined Crofts Corp., 54 B.R. 294, 297 (Bankr. W.D. Wisc. 1985); In Re National Enterprise Wire Co., 103 B.R. 56, 59 (Bankr. N.D.N.Y. 1989).

[12] Maxwell v. KPMG LLP, 520 F.3d 713, 718 (7th Cir. 2008) (citing 11 U.S.C. § 330(a)(4)(A)(ii)(I)); In Re Khan’s Corp.  184 B.R. 398, 401 (Bankr. S.D Fla. 1995) (“[B]ankruptcy estates should not be administered for the sole or primary benefit of the professionals appointed to administer such estates.”).

[13] In Re Williamson, supra, 94 B.R. at 963

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About Author: Colin Robins

Colin Robins
Colin Robins is the online editor for DSNews.com. He holds a Bachelor of Arts from Texas A&M University and a Master of Arts from the University of Texas, Dallas. Additionally, he contributes to the MReport, DS News' sister site.

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