Debtors Cannot Sell Unsecured Creditor's Collateral

Under a common Chapter 11 scenario, a debtor and its prepetition lender agree to the filing of a Chapter 11 proceeding with the goal of selling the lender's collateral (either to a third party or to the lender) pursuant to 11 U.S.C. Section 363. The purchaser will acquire the assets free and clear of liens, claims and encumbrances and the lender's liens will attach to the sale proceeds. The lender therefore benefits from an expeditious and efficient sale process and, in exchange, usually agrees to provide a modest carve-out for unsecured creditors.

A Rare Scenario

However, in In re Ferris Properties, No. 14-10491 (MFW) (Bankr. D. Del. July 30, 2015), U.S. Bankruptcy Judge Mary F. Walrath of the District of Delaware was faced with a relatively rare scenario. In that case, the debtors owned 37 parcels of real estate. After selling 26 parcels, the debtors sought to sell the remaining 11 parcels for $240,000 to a purchaser under a “bulk sale” agreement. The sale proceeds would be less than the outstanding indebtedness to the first lien lender, Wells Fargo Bank. Wells Fargo objected to the sale.

Under Section 363(f) of the Bankruptcy Code, a debtor may sell property free and clear of a third-party's liens, claims and encumbrances only if that party “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction” of that party's interest in the property. The debtor argued that Wells Fargo could be compelled to accept a money satisfaction under 11 U.S.C. Section 724(b)(2), 11 U.S.C. Section 1129(b)(2)(A), a state court “monition sale,” or a partition sale. The debtors also argued that Wells Fargo consented to the sale, within the meaning of 11 U.S.C. Section 363(f), by filing a defective objection to the sale. Walrath rejected each argument.

A Mortgage, Not a Tax Lien

Section 724(b)(2) subordinates certain tax liens to administrative expenses. In In re Grand Slam U.S.A., 178 B.R. 460 (E.D. Mich. 1995), the court held that Section 724(b), in conjunction with Section 363(f)(5), could sustain a sale over a tax lien creditor's objection. Judge Walrath rejected the application of Section 724(b), noting that Wells Fargo was a first lien mortgagor and not the holder of a tax lien.

Walrath noted that courts are divided as to whether the cramdown provisions of 11 U.S.C. Section 1129(b)(2)(A) may support a sale over a lender's objection. (Compare In re Terrace Chalet Apartments, 159 B.R. 821, 829 (N.D. Ill. 1993), holding that Section 1129(b)(2)(A) may satisfy Section 363(f), with In re PW LLC, 391 B.R. 25, 46 (B.A.P. 9th Cir. 2008), holding that cramdown provisions of Section 1129(b)(2)(A) may not satisfy the requirements of Section 363(f).) She concluded, however, that Section 1129(b)(2)(A) was inapplicable to this case, because there was no evidence that the debtors could satisfy any of the cram-down requirements (i.e., Wells Fargo was not retaining its liens, was not receiving deferred cash payments equal to the amount of its allowed claim and was not receiving the indubitable equivalent of its claim).

Delaware Law

Under Delaware law, property that is subject to delinquent taxes may be sold to a third party free and clear of liens, claims and encumbrances in order to satisfy the existing tax liabilities. The debtors argued that eight of the 11 properties were delinquent on payment of county taxes, the county could conduct a “monitions sale” and Wells Fargo could be forced to accept, in satisfaction of lien, the sale proceeds net of delinquent taxes. Wells Fargo successfully argued that it could not be forced to accept a money satisfaction of its claim for two reasons: First, it could satisfy the delinquent taxes and thereby prevent a sale; second, it could redeem the properties post-sale.

The debtors next argued that Wells Fargo could be compelled to accept a money satisfaction of its interests in partition sale under Title 25, Section 732 of the Delaware Code. Under that section, a court may order the sale of property held by joint tenants or tenants in common free and clear of all ownership interests. Walrath refused to extend the scope of this statute to lien holders.

Finally, the debtors argued that Wells Fargo had not properly objected to the sale and thus should be deemed to consent to the sale. The debtors' argument was based on the fact that, in its sale objection, Wells Fargo identified 13 properties on which it alleged that it held liens. However, the liens on two of those properties had been satisfied. Walrath held that any defect in the objection was insignificant and could not support a finding of consent.

Having rejected each of the debtors' arguments, Walrath upheld Wells Fargo's sale objection.

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington, DE, office. This article also appeared in the Delaware Business Court Insider, an ALM sister publication of this newsletter.

Under a common Chapter 11 scenario, a debtor and its prepetition lender agree to the filing of a Chapter 11 proceeding with the goal of selling the lender's collateral (either to a third party or to the lender) pursuant to 11 U.S.C. Section 363. The purchaser will acquire the assets free and clear of liens, claims and encumbrances and the lender's liens will attach to the sale proceeds. The lender therefore benefits from an expeditious and efficient sale process and, in exchange, usually agrees to provide a modest carve-out for unsecured creditors.

A Rare Scenario

However, in In re Ferris Properties, No. 14-10491 (MFW) (Bankr. D. Del. July 30, 2015), U.S. Bankruptcy Judge Mary F. Walrath of the District of Delaware was faced with a relatively rare scenario. In that case, the debtors owned 37 parcels of real estate. After selling 26 parcels, the debtors sought to sell the remaining 11 parcels for $240,000 to a purchaser under a “bulk sale” agreement. The sale proceeds would be less than the outstanding indebtedness to the first lien lender, Wells Fargo Bank. Wells Fargo objected to the sale.

Under Section 363(f) of the Bankruptcy Code, a debtor may sell property free and clear of a third-party's liens, claims and encumbrances only if that party “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction” of that party's interest in the property. The debtor argued that Wells Fargo could be compelled to accept a money satisfaction under 11 U.S.C. Section 724(b)(2), 11 U.S.C. Section 1129(b)(2)(A), a state court “monition sale,” or a partition sale. The debtors also argued that Wells Fargo consented to the sale, within the meaning of 11 U.S.C. Section 363(f), by filing a defective objection to the sale. Walrath rejected each argument.

A Mortgage, Not a Tax Lien

Section 724(b)(2) subordinates certain tax liens to administrative expenses. In In re Grand Slam U.S.A., 178 B.R. 460 (E.D. Mich. 1995), the court held that Section 724(b), in conjunction with Section 363(f)(5), could sustain a sale over a tax lien creditor's objection. Judge Walrath rejected the application of Section 724(b), noting that Wells Fargo was a first lien mortgagor and not the holder of a tax lien.

Walrath noted that courts are divided as to whether the cramdown provisions of 11 U.S.C. Section 1129(b)(2)(A) may support a sale over a lender's objection. (Compare In re Terrace Chalet Apartments, 159 B.R. 821, 829 (N.D. Ill. 1993), holding that Section 1129(b)(2)(A) may satisfy Section 363(f), with In re PW LLC, 391 B.R. 25, 46 (B.A.P. 9th Cir. 2008), holding that cramdown provisions of Section 1129(b)(2)(A) may not satisfy the requirements of Section 363(f).) She concluded, however, that Section 1129(b)(2)(A) was inapplicable to this case, because there was no evidence that the debtors could satisfy any of the cram-down requirements (i.e., Wells Fargo was not retaining its liens, was not receiving deferred cash payments equal to the amount of its allowed claim and was not receiving the indubitable equivalent of its claim).

Delaware Law

Under Delaware law, property that is subject to delinquent taxes may be sold to a third party free and clear of liens, claims and encumbrances in order to satisfy the existing tax liabilities. The debtors argued that eight of the 11 properties were delinquent on payment of county taxes, the county could conduct a “monitions sale” and Wells Fargo could be forced to accept, in satisfaction of lien, the sale proceeds net of delinquent taxes. Wells Fargo successfully argued that it could not be forced to accept a money satisfaction of its claim for two reasons: First, it could satisfy the delinquent taxes and thereby prevent a sale; second, it could redeem the properties post-sale.

The debtors next argued that Wells Fargo could be compelled to accept a money satisfaction of its interests in partition sale under Title 25, Section 732 of the Delaware Code. Under that section, a court may order the sale of property held by joint tenants or tenants in common free and clear of all ownership interests. Walrath refused to extend the scope of this statute to lien holders.

Finally, the debtors argued that Wells Fargo had not properly objected to the sale and thus should be deemed to consent to the sale. The debtors' argument was based on the fact that, in its sale objection, Wells Fargo identified 13 properties on which it alleged that it held liens. However, the liens on two of those properties had been satisfied. Walrath held that any defect in the objection was insignificant and could not support a finding of consent.

Having rejected each of the debtors' arguments, Walrath upheld Wells Fargo's sale objection.

Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington, DE, office. This article also appeared in the Delaware Business Court Insider, an ALM sister publication of this newsletter.