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Yours, Mine, and Ours: May a Bankruptcy Court Authorize the Sale of a Co-Owner’s Interest Free and Clear of Its Creditors’ Claims?

Business Law

Few sections of the Bankruptcy Code[1] have received as much attention as §363(f). Yet, surprisingly, only a handful of decisions have evaluated whether a bankruptcy court may authorize a sale free and clear of a non-debtor’s creditors’ claims. As a whole, §363 is designed to strike a balance between the competing needs for debtors’ continuing operations with protecting secured creditors from dissipating collateral. This equation is complicated further when the interests of co-owners must be accounted for. To understand how the pertinent sections operate in conjunction it is necessary to first examine how §§363(f)(4) and (h) operate separately.

Section 363 Background

A Ch. 11 debtor may use or sell property in the ordinary course of business if 1) the business of the debtor is authorized; 2) the court has not previously ordered otherwise; and 3) as for cash collateral, certain conditions are met.[2]

But a debtor may sell property not in the ordinary course of business only after notice and a hearing.[3]

Approval of §363(b) transactions requires that the bankruptcy court find that the debtor justify [ ] the proposed transaction. That is, for the debtor-in-possession…to satisfy its fiduciary duty to the debtor, creditors and equity holders, there must be some articulated business justification for using, selling, or leasing the property outside the ordinary course of business.[4]

In determining whether a transaction is in the ordinary course of business, courts typically analyze the matter across two dimensions — vertical and horizontal.[5] The vertical dimension focuses internally, comparing the debtor’s own pre-petition and post-petition conduct.[6] In contrast, the horizontal dimension focuses externally, comparing the debtor’s operations to those industry-wide.[7]

Whether or not the sale is in the ordinary course, to carry out Congress’ objectives, the Bankruptcy Code contains two important sections that allow for the sale to be free and clear of interests.

First, §363(f)(4) facilitates a free-and-clear sale of any interests that are in bona fide dispute.[8] The rationale is straight forward — unencumbered property will generate a higher sales price while the released interest is still protected (for example, by a claim to the sales proceeds). The Bankruptcy Code does not define what a bona fide dispute is.[9] “However, bankruptcy courts have held that the standard for determining if such a dispute exists is, whether there is an objective basis for either a factual or a legal dispute as to the validity of the asserted interest.”[10] “Clearly this standard does not require the Court to resolve the underlying dispute, just determine its existence.”[11] Indeed, the debtor need not have even filed an adversary proceeding to show a bona fide dispute.[12]

Second, §363(h) permits a trustee may sell not only the estate’s interest in property but that of a co-owner as well.[13] The co-owner’s interest must be that of a tenant in common, joint tenant, or tenant by the entirety.[14] And even then, the co-owner’s interest may be extinguished only if:

1) partition in kind of such property among the estate and such co-owners is impracticable;

2) sale of the estate’s undivided interest in such property would realize significantly less for the estate than sale of such property free of the interests of such co-owners;

3) the benefit to the estate of a sale of such property free of the interests of co-owners outweighs the detriment, if any, to such co-owners; and

4) such property is not used in the production, transmission, or distribution, for sale, of electric energy or of nature or synthetic gas for heat, light, or power.[15]

“Moreover, [§]363(h) of the Code permits the sale of property which is jointly owned without regard to consent or applicable non-bankruptcy law.”[16] Or put another way, §363(h) operates only when the co-owner objects to the process.[17] Sections 363(f)(4) and (h) invite the question, do they work in tandem such that a debtor could sell property free and clear of disputed interests in the co-owner’s interest in the property? Few cases have delved into the intersection of these provisions and, of those that have, there is conflicting authority on the bankruptcy court’s authority to proceed forward.

Majority View: A Bankruptcy Court May Permit Such a Sale

The issue of the intersection of §363(f)(4) and (h) was taken up in Barnes v. Barnes (In re Barnes) upon a motion to dismiss the complaint in an adversary proceeding.[18] There, the debtor filed a complaint to obtain court approval for the sale of both her interest and her non-filing husband’s interest in residential real property, but the husband’s interest was encumbered by several mortgages, tax liens, and judgment liens.[19] Two judgment lienholders, whose liens only extended to the non-debtor spouse, each moved to dismiss for failure to state a claim on which relief could be granted.[20] These judgment lienholders argued that §363(h) “does not reference free and clear authority or provide for adequate protection of their liens. [Therefore, they] submit that the Court cannot order a sale pursuant to §363(h) because a sale under §363(h) would otherwise fail to provide them with adequate protection.”[21]

The court had two responses to the lienholders’ arguments — textualism and practicality. First, looking to the text itself, §363(h) begins “[n]otwithstanding section (f) of this section, the trustee may sell both the estate’s interest, under subsection (b) or (c) of this section, and the interest of any co-owner in property….”[22] Therefore, “subsection h’s ‘notwithstanding’ clause simply and expressly authorizes that the non-debtor interest may also be sold with the estate’s interest.”[23] Second, the court noted that even if §363(h) is silent, §§105, 361, and 363(e) are all potential vehicles for adequate protection.[24] Thus, the competing goals of advancing a bankruptcy case while protecting creditors is still accomplished. Ultimately, the court denied the motions to dismiss and permitted the trial to proceed forward, in turn meaning the sale could proceed forward if the debtor met her remaining burdens.[25]

Likewise, the court tackling the matter in Hull v. Bishop (In re Bishop), 554 B.R. 558 (Bankr. D. Me. 2016), permitted a sale free and clear of a disputed mortgage on both the debtor and non-filing husband’s interest. Here, the Ch. 7 trustee sought to avoid a mortgage on real property owned jointly by the debtor and her non-filing spouse.[26] The court first notes that “TD Bank is correct that [§]363(f) authorizes sale free and clear, and that [§]363(h), on its face, does not.”[27] In the court’s opinion that alone did not compel the result the bank sought.[28]

The court went on to state that “[i]f the property were jointly owned, but not encumbered by a mortgage lien, the trustee could sell both ownership interests using a combination of subsections 363(b), (f), and (h).”[29] The court further remarked:

In those circumstances, the co-owner would be protected by subsections 363(i) and (j). See 11 U.S.C. §363(i) (granting, in a sale under subsection (h), a right of first refusal to the co-owner); 11 U.S.C. §363(j) (directing, in a sale under subsection (h), the trustee to distribute the net proceeds to the co-owner according to its interest in the property).[30]

Simply put, “[t]here is no good reason why the result should be different here.”[31] It is worth noting, the court also identifies §105, which authorizes the courts to issue orders necessary and appropriate so long as they do not contravene other sections, to sell the property free and clear of the co-owner’s interest.[32]

Minority View: A Bankruptcy Court’s Limited Authority Does Not Permit This Course

Not all cases exploring the issue have come out in favor of this extraordinary sale process. In In re Marko, No. 11-31287, 2014 WL 948492, at *2 (Bankr. W.D.N.C. Mar. 11, 2014), the Ch. 7 trustee sought to sell real property owned by the debtor and the debtor’s parents free and clear of a mortgage on the parents’ interest. The court began its analysis by conceding there are authorities in favor of permitting the sale, or at least compatible with the purpose behind the section.[33]

“However, the Eighth Circuit has cautioned that courts should use the free and clear power with caution — meaning they should carefully consider their jurisdictional limitations — when the bona fide dispute concerns only the rights of third parties vis a vis one another and is not a dispute with the debtor.”[34] The court further found that this sentiment is particularly appropriate given two fundamental principles guiding bankruptcies.[35] First, that bankruptcy courts act within limited jurisdiction, and, second, that bankruptcy relief is seldomly afforded to non-debtors.[36] In light of these reasons, the court found that the trustee could not sell free and clear of disputed interests in the parents’ interest.

Other courts have denied the relief based on procedural grounds. Some courts have found that such relief is only appropriate in the context of an adversary. For instance, in In re Romano, 378 B.R. 454, 471-72 (Bankr. E.D. Pa. 2007), the court contrasted the language in Fed. R. Bankr. P. 6004(c), which permits the sale of property free and clear by motion, with that of Rule 7001(3), which requires an adversary proceeding for the sale of co-owners’ interests.[37]

Some courts have gone even further, finding the mere filing of an adversary is insufficient and the case must come to full fruition. In one instance, the debtor filed an adversary proceeding seeking to determine the validity of an interest in property and to sell property under §363(h).[38] While that adversary proceeding was pending, the debtor moved for authority to sell the subject real property.[39] The court denied the sale motion stating that “[t]he instant [m]otion cannot be granted when there has been no adjudication in the adversary proceeding.”[40]

Consent Should Be Sought Whenever Possible

There are scant few cases that have squarely addressed the interplay between these two Bankruptcy Code sections. The majority support the proposition that the trustee is allowed to sell property free and clear of interests against a co-owner. This furthers, and simplifies, a bankruptcy case by liquidating property unnecessary for reorganization. This outcome also tracks the general trend among cases that broadly interprets an “interest” under §363(f)(4).[41]

Even so, practitioners should consider the conflicting minority opinions. As a practical matter, whenever possible, the party desirous of selling should attempt to obtain the consent of the interested party, the co-owner, or both. Consent of the interested party is grounds under §363(f)(2) to sell property free and clear of the interest.[42] This will eliminate anticipated objections and the evidentiary burden the debtor must bear, thus, saving expense. Similarly, consent of the co-owner is grounds to remove the equation from §363(h).[43] This will eliminate the need for an adversary proceeding, thus, saving time. Either consent will present immense savings to the estate. In sum, it would appear, when pressed, a debtor may file an adversary under §§363(f)(4) and (h) to reach its desired result, but the cost and time of doing so may ultimately cannibalize the value before getting there.

[1] 11 U.S.C. §§101-1531.

[2] 11 U.S.C. §363(c).

[3] 11 U.S.C. §§363(b).

[4] In re ASARCO LLC, 441 B.R. 813, 823 (S.D. Tex. 2010) (internal quotations omitted).

[5] U.S. ex rel. Harrison v. Estate of Deutscher, 115 B.R. 592, 598 (M.D. Tenn. 1990).

[6] Id.

[7] Id.

[8] 11 U.S.C. §363(f)(4).

[9] In re Daufuskie Island Props., LLC, 431 B.R. 626, 646 (Bankr. D.S.C. 2010).

[10] Id. (internal quotations omitted).

[11] In re Collins, 180 B.R. 447, 452 (Bankr. E.D. Va. 1995).

[12] See, e.g., In re Oneida Lake Dev., Inc., 114 B.R. 352, 358 (Bankr. N.D.N.Y. 1990).

[13] 11 U.S.C. §363(h).

[14] Id.

[15] Id.

[16] In re Murray, 31 B.R. 499, 502 (Bankr. E.D. Pa. 1983).

[17] Veltman v. Whetzal, 93 F.3d 517, 522 (8th Cir. 1996).

[18] In re Barnes, Adv. Pro. No. 19-02025 (JJT)2019 Bankr. LEXIS 3839, at **4-6 (Bankr. D. Conn. Dec. 19, 2019).

[19] Id. at **2-4.

[20] Id. at *4.

[21] Id. at *14.

[22] Id. at *12 (emphasis added).

[23] Id. at *14.

[24] Id. at **15-16.

[25] Id. at **16-17.

[26] In re Bishop, 554 B.R. at 559.

[27] Id. at 567.

[28] Id.

[29] Id.

[30] Id.

[31] Id.

[32] Id.

[33] In re Marko, No. 11-31287, 2014 WL 948492, at *11 (Bankr. W.D.N.C. Mar. 11, 2014). (“There is precious little cause authority on this point, and what there is appears to be conflicting. In In re Gerwer, the Ninth Circuit held that a trustee could exercise his powers under §363(f)(4) even when the bona fide dispute was not between the debtor and a lienholder, but between the lienholders on the property, provided that the dispute could indirectly affect the bankruptcy estate. 898 F.2d 730, 733 (9th Cir. 1990). ‘[T]he purpose behind §363(f)(4) is to allow the sale of estate property free and clear of disputed interests so the liquidation of assets is not unnecessarily delayed while the disputes are being litigated.’ In re N.J. Affordable Homes Corp., No. 05-60442, 2006 Bankr. LEXIS 4498, 2006 WL 2128624, at *10 (Bankr. D. N.J. June 29, 2006) (citations omitted). Admittedly, selling a co-owned asset free and clear of a disputed lien is congruent with that purpose.”).

[34] Id. (citing Mo. v. U.S. Bankr. Ct., 647 F. 2d 768, 778 (8th Cir. 1981)).

[35] In re Marko, 2014 WL 948492, at **11-12.

[36] Id. (“The [p]arents could not effectuate such a sale under state law. Thus, it is clear that a ruling in favor of the [t]rustee would, effectively, extend bankruptcy relief to these non-debtor parties.”).

[37] In re Romano, 378 B.R. 454, 471-72 (Bankr. E.D. Pa. 2007); see also In re Gong, 2016 Bankr. LEXIS 232, **6-8 (Bankr. C.D. Cal. 2016).

[38] In re Haile, Case No. 17-00091, 2017 Bankr. LEXIS 1385, at **1-2 (Bankr. D.D.C. May 17, 2017).

[39] Id.

[40] Id. (noting there was not even a trial scheduling order yet and that there could be significant intervening developments such as fluctuations in the property value).

[41] See, e.g., Elliott v. General Motors LLC (In re Motors Liquidation Co.), 829 F.3d 135, 155 (2d Cir. 2016) (“At minimum, the language in §363(f) permits the sale of property free and clear of in rem interests in the property, such as liens that attach to the property. But courts have permitted a broader definition that encompasses other obligations that may flow from ownership of the property. Sister courts have held that §363(f) may be used to bar a variety of successor liability claims that relate to ownership of property: an ‘interest’ might encompass Coal Act obligations otherwise placed upon a successor purchasing coal assets, travel vouchers issued to settle an airline’s discrimination claims in a sale of airline assets, or a license for future use of intellectual property when the property is sold.”) (internal citations omitted).

[42] 11 U.S.C. §363(f)(2) (“The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if — … (2) such entity consents…”).

[43] Veltman v. Whetzal, 93 F.3d 517, 522 (8th Cir. 1996).

Daniel Etlinger Daniel Etlinger is a partner with Jennis Morse Etlinger in Tampa. He is a frequent speaker on bankruptcy topics including at the 2023 Alexander L. Paskay Memorial Bankruptcy Seminar. He is also the credit abuse resistance education liaison for the Tampa Bay Bankruptcy Bar Association.

This column is submitted on behalf of the Business Law Section, Douglas A. Bates, chair, and Utibe Ikpe and Luis Rivera, editors.

Business Law