This article discusses the issues and opportunities for brokers and their customers when bankruptcy or its specter intervene in a home sale.
At any given time, there is a multitude of home sales that will be affected when a buyer or seller enters a bankruptcy proceeding. Though the number of individual bankruptcy filings declined dramatically after the 2005 effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA),[1] recent statistics show a marked increase in filings. Even before news of the volatile credit, securities and real estate markets and the national crisis in subprime mortgages and real estate development, total bankruptcy filings rose 48 percent in the first half of 2007. As filings rise, so does the prospect of bankruptcy in otherwise ordinary home sales.
Rather than blocking possible sales, bankruptcy tends to reinforce the drive to sell. Thus, both brokers who have labored to sell or purchase a home for a customer or an “outside” broker who is willing to risk her time to pursue a sale can benefit from the process.
While bankruptcy does not doom a sale, it surely complicates it. A seller’s financial condition affects a closing if there are judgments pending. An insolvent buyer’s problems will affect his ability to close and get financing.
Banks and brokers are also affected by bankruptcy. Frequently a condominium sponsor goes into bankruptcy, thus jeopardizing multiple closings. Though not addressing bankruptcies of condominium sponsors, many issues affecting sponsor filings are alluded to in this paper.
The Seller or Buyer Files
Let’s say your customer was not the successful bidder on a negotiation for a home purchase, the seller and the buyer have signed a contract of sale and the seller then files or is threatened with bankruptcy. There is a good chance that the home will be back on the market.
If the buyer files after the contract is signed, it's unlikely that he can close, or that the bankruptcy court will approve the purchase. If the seller files a petition, bankruptcy rules and practices likely will reopen the sale process. Aside from the “automatic stay” discussed below, the unclosed contract of sale is an "executory contract.” Bankruptcy court approval of the debtor’s assumption or rejection of the executory contract is required. Notice to creditors and interested parties is required for any proposed asset sale or executory contract assignment, enabling others to make higher and better offers for the home. Practically, there will be an auction sale of the home instead of an ordinary closing.
Two of the most commonly applied sections from the Code relate to (a) assumption or rejection of executory contracts[2] and (b) sale of estate assets.[3] Often defined as contracts where both parties have material obligations remaining to be performed, executory contracts in the real estate area include a real estate lease, a contract of sale that has not closed and a brokerage agreement where the home sale has not closed. An executory contract is property of the estate subject to the protection of the automatic stay. The Code governs time limitations and procedures for the DIP, the trustee or the chapter 13 debtor to elect to assume or reject executory contracts. Ccreditors and parties in interest may move in the bankruptcy court to lift the stay and a counterparty may move to compel assumption or rejection of executory contracts.[4]
Property of the estate may only be sold or assigned after notice is given to creditors and parties in interest, a hearing is held and a court order is entered (a) approving the sale or assignment, (b) finding that due notice has been given to creditors and interested parties, (c) finding that the sale or assignment is a reasonable exercise of business judgment of the seller representing the bankruptcy estate, and (d) determining that the sale terms are in the best interests of the estate and its creditors.[5]
The last point deserves emphasis. Bankruptcy court approval will be given only if the sale or assignment confers a benefit upon the estate. If a home has inconsequential value, such as a home with mortgage(s) exceeding the market value or sale price, it should be abandoned by the Trustee/DIP.[6] Once abandoned, it is no longer estate property protected by the stay. Thus, a home should be sold and assigned if there will be a profit beyond liens (mortgages), transaction costs (taxes, fees and commissions) and cure costs. The profit will be deposited into the estate bank account for distribution to creditors.
Because bankruptcy is a federal court proceeding, the courts and the participants are vigilant to project fairness in the process to protect the estate and its creditors. The sale notice to creditors and parties in interest should (a) state the terms and conditions of the proposed sale and (b) solicit "higher or better offers." Thus, virtually all sales can become public auctions. Transparency is central to the bankruptcy process. If a broker or buyer takes or threatens action against a competitive bidder, the court may find that action to be interference with estate property by chilling the bidding, hold the offender in contempt, deny her any commissions and disqualify her customer from bidding or buying.[7]
Apart from lengthy state court foreclosure proceedings, only bankruptcy courts have the unique power to authorize and approve sales "free and clear" of mortgages, claims, liens and encumbrances;[8] the bankruptcy sale process takes place a lot faster than foreclosure sales. Buyers of distressed assets and businesses often favor bankruptcy sales for the assurance of clean title because they can obtain bankruptcy court approval of a free and clear sale and a court finding that the buyer is a “good faith purchaser.”[9] With such a finding, the closing of the sale is final and the sale order can not be reversed on appeal unless the appellant obtains a court stay of closing—usually requiring the appellant to file a substantial appeal bond.
The Broker as a “Professional Person”
Real estate brokers for the trustee or DIP are “professional persons” under §327(a) of the Code and Rule 2014 of the Rules of Bankruptcy Procedure. Prior bankruptcy court approval of both her engagement and her compensation arrangements is required in order for the broker to receive a commission. The process is not complicated, but it is necessary, and brokers ignoring the rules are playing with fire. For the seller’s broker, the first step is seeking a letter agreement with the trustee or DIP spelling out the engagement and fashioned to address the bankruptcy case and the home involved. Professional persons are required to be disinterested, which means, among other things, they cannot be creditors, partners or relatives of the debtor and they cannot hold or represent any interest adverse to the estate. Consequently, the broker for the estate cannot represent anyone else in connection with the sale. Sharing of commissions is forbidden.[10] Nevertheless, retained brokers can and should agree to reduce their commissions to allow a separate commission to be paid to a nonretained buyer’s broker as an approved cost of the deal and, when appropriate, should encourage participation of a buyer’s broker for a mere spirited auction and a higher sale price. The engagement letter must then be approved by court order.
Prior to a sale of the home, the court generally will approve bidding procedures that set forth the submission of bids for the home, bidding increments, deposits to be submitted with bids and the location and procedures of the auction (usually the counsel’s office or the bankruptcy judge’s courtroom).
Soon after the auction, the home sale must be approved by court order. It is good practice to include in the order a finding that the broker/agent has procured the sale and earned her commission and authorizing payment of the commission at closing. If a commission award is not made before sale closing, a broker/agent will have to file with the court a separate application for her commission on notice to creditors and wait until the court approves the application. Thus, without early diligence, payment of a commission will be delayed.
In instances where the court requires brokers to file applications for compensation after the sale is closed, it is desirable to have the commission escrowed with the trustee or DIP at the time of closing. In the home sale setting, the broker, salesman and agent are agents and advocates for their respective clients. The laws of agency require brokers to exercise loyalty, due care and good faith in behalf of their customers.
Conclusion
In this digital age, in many districts virtually all documents are filed electronically and can be accessed from a computer terminal, assuming one has a password for access to the court’s documents. Most lawyers practicing in federal courts have such passwords, so if the broker is not a lawyer herself, she should ask her lawyer to check the electronic court docket for her. Whether or not the broker gets electronic access to the court file, the broker should find out contact information for officers and professional persons involved in the bankrupt estate, become familiar with the effect of the automatic stay, the process of asset sales and the requirement of court approvals for engagement of the broker as a professional person and approval of a home sale. A broker already invested in the deal (for seller or buyer) at the time of filing should have her lawyer serve and file a notice of appearance in the bankruptcy case. The broker should communicate with the trustee and other estate representatives early to educate them as to how the broker will aid the estate by facilitating a sale.
Time of the essence clauses are helpful and important. They need to be drafted so that the closing is after court approval. When all approvals have been obtained, such a clause is appropriate.
The following suggestions are not exhaustive. Your counsel should advise you of local legal requirements.
1. Call/write to the trustee or DIP and/or their attorney. Since much of the pre-contract process in bankruptcy has legal ramifications, knowing the bankrupt estate’s representatives at an early stage is critical. Early communication pays dividends later.
2. Your company’s bankruptcy counsel should be given the trustee or DIP contact information and review the petition and relevant filings to (a) ascertain the sale timetable and intended procedures and (b) learn if a selling broker has been retained to market and sell the property. Provide your firm’s marketing information to the trustee or DIP.
3. If you have a chance to represent a seller, after talking with the trustee, DIP or his counsel, have the bankruptcy counsel draft an engagement letter (the equivalent of a listing agreement) to memorialize the engagement and compensation. If another broker has been engaged to represent the seller, seek a copy of the engagement letter and (proposed) court order to confirm protections for the buyer’s broker.
4. If you represent a buyer, provide to your customer information from the court file and encourage the customer to seek counsel with bankruptcy experience. Insights and experience will enhance the prospect of success. Send a letter to the customer confirming that you are his broker/agent.
5. Seek a meeting with the trustee of DIP and your counsel to confirm the sale process and acquaint the trustee with your customer’s bid. A trustee’s or DIP’s principal goals are to liquidate assets and make distributions to creditors. As the estate representative, the trustee or DIP will seek court approval, not only to sell the home, but also to remove the personal property and any occupants.
6. As the sale process advances, communicate with creditors’ committee counsel and ask what you can do to assure closing.
7. If your customer will be a bidder, have your company’s counsel file a “Notice of Appearance” in the case identifying the brokerage firm as a party in interest. In this way, notices of motions and hearings will be sent to your counsel.
8. Armed with information and insight (a) have patience, (b) work the sale, (c) don’t antagonize/overwhelm the trustee/DIP and (d) provide to the trustee/DIP evidence of the buyer’s strength.
9. As buyer’s broker, explain to your customer that the contract usually is the “opening bid” that will be subject to higher bids at an auction, which the customer and his counsel should attend.
10. To protect the buyer, his counsel should negotiate bidding protections, including a breakup fee, a topping bid, a timetable for receiving bids, a prohibition against conditional bids and minimum bidding increments when the auction begins.
11. A less complicated bid is more attractive to the trustee/DIP. Try to avoid financing or other conditions.
[1] S.256, Pub. L. No. 109-8, 119 Stat. 23. BAPCPA was enacted on April 20, 2005 and became effective on October 17, 2005.
[2] 11 U.S.C. §365(a). In a case under chapter 7, if the chapter 7 trustee does not assume or reject an executory contract for residential real property within 60 days after the date of the bankruptcy petition (or as extended by court order), the contract is deemed rejected. 11 U.S.C. §365(d)(1).
[3] 11 U.S.C. §363(b).
[4] 11 U.S.C. §362(d) (standard for lifting automatic stay); 11 U.S.C. §365(d)(2) (in the context of residential real property executory contracts, any party to the contract can move the court to order the trustee to determine whether to assume or reject the contract).
[5] See, e.g., Myers v. Martin (In re Martin), 91 F.3d 389, 395 (3d Cir. 1996); In re Enron Corp., S.D.N.Y. 2005); In re Montgomery Ward Holding Corp., 242 B.R. 147, 153 (D. Del. 1999).
[6] 11 U.S.C. §554.
[7] See, e.g., Hower v. Molding Systems Engineering Corp., 445 F.3d 935, 938 (7th Cir. 2006) (bankruptcy asset sale may be challenged after closing if there was collusion, fraud or the sale otherwise manifests bad faith.); In re Cameron Shoe Corp., 12 F.2d 103, 104 (S.D. Cal. 1926) (parties who agreed to control bidding at a sale of assets by bankruptcy trustee held guilty of contempt).
[8] 11 U.S.C. §363(f).
[9]11 U.S.C. §363(m).
[10] 11 U.S.C. §504(a).