Even if the obligation is future and contingent, the beneficiary of a covenant running with the land is entitled to actual notice of a sale “free and clear” under Section 363(f).
The Sixth Circuit held that notice by publication was constitutionally infirm, presumably entitling the creditor to enforce rights to payment that might have been cut off had there been proper notice.
The Recorded Sale of Rights
The debtor had rights to mine coal in Illinois. In 1998, a purchaser (whom we shall call the gas purchaser) paid $2.6 million for the right to extract methane from the coal bed. In a deed filed with the county clerk, the rights were characterized as a covenant running with the land.
The debtor retained the right to produce coal from the acreage. Once the debtor began producing coal, the gas purchaser could no longer extract methane. The deeded rights therefore required the debtor to pay the gas purchaser a fee in compensation for the loss of the ability to produce methane.
In 2002, four years after the gas transaction, the debtor filed a chapter 11 petition. Under Section 363(f), the debtor sold the property to a buyer, whom we shall refer to as the coal purchaser. The debtor gave notice of the sale by publication in a local and a national newspaper. The debtor did not give actual notice to the gas purchaser.
Years later, the coal purchaser applied for a permit to mine coal from the acreage. Still later, the gas purchaser sued the coal purchaser in Illinois state court, claiming an $11 million fee for the loss of ability to extract methane.
The coal purchaser responded by reopening the bankruptcy case and asking the court to enjoin prosecution of the Illinois lawsuit. The coal purchaser contended that the fee obligation was cut off by the sale free and clear.
According to the July 12 opinion by Circuit Judge Joan L. Larsen, the gas purchaser first learned about the bankruptcy when the coal purchaser reopened the bankruptcy case.
Chief Bankruptcy Judge Tracey N. Wise of Lexington, Ky., held that notice by publication did not satisfy the Due Process Clause of the Fifth Amendment. She allowed the Illinois suit to go forward and said that the prior orders had no effect on the gas buyer’s rights.
The district court affirmed, prompting the coal purchaser’s appeal to the Sixth Circuit.
When Actual Notice Is Required
Judge Larsen said that the appeal turned on the constitutional sufficiency of the notice given to the gas purchaser.
The sufficiency of notice by publication turned on whether the gas purchaser was a known or unknown creditor, Judge Larsen said. Someone whose interest cannot be ascertained with due diligence is an unknown creditor, she said.
Under Illinois law, Judge Larsen concluded that the gas purchaser had a covenant running with the land. Her conclusion made the case “straightforward.”
Judge Larsen noted that the debtor itself had granted the gas rights. The rights had not been conveyed centuries or decades earlier. Furthermore, she said that the gas buyer’s rights were “undeniably reviewed” in due diligence by the debtor and the coal purchaser.
Judge Larsen therefore held that the gas purchaser “was a known party with a known, present, and vested interest in real property; it was thus entitled to more than publication notice.”
Arguments that Failed
The coal purchaser made several arguments that failed.
For example, the coal purchaser contended that the gas purchaser was not entitled to actual notice because the obligation was not an account payable or a long-term liability shown on financial statements. Judge Larsen responded by saying that a “reasonably diligent debtor would not simply turn a blind eye to anything outside its financial statements in conducting that search.”
Because the gas purchaser’s interest was “a recorded interest in real property,” Judge Larsen found it “difficult to believe that [the debtor] could not reasonably identify [the gas purchaser’s] recorded interest only a few years after it conveyed that same interest.” She said that the gas purchaser’s address and that of its registered agent had been unchanged since 1998.
Judge Larsen distinguished cases holding that notice by publication was sufficient. The case on appeal, she said, did not involve “speculative tort or tort-like claims by plaintiffs whose interests were not reasonably ascertainable by the debtor at the time of bankruptcy.”
Judge Larsen also rejected the idea that the gas purchaser’s interest was a future, conjectural or speculative claim for which notice by publication would be sufficient. “Quite the opposite,” she said. The covenant running with the land “was a present, vested, and readily ascertainable interest in real property that was held by a known party.”
Judge Larsen likewise rejected policy arguments based on a federal interest in the finality of bankruptcy sales. The argument, she said, ignored how the bankruptcy power is subject to the Fifth Amendment.
Judge Larsen therefore held that “publication notice was constitutionally deficient” and found no error in allowing the Illinois suit to proceed.
Even if the obligation is future and contingent, the beneficiary of a covenant running with the land is entitled to actual notice of a sale “free and clear” under Section 363(f).
The Sixth Circuit held that notice by publication was constitutionally infirm, presumably entitling the creditor to enforce rights to payment that might have been cut off had there been proper notice.
The Recorded Sale of Rights
The debtor had rights to mine coal in Illinois. In 1998, a purchaser (whom we shall call the gas purchaser) paid $2.6 million for the right to extract methane from the coal bed. In a deed filed with the county clerk, the rights were characterized as a covenant running with the land.
The debtor retained the right to produce coal from the acreage. Once the debtor began producing coal, the gas purchaser could no longer extract methane. The deeded rights therefore required the debtor to pay the gas purchaser a fee in compensation for the loss of the ability to produce methane.
In 2002, four years after the gas transaction, the debtor filed a chapter 11 petition. Under Section 363(f), the debtor sold the property to a buyer, whom we shall refer to as the coal purchaser. The debtor gave notice of the sale by publication in a local and a national newspaper. The debtor did not give actual notice to the gas purchaser.
Years later, the coal purchaser applied for a permit to mine coal from the acreage. Still later, the gas purchaser sued the coal purchaser in Illinois state court, claiming an $11 million fee for the loss of ability to extract methane.
The coal purchaser responded by reopening the bankruptcy case and asking the court to enjoin prosecution of the Illinois lawsuit. The coal purchaser contended that the fee obligation was cut off by the sale free and clear.
According to the July 12 opinion by Circuit Judge Joan L. Larsen, the gas purchaser first learned about the bankruptcy when the coal purchaser reopened the bankruptcy case.
Chief Bankruptcy Judge Tracey N. Wise of Lexington, Ky., held that notice by publication did not satisfy the Due Process Clause of the Fifth Amendment. She allowed the Illinois suit to go forward and said that the prior orders had no effect on the gas buyer’s rights.
The district court affirmed, prompting the coal purchaser’s appeal to the Sixth Circuit.