Even if a creditor had constitutionally adequate constructive notice of a bankruptcy sale, the Seventh Circuit is saying that the buyer will not be in good faith and will not have protection from Section 363(m) if the buyer knew about a creditor’s interest in the property but did not give actual notice.
Three years before bankruptcy, the creditor was given a right of first refusal to buy the debtor’s real property. The ROFR was recorded with the land records.
In chapter 11, the debtor did not schedule the ROFR. Alongside a confirmed chapter 11 plan, Bankruptcy Judge Susan V. Kelley, now retired, approved the sale of the property free and clear of all liens, claims and encumbrances. No one told her about the ROFR.
According to the April 4 opinion for the Seventh Circuit by Circuit Judge Frank H. Easterbrook, the buyer evidently had run a title search and had a copy of the ROFR before the bankruptcy sale.
Although the debtor obviously knew about the ROFR, neither the debtor nor the buyer gave the creditor actual notice of the bankruptcy or the sale. In fact, Judge Easterbrook said that the buyer did not give notice to the creditor even after the creditor’s lawyer inquired about one week before the pending sale.
In other words, the creditor might have had constitutionally adequate constructive notice of the sale but was not given actual notice.
Four years after the chapter 11 sale, the buyer resold the property to a third party. The creditor responded with a suit in state court seeking damages from the original buyer for disregarding the ROFR.
The original buyer returned to bankruptcy court, aiming to enforce the “free and clear” aspects of the sale. Bankruptcy Judge Kelley refused to enjoin the suit in state court under Section 363(m), and the district court affirmed. See Archer-Daniels Midland Co. v. Country Visions Cooperative, 628 B.R. 315 (E.D. Wis. Feb. 19, 2021). To read ABI’s report on the district court affirmance, click here.
On appeal to the Seventh Circuit, Judge Easterbrook said that the parties “devoted a lot of time and space” to the question of whether the creditor had sufficient notice before the 2011 sale to comply with the Fifth Amendment requirement of constitutionally adequate notice.
“We do not address that subject,” Judge Easterbrook said, “because statutory questions [under Section 363(m)] precede constitutional ones.” The section says,
The reversal or modification on appeal of . . . a sale . . . of property does not affect the validity of a sale . . . to an entity that purchased . . . such property in good faith . . . .
If the buyer “did not buy the parcel in ‘good faith’ in 2011,” Judge Easterbrook said, “it loses no matter what the Constitution has to say about the sort of notice [that the creditor] should have received.”
Turning to the facts, Judge Easterbrook said it was “clear” that the debtor “proceeded in bad faith” by not giving notice to the creditor. However, he said that the “question is whether [the buyer] bought the parcel in good faith, not whether the [debtor] sold it in bad faith.”
Still, Judge Easterbrook could not resist adding dicta when he said, “If anyone should be made to compensate [the creditor], it is the [debtor’s two principals].”
Turning to the responsibility of the buyer, Judge Easterbrook noted that the buyer had constructive notice of the ROFR by the real estate recording and actual notice by possession of the title search.
Judge Easterbrook therefore found it “impossible to disagree” with the two lower courts that “someone who has both actual and constructive knowledge of a competing interest, yet permits the sale to proceed without seeking the judge’s assurance that the competing interest-holder may be excluded from the proceedings, is not acting in good faith.”
Judge Easterbrook affirmed the lower courts, saying, “Good-faith purchasers enjoy strong protection under §363(m). But [the buyer] is not a good-faith purchaser. It must defend the state litigation.”
Observation
This is an important decision. It could be cited for the following proposition:
A buyer will not be in good faith under Section 363(m) if the buyer does not give written notice required by the Bankruptcy Code and Rules to someone with an interest in the property being sold. The buyer is not in good faith even if the holder of the interest knew about the bankruptcy or the sale.
Even if a creditor had constitutionally adequate constructive notice of a bankruptcy sale, the Seventh Circuit is saying that the buyer will not be in good faith and will not have protection from Section 363(m) if the buyer knew about a creditor’s interest in the property but did not give actual notice.
Three years before bankruptcy, the creditor was given a right of first refusal to buy the debtor’s real property. The ROFR was recorded with the land records.
In chapter 11, the debtor did not schedule the ROFR. Alongside a confirmed chapter 11 plan, Bankruptcy Judge Susan V. Kelley, now retired, approved the sale of the property free and clear of all liens, claims and encumbrances. No one told her about the ROFR.
According to the April 4 opinion for the Seventh Circuit by Circuit Judge Frank H. Easterbrook, the buyer evidently had run a title search and had a copy of the ROFR before the bankruptcy sale.