The bankruptcy court can sell property under Section 363(h) in which both the debtor and a co-owner have an interest, but Section 363(f) does not permit the bankruptcy court to sell the property free and clear of a lien that a third party holds on the co-owner’s interest in the property.
That’s the learning from a June 28 opinion by the Ninth Circuit Bankruptcy Appellate Panel on an issue where there is little authority.
The case had a multitude of issues and procedural complications, but the facts regarding free and clear sales are straightforward.
The debtor and a nonbankrupt co-owner had undivided, joint ownership of real property. To purchase the property, the co-owners borrowed from a lender. Evidently, the lender intended to have a mortgage on the property to secure the notes signed by the two owners. However, the mortgage as recorded only gave the lender a lien on each owner’s interest in the property. In other words, the lender did not have a mortgage on the property itself.
In bankruptcy, the debtor moved to sell both the debtor’s and the co-owner’s ownership interests in the property. The co-owner consented to the sale, satisfying the condition required by Section 363(h).
The lender did not object to the sale but insisted that half the proceeds, from the co-owner’s interest in the property, be paid to it in partial satisfaction of the debt owing by both the debtor and the co-owner.
The co-owner objected, arguing that the court should sell the property free and clear of the lien on its ownership interest in the property. The co-owner claimed there was a bona fide dispute about the validity of the lien on its interest, permitting a sale free and clear under Section 363(f)(4).
On consent of all the parties, the bankruptcy court ruled on the merits by holding that the lien was valid and enforceable on the co-owner’s interest in the property. The bankruptcy court therefore directed that half of the sale proceeds be paid to the lender.
The co-owner appealed to the BAP.
Affirmed on Other Grounds
In his opinion for the BAP, Bankruptcy Judge Gary Spraker said that Section 363(h) provides the sole exception to the rule that the bankruptcy court may only sell property of the estate. Provided that conditions are met, Section 363(h) allows the court to sell the interest of a co-owner. In the case on appeal, there was no question about the power to sell, because the co-owner had consented to the sale.
Did the court also have power to sell free and clear of the lender’s security interest in the co-owner’s interest in the property?
Judge Spraker found only two cases on the topic and was persuaded by In re Marko, 2014 WL 948492 (Bankr. W.D.N.C. Mar. 11, 2014). He said that Section 363(h) allows the sale of jointly owned property, “but it does not permit the trustee or debtor-in-possession to sell free and clear of liens on the nondebtor party’s interest in that jointly owned property.”
Judge Spraker explained that “Section 363(f) expressly provides when an estate may sell property free and clear of liens and it, like § 363(b), is limited to the sale of property of the estate.”
“Though the estate may sell jointly owned property,” Judge Spraker held, “the nondebtor co-owner’s interest in the property does not become property of the estate, and the sale is subject to any liens or interests against the nondebtor’s interest.” In other words, “the bankruptcy court could not authorize the sale of the [property] free and clear of [the lender’s] recorded deed of trust under § 363(f)(4).”
In short, the bankruptcy court reached the correct result. Rather than ruling on the merits of the validity of the lender’s security interest, the bankruptcy court should have simply ordered the trustee to turn over half of the proceeds to the lender.
The bankruptcy court can sell property under Section 363(h) in which both the debtor and a co-owner have an interest, but Section 363(f) does not permit the bankruptcy court to sell the property free and clear of a lien that a third party holds on the co-owner’s interest in the property.
That’s the learning from a June 28 opinion by the Ninth Circuit Bankruptcy Appellate Panel on an issue where there is little authority.
The case had a multitude of issues and procedural complications, but the facts regarding free and clear sales are straightforward.
The debtor and a nonbankrupt co-owner had undivided, joint ownership of real property. To purchase the property, the co-owners borrowed from a lender. Evidently, the lender intended to have a mortgage on the property to secure the notes signed by the two owners. However, the mortgage as recorded only gave the lender a lien on each owner’s interest in the property. In other words, the lender did not have a mortgage on the property itself.