Judge Robert E. Grossman of the United States Bankruptcy Court of the Eastern District of New York recently decided whether a chapter 7 Trustee could use Section 363(f)(5) of the Bankruptcy Code (the “Code”) to sell property free and clear of nonconsensual judicial liens. Judge Grossman confirmed that under the specific facts and circumstances of the case, the Trustee had met the requirements of Section 363(f) and a sale of the debtor’s encumbered property free and clear would be proper, even though holders of judicial liens would not be paid.
In the case, In re Hamilton Road Realty, LLC (Case No. 19-72596), the Trustee moved to approve the sale of the debtor’s property to a third party free and clear under Section 363(b) and 363(f) (the “Motion”). The property at issue was owned by the principal of the corporate debtor who held a property in his individual name. The debtor’s principal transferred the property to the corporate debtor on the eve of the corporate debtor’s bankruptcy filing. At the time the property was transferred it was subject to numerous liens that were not disclosed on the debtor’s schedules. The liens included judicial liens on the property to secure judgments obtained against the principal of the debtor and tax liens. While the Court agreed with the debtor that it had standing to object to the Motion and that the Trustee could not use Section 363(f)(3) because the face amount of the liens encumbering the property exceeded the sale price, the Court held that the Trustee nevertheless satisfied Section 363(f)(5) as to the liens on the property. Specifically, the Court noted that the nonconsensual judicial lienors could be compelled to take money in satisfaction of their liens on the property which could result in payment in full from a source separate and apart from the sale of the property so as a matter of law, the liens at issue could be removed and Section 363(f)(5) would be fulfilled.
Within bankruptcy, assets can be sold either under section 363 or section 1123 of the Code. Section 363(f) of the Code authorizes a trustee or debtor in possession to sell property “free and clear of any interest in such property of an entity other than the estate” under any one of five specified conditions. These conditions include, among other things, if applicable nonbankruptcy law permits such a free-and-clear sale, if the sale price exceeds the aggregate value of all liens encumbering the property, or if the interest is in bona fide dispute. Additionally, the sale of a property free and clear of judicial liens is permitted if the interest is a lien, and the price the property is sold for is greater than the aggregate of all the liens of the property. Under Section 363(f)(5) the Trustee can sell property free and clear of all liens if the entity holding the lien can be compelled in a legal or equitable proceeding to accept money to satisfy their interest.
In determining the issue raised in the Motion, Judge Grossman examined the applicability of Section 363(f)(3), looking to the statute’s plain language to establish whether the Trustee could use this section to obtain approval to sell the property free and clear of all liens. He then addressed whether the nonconsensual judicial liens fell within Section 363(f)(5).
Regarding the applicability of Section 363(f)(3), the Court examined the word “value” looking to two interpretations used by Courts. The first group of cases, which the Trustee urged the Court to follow, focus on the word “value” as used in Section 506(a) of the Code. Judge Grossman could adopt the view of the late Bankruptcy Judge Howard C. Bushman III followed in In re Beker Indus. Corp., 63 B.R. 474 (Bankr. S.D.N.Y. 1986) for the premise that the term “aggregate value” meant only the amount of value of the creditor’s interest in the property. Judge Grossman disagreed with this interpretation, instead following a second line of cases that view the “aggregate value” as the face value of the liens on a property. Under this approach, the proposed sale price of the property must be “greater than” the aggregate and actual amount of all liens encumbering the property. Despite these differing views, the Court held that a straightforward reading of Section 363(f)(3) supported equating “value” with “face value”. Pursuant to Section 363(f)(3) the amount of the purchase price of the property would have to be much greater than the amount of the liens, not equal to the amount of the liens.
The Court then addressed the applicability of Section 363(f)(5) which required examination of the type of liens encumbering the property. The judicial liens at issue in the case resulted from judgments entered by a court against the debtor’s principal and/or his spouse. The judgments were recorded as liens on the property and all other property owned by the obligors. At the time the property was transferred to the debtor, the judgment creditor had not received notice and/or disclosure on the bankruptcy schedules. Judge Grossman followed precedent from the Second Circuit and other courts that have found Congress to have intended “interest” to have an expansive scope with respect to the definition of a lien under Section 101(37) of the Code. The judicial liens placed on the property represented the judicial lienors’ interests and the fact that the encumbrances were judicial liens did not preclude the Trustee from seeking authorization for a sale under Section 363(f)(5).
Judge Grossman then considered the sale provision under Section 363(f)(5). Under this section, a sale free and clear of judicial liens is allowed if the lien holder would be compelled in a legal or equitable proceeding to accept money in satisfaction of the interest. Here, Judge Grossman was tasked with determining whether the Code mandates that the legal proceeding be limited to a proceeding involving the property on which the lien is recorded or whether “proceeding” applies to any actual or potential proceeding which would allow the judicial lienors to enforce their rights. In the case, the debtor was not legally obligated to the judicial lienors and the liquidation of the debtor had no impact on the judicial lienor’s rights to proceed against the original obligor (the principal of the debtor and his spouse) under applicable non bankruptcy law. When examining the plain language of “satisfaction” in the context of the Code, Judge Grossman held that the plain language must refer to the giving of money with the intention that the money would extinguish a legal or moral obligation. If the junior lienholder’s interest is extinguished without any form of monetary satisfaction in a foreclosure (ex. the interest is wiped out) then the foreclosure would not compel the junior lienholder to accept a “money satisfaction” because the funds would be nonexistent. Judge Grossman then paralleled this premise against a situation where the judicial lienors could be compelled to accept money in exchange for their liens, even if it were not for the full amount. This type of scenario would satisfy the requirement of Section 363(f)(5). In the case, the judicial lienors could not bring a foreclosure action under New York Law, or commence a UCC proceeding against the property, nor was cramdown a mechanism that could be used in the chapter 7 case. The judicial lienors could bring a proceeding under NYCPLR §§ 5235 and 5236 to compel a sheriff to conduct a sale of the property, but at any point before bringing such an action, the judicial lienors could be forced to accept amounts they were owed in full. If they were to receive such funds, a satisfaction of lien could be issued that would effectively terminate their liens on the property.
Given the unique circumstances of the facts of the case, the only avenue for the judicial lienors to satisfy their claims in the bankruptcy case was through a sale of the property with proceeds sufficient to pay them off. Further, the original obligors would remain liable on the debts. While a sale of the property would not result in payment of the judicial lienors’ claims in full, the judicial lienors would have a realistic and viable avenue to collect payments. For these reasons, full satisfaction of the claims by the debtor was not required.
With respect to the tax liens, Judge Grossman held that such liens qualified as “interests” based on the analysis applied to the judicial lienors. Additionally, because the Trustee could utilize Section 724 of the Code to subordinate the tax liens encumbering the property, there was a proceeding by which the United States could be compelled to accept monetary satisfaction. This satisfaction would result in the receipt of funds by the tax lienors in exchange for their liens. The Court held that the Trustee satisfied Section 363(f)(5) as Section 724(b) constitutes a “proceeding.”
This recent opinion from the United States Bankruptcy Court for the Eastern District of New York raises concerns for parties holding liens against property held by corporate debtors. Specifically, lienors should pay close attention to listed assets in debtor schedules and address whether property may have been transferred from corporate officers as a method of obtaining bankruptcy protection. Even if such property is part of a debtor’s estate, the Court can still authorize sale of the property, where a sale may not result in full payment to lienors.