Bankruptcy Law and the Conveyancer
Articles from The Massachusetts Focus
Newsletter of Stewart Title Guaranty Company, Massachusetts Offices
Spring 2003, Volume 2, Number 2
Bankruptcy Law and the Conveyancer
by Gary F. Casaly, Special Counsel
With some exceptions, attorneys who devote their practices to conveyancing do not get involved with filing bankruptcy proceedings for their clients. Such an "esoteric" area of the law seems to require the involvement of a "specialist" in that field. But the fact remains that conveyancers are many times faced with reviewing a bankruptcy proceeding that appears in the chain of title and determining whether and how a good title can be obtained out of those proceedings.
The purpose of this article and the one that will follow in the next edition of The Massachusetts Focus will be to specifically describe what needs to be done in order to "get a good title out of bankruptcy." But before getting into the specific "nuts and bolts," it may be helpful to give an overview of what's involved in bankruptcy proceedings generally. That's what I'll do in this first installment of my article. The next installment that will appear in the upcoming edition of this newsletter will deal with the specific statutory requirements that must be met in order to effectuate a particular type of transaction when the seller is in bankruptcy.
The Bankruptcy Estate
Under the bankruptcy code the filing of a petition for bankruptcy creates a new fictitious entity known as the bankruptcy estate. This entity succeeds to all interests of the debtor in all property, real and personal, which the debtor had at the time of the filing of the petition. (As we'll see later on, even some property acquired after the filing of the petition can be bound up in this fictitious estate.) Also, even though the debtor's spouse may not have joined in the petition, his or her property is brought under the jurisdiction of the bankruptcy court upon the filing thereof. However, even though the bankruptcy estate holds title, the debtor is capable of conveying that title to a good faith purchaser who has no knowledge of the bankruptcy, provided that there is no notice of the bankruptcy filed with the records where the deed is to be recorded. In such a case the bankruptcy trustee cannot thereafter avoid a sale.
The Automatic Stay
When the bankruptcy petition is filed, an automatic stay against the creation, perfection or enforcement of any lien against the property of the estate is put in place. This stay arises automatically, without any requirement of a judicial order to that effect.
The stay provides the basis for the orderly administration of the bankruptcy estate. Acts in violation of the stay, at least in the First Circuit (and in many other circuits) are void, not simply voidable. It is important to recognize that the stay affects the enforcement of liens even if no notice of the bankruptcy appears in the public records. In order to commence or continue with a foreclosure action, therefore, it is necessary that the lender determine whether a bankruptcy is pending and, if so, have the court "lift" the stay so that the foreclosure may proceed. In some instances, however, the court may only partially lift the stay, authorizing foreclosure only up to the point of the auction and reserving the right to take one "last look" at the situation before the property is permitted to leave the estate.
A few things should be noted about the automatic stay or, more precisely, the automatic stays. There are really two separate stays: one regarding the debtor and one regarding property of the bankruptcy estate. Under subsection (a) of Section 362 the acts that are stayed (and not stayed) are listed. Under subsection (c) of Section 362 it is provided that "the stay . . . against the property of the estate . . . continues until such property is no longer property of the estate [while] the stay of any other act . . . continues until . . . a discharge is granted or denied." As conveyancers, of course, we are interested in the stay that affects the property of the estate, the title which we are trying to obtain.
The automatic stay was first introduced as a rule to the Bankruptcy Act on July 1, 1974, and ultimately became codified in the Bankruptcy Code in 1978. (Note the references to the "Bankruptcy Act" and the "Bankruptcy Code." The former is the "old" law and the latter is the name of the current legislation.) Regarding the history of the stay, see the discussion in Goodman v. Sheehan, 6 Mass.App.Ct. 927, 381 N.E.2d 155 (1978). It is important to note this fact, as foreclosures before these dates would not be affected by a bankruptcy.
In connection with the automatic stay something should be said about the difference between enforcing a lien, as in the case of a foreclosure, and simply perfecting it. For example, although a mechanic lienor could not sell property to satisfy a lien in the case of a pending bankruptcy, the lienor would be permitted to take the actions required under G.L.c. 254 to perfect the lien or prevent it from being extinguished. See, for example, In re Yobe Electric, Inc., 30 B.R. 114 (Bkrtcy W.D. Penn 1983).
One last point about the general attributes of the stay that affects the enforcement of mortgages and other liens: although a bankruptcy will stop a foreclosure in process due to the automatic stay, it was decided in Massachusetts Automatic Transmissions, Inc., 35 B.R. 328 (Bkrtcy. Mass. 1975), which cited as authority Outpost Cafe, Inc. v. Fairhaven Savings Bank, 3 Mass.App.Ct. 1, 322 N.E.2d 183 (1975) that the bankruptcy estate had no interest in property, legal or equitable, that had been sold by foreclosure sale six days prior to the debtor filing for bankruptcy, inasmuch as at the time of the filing the bankruptcy debtor had no equity of redemption in the property. That interest, as was stated in the Outpost case" was barred . . . at least as early as the point in time when the memorandum of sale was executed with the purchaser at the foreclosure sale."
Jurisdiction of the Court
Certain property may not be subject to being administered in the course of the bankruptcy proceedings, and may eventually no longer be under the jurisdiction of the bankruptcy court. This is important with respect to considerations concerning the automatic stay and the avoidance powers of the trustee. Property that is subject to an exemption is in this category. Also, because the object of the bankruptcy proceedings is to maximize the estate for the purposes of distribution, property that is burdensome may be abandoned by the trustee and not otherwise be administered. Moreover, property that remains unadministered at the time the bankruptcy is closed will be deemed abandoned and will revest in the debtor, subject to some qualifications (discussed later).
With respect to the closing of the bankruptcy estate, or the dismissal of the bankruptcy proceedings, a distinction should be made regarding the discharge of the debtor. A discharge of the debtor does not end the pendency of the proceedings and does not place the property of the estate outside the jurisdiction of the bankruptcy court. A discharge of the debtor has an impact only on the question of the liability of the debtor personally to pay obligations. A discharge in effect is an injunction against creditors proceeding against the debtor personally, but the property of the bankruptcy estate continues thereafter to be administered subject to the jurisdiction of the court and may be required to be liquidated to satisfy those obligations until the case is closed.
One last point on the question of jurisdiction. Bankruptcy law is federal law and, because of this, actions of a bankruptcy court that sits in another state are just as binding as if the court sat in the county, district or state where the property itself is located. No "ancillary" proceedings are required in order for the court in another state to gain jurisdiction over the property in Massachusetts.
After the petition for bankruptcy is filed, either the trustee in bankruptcy (in, for example, a Chapter 7 case) or the debtor in possession (in a reorganization case under Chapter 11) have vast powers enabling them to avoid transactions that have already occurred.
What kind of transactions can be avoided? A transfer to a creditor in payment of a pre-existing debt can be set aside if the transfer was made within 90 days before the bankruptcy petition was filed. (The period is extended to one year if the transfer was made to an "insider.") Also, the power exists to set aside transfers that took place up to a year prior to the filing of the bankruptcy petition if those transfers were made (i) with actual intent to hinder, delay or defraud a creditor of the debtor or (ii) for less than equivalent value if the debtor was (a) insolvent at the time, (b) rendered insolvent by the transfer, (c) engaged in or was about to engage in a business or transaction for which the remaining property of the debtor was an unreasonably small amount of capital, or (d) believed by the creditor to have incurred debts that the debtor could not pay as they matured. Although the transactions that are subject to being avoided are generally referred to as fraudulent transactions, it is clear that the avoidance powers are not limited to those transactions made with the intent to defraud. A transaction that appears to be arm's length, therefore, might be subject to avoidance.
Sales During Bankruptcy
Sales during bankruptcy is, of course, the substance of this article. (We will see, however, that sales even after the bankruptcy case has been closed can present their own issues.) One of the issues encountered regularly by the conveyancer - and which will be the subject of the rest of this and the second part of this article - is the ability of a purchaser to deal with the bankruptcy estate, the trustee in bankruptcy or the debtor in possession in connection with the transfer of title. Obviously, the trustee in bankruptcy can sell property of the estate once armed with an order to do so. Moreover, the trustee can sell free and clear of liens, after "notice and hearing." (The term "notice and hearing," as used in the Bankruptcy Code, means, as we shall see, notice with an opportunity to be heard; no hearing in fact needs to occur if no objections are made.) The notice, of course, is given to the lienors whose liens will be affected and, if no objection is made or if an objection is made and it is withdrawn or disposed of by the court, the sale may proceed. Up until recently the sale could proceed even if an appeal was pending and even if the appellate court reversed, if the lower court had failed to stay the effect of the authority to sell, based on the provisions of 11 U.S.C §363(m), which provides:
The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to any entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.
That situation has now changed with the adoption of Rule 6004(g), which appears to be in conflict with the statute. The rule provides:
An order authorizing the use, sale or lease of property other than cash collateral is stayed until the expiration of 10 days after entry of the order, unless the court orders otherwise.
The rule seems to lead to the conclusion that the default situation is exactly opposite to that previously in place, i.e., that the order now is stayed without any action on the part of the court and that for the statute's provisions to apply it is presently necessary for the court to enter an order lifting the stay.
Even before the adoption of the rule it had always been believed, however, that if the appeal is based on jurisdictional or due process grounds a sale could thereafter be overturned even in the absence of a stay of the lower court's order.
The debtor in possession in a reorganization case has broad powers, not dissimilar to those of a trustee. Therefore, in the absence of an order prohibiting the same, the debtor in possession may sell the property in the ordinary course of business without any particular court authority. The sale of "inventory," such as units in a condominium, would likely fall into this category, but the sale of an entire condominium project would require further judicial permission.
Effect of Bankruptcy on Liens
There seems to be a common misunderstanding as to the effect that bankruptcy has on liens that have been filed against the property of the debtor. Although post-petition liens are void as against property of the estate, existing liens are not. But many commentators believe that where the debtor is discharged in bankruptcy, liens against the property will be extinguished. Their theory is that if the underlying debt or obligation has been rendered unenforceable, the lien that secures the same must, likewise, collapse. This is not the case, however. A discharge in bankruptcy is not an extinguishment of the debt discharged, but rather is an injunction against the creditors regarding the enforcement thereof against the debtor personally. The debt itself continues and the lien against the property remains undisturbed.
I will continue with the subject of bankruptcy in "Bankruptcy Law and the Conveyancer — Traps to Watch Out For" in the next edition of The Massachusetts Focus.