Daily Development for
Monday, August 3, 1997

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

These three cases are reported and discussed by Jim Stillman, Murphy, Weir & Butler, San Francisco.

BANKRUPTCY; SALE FREE AND CLEAR OF LIENS; REQUIREMENTS; DEEMED CONSENT: A debtor is not authorized to sell property free and clear of liens, under Bankruptcy Code section 363(f), where the only property at stake has been claimed as exempt, and where the holders of all liens and interests have not been properly identified in the motion.

In re Penniston, 1997 Bankr. LEXIS 355 (Bankr. D. Minn. 1997).

Once property is exempted by the debtor, it is no longer property of the estate; thus, section 363(f) could not be used for purposes of selling a homestead interest. The fact that the principal secured creditor had not objected to the sale would not "necessarily be construed as consent" to the sale.

A sale free and clear of liens and interests cannot be approved, where the motion did "not identify who the holders of these interests might be, what their claimed interests are, nor what the bases of any disputes are...[nor] whether...those entities have even been served with the motion." A Chapter 13 debtor has the right of a trustee to sell free and clear, in a proper case, by force of section 1303.

Reporter's Comment: There is contrary authority on the question whether a creditor's decision not to object to the motion will be construed as "consent" for purposes of section 363(f)(2). See In re James, 203 B.R.449, 453 (Bankr. W.D.Mo. 1997). In the instant case, the Bankruptcy Court clearly thought it had been asked to render an unnecessary, "advisory" title-clearing opinion. It refers the parties to the Minnesota Title Standards "white pages," in which the title insurance industry says that Bankruptcy Court orders are not required for sales of homesteads.

BANKRUPTCY; SALES FREE AND CLEAR OF LIENS; BENEFIT TO THE ESTATE: After making no objection to the trustee's motion to sell its collateral free and clear of liens, and after absenting itself from the sale, the mortgagee will not be allowed to vacate confirmation of a bona fide sale at auction to a third party for a fair price, on the grounds that the sale rendered the mortgagee partially unsecured, to the detriment of other unsecured creditors.

In re James, 203 B.R. 449 (Bankr. W.D.Mo. 1997).

"No one can predict with any accuracy what will occur at an auction" (p. 455), the Bankruptcy Court wrote. The mortgagee's failure to object to the sale would be construed as consent, for purposes of satisfying the requirement of section 363(f)(2). Also, it appeared that the bank's deed of trust was a preference, insofar as it had been re-recorded, within the 90 days preceding the petition, to cover accidentally omitted real estate. The rights of third parties who participate at bankruptcy sales must, at some point, be respected, "if parties are to be encouraged to bid at judicial sales" (p. 454). The bank could have protected itself from becoming partially unsecured, by bidding at the sale under section 363(k).

BANKRUPTCY: SALE FREE AND CLEAR OF LIENS; COLLATERAL ATTACK; REMOVAL: The District Court properly denied a motion to remand to Louisiana state court an action filed by an erstwhile junior lienor 8 years after entry of a final Bankruptcy Court order selling the subject collateral free and clear of liens.

In re Rivet, 108 F.3d 576 (5th Cir. 1997).

Because it made no reference to the Bankruptcy Court order, which was res judicata, the complaint fit the "artful pleading exception" to the "well-pleaded complaint doctrine," pursuant to which federal removal jurisdiction can be shown by evidence extrinsic to the averments of the complaint in limited cases. Finding the state court action to be no more than "a thinly veiled collateral attack on the Bankruptcy Court's prior orders," the Court of Appeals upheld the district court's summary judgment against the plaintiff. "[A]n order by a Bankruptcy Court authorizing or approving the sale of an asset of the bankrupt estate is a final judgment on the merits for res judicata purposes." The fact that the mortgage was accidentally left of record following the sale free and clear did not create a right.

Judge Edith Jones, dissenting, did not see that the defendants had "an essentially federal claim," and would have directed them to raise the bar of res judicata as an affirmative defense in state court.

Reporter's Comment: Experienced real estate litigators periodically face the decision of selecting the forum in which to raise the res judicata defense. In a clear case such as this, the defendant's preference will be to return the parties to the forum in which the order or judgment was made, by removal, or by an independent action for an injunction; but in some cases, an order may appear to have more res judicata effect if viewed from afar.

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