Unwitting Real Estate Owners Get Roped Into Co-Owner's Bankruptcy Proceeding As Chapter 7 Trustee Seeks Court Approval For Sale Of Entire Jointly-Owned Property, As Opposed To Just Debtor's Interest

From a recent post from Bankruptcy-RealEstate-Insights.com by attorney Vicki R. Harding, Esq.:

• A chapter 7 debtor owned real estate jointly with three other people as tenants in common. The chapter 7 trustee sought court approval to sell the entire property, as opposed to just the debtor’s tenant in common interest.
  
  The debtor and his wife listed a 50% interest in real estate described as “125.8 acres rough land” in their bankruptcy schedules. The chapter 7 trustee and the debtors settled a dispute regarding claimed exemptions in the property and agreed to liquidate the non-exempt portion for the benefit of the estate.
  
  Section 363(h) of the Bankruptcy Code provides that if a bankruptcy estate has an undivided interest in property as a tenant in common, the trustee can sell the interests of both the estate and any co‑owner if (and only if):

(1) partition in kind of such property among the estate and such co-owners is impracticable;

(2) sale of the estate’s undivided interest in such property would realize significantly less for the estate than sale of such property free of the interests of such co‑owners;

(3) the benefit to the estate of a sale of such property free of the interests of co‑owners outweighs the detriment, if any, to such co-owners; and

(4) such property is not used in the production, transmission, or distribution, for sale, of electric energy or of natural or synthetic gas for heat, light, or power.

In this case two of the three other co‑owners consented to a sale and stipulated that the trustee was entitled to sell the entire property pursuant to Section 363(h). However, the remaining co‑owner (Simons) objected.

The trustee and Simons stipulated to various facts and agreed that “the only issue remaining under §363(h) is whether the Real Property is capable of partition or must be sold as a whole.” However, the court took issue with this characterization of the issue. In particular, it pointed out that if the trustee did not prevail, the result would not be to partition and sell the property, but rather the trustee’s request would be denied, leaving him with the right to sell the debtor’s undivided interest as a tenant in common.

The court decided that the parties had stipulated that factors 3 and 4 were met. Although their characterization of the question suggested that they were focusing only on factor 1, the court felt compelled to consider both factors 1 and 2 since it was not entirely clear what they intended.

On the issue of whether partition was “impracticable”:

[P]racticable is not a synonym for possible; nor is it a synonym for practical. Its meaning falls between the two concepts of possibility and practicality, and incorporates both ideas – something that is not only possible, but also feasible and sensible.

The trustee had the burden of proof, and his only witness clearly did not impress the court. The witness described the property as “rough, rock, and hilly land with no improvements.” According to him, the property could not be divided without affecting his estimated value. However, he gave no indication of the reduction in value nor the basis for these conclusions. (Apparently his testimony was based on a “drive-by” of the property, and he neither walked the property nor had any knowledge of the topography other than a brief view from an adjacent property and a review of an aerial map.)

In response, Simons testified as a fact witness that the property had been in her family for several generations, its only value was timber, and an old logging road evenly divided the property that would allow for a fair partition. The court determined that the trustee did not establish that partition was impracticable.

Considering the issue of whether a sale of an undivided interest would bring significantly less than a sale of the entire property, there was very little information to consider. The range of the only values available in the record led to a maximum difference of ~$6,500. The court concluded that the record did not contain proof that a sale of the tenant in common interest would bring significantly less, nor did the small change in value support a finding that partition was impracticable.

A more interesting argument was the trustee’s attempt to use a state statutory presumption of indivisibility. Although bankruptcy courts frequently look to state law to decide issues, in this case the court held that the question of whether a partition was practicable was a matter of federal and not state law.

The court further commented that it appeared the parties agreed that either the property should be sold as a whole or it should be partitioned. However, partitioning property is not an option under Section 363(h): the trustee either sells all of the interests in the property as provided in Section 363(h), or sells only the debtor’s undivided interest. Notwithstanding the desire of the parties, the court’s judgment was simply that the trustee failed to prove that the elements of Section 363(h) were met, and consequently he was not entitled to sell the property free of Simons’ interest.

The court’s decision to apply federal law to determine whether partition was practicable, while leaving the partition process to state law, could lead to a catch-22 where a trustee is not able to sell all of the co-owners’ interests based on federal law, but also is not able to partition the property under state law.

A co‑owner that is not familiar with bankruptcy would likely be surprised that the bankruptcy court can order the sale of its interests as well as the debtor’s interests. However, it is worth noting that a trustee (or debtor in possession) does not automatically have that right.

Source: Potential Sale of Jointly Owned Property: Practicable Partition Is Somewhere Between Possible and Practical.

For the court ruling, see Higgason v. Brown (In re Brown), 506 B.R. 446 (Bankr. E.D. Ky. 2014). rogue