Business Law

In re Groves, 652 B.R. 104 (B.A.P. 9th Cir. 2023)

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The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:

SUMMARY

The Ninth Circuit Bankruptcy Appellate Panel (the BAP) recently ruled in a published opinion that a chapter 13 debtor may not sell co-owned property free and clear of debt secured by which the nondebtor’s interest in the property.  In re Groves, 652 B.R. 104 (B.A.P. 9th Cir. 2023).

To view the opinion, click here.

FACTS

Debtor Andrea Groves and her wholly owned limited liability company, A&D Property Consultants, LLC, (Consultants) jointly owned two parcels of real property in Phoenix, Arizona, as tenants in common. One was an investment property on Rancho Drive (Rancho Property) and the other was her residence on 44th Street (Residence). Groves and Consultants borrowed money from Merchants Funding AZ, LLC (Merchants) and jointly executed a promissory note secured by a deed of trust covering both properties.  However, the deed of trust did not encumber both properties; instead it only encumbered Consultants’ interest in the Rancho Property and Groves’ interest in the Residence.  Merchants assigned its interest in the loan to A&S Lending, LLC (A&S).

Groves filed chapter 13 in December 2018.  She scheduled Merchants with a disputed secured claim. In an objection to the plan, A&S asserted that its trust deed was secured by both parties’ interests in both properties, but it never filed a proof of claim. Groves filed an adversary complaint against A & S, seeking declaratory relief to determine the validity and priority of its lien, arguing that the deed of trust was only secured by Consultants’ interest in the Rancho Property and her interest in the Residence.   Consultants was not a party to the complaint.  A&S filed a counterclaim against Groves and a cross-claim against Consultants for reformation of the deed of trust, asserting that it was meant to be secured by both parties’ interest in both properties.  After trial, the bankruptcy court entered judgment for Groves and Consultants, declaring the trust deed only encumbered Consultants’ interest in the Rancho Property and Groves’ interest in the Residence and dismissing the reformation claims with prejudice.

Groves then moved to sell the Rancho Property under § 363(h) of the Bankruptcy Code, stating that Consultants consented.  She proposed to sell under § 363(f)(4), free and clear of all claims and interest, including the secured claim against Consultants’ interest.  She asserted that she had grounds to sell free and clear because the secured claim against Consultants was disputed based on A&S’s failure to assert a compulsory counterclaim under Bankruptcy Rule 7013 in the adversary proceeding.  A&S’s opposition to the sale motion focused only on the fact it had not forfeited its secured claim against Consultants.  It requested that upon sale, one-half of the net proceeds should be paid to it.

The Bankruptcy Court approved the sale and agreed that the A&S trust deed was in dispute.  Then it resolved the dispute by ruling that A&S did not forfeit the trust deed.  It ordered that Consultants’ half interest in the net proceeds should be paid to A&S.   Consultants appealed to the BAP, which affirmed.

REASONING

  Although neither party challenged the bankruptcy court’s jurisdiction to resolve the validity of A&S’s secured claim against nondebtor Consultants’ interest in the Rancho Property, the BAP was compelled to determine its own jurisdiction.  It ruled that the bankruptcy court had related to jurisdiction under 28 U.S.C. 157(a) because whether A&S was paid in part on the joint debt of Groves and Consultants, which was also secured on Groves’ interest in the Residence, would have an impact on Groves and her estate.  If A&S was paid in part, then the burden on the debtor and her estate would be less, creating related to jurisdiction.   It also ruled that Consultants was a party aggrieved and had standing to appeal because of the monetary impact of its net proceeds being used to pay A&S.

Turning to the merits, the BAP then held that the Bankruptcy Code does not permit a sale free and clear of a lien attaching to a nondebtor co-owner’s share of property being sold under § 363(h).  The bankruptcy court’s power to approve the sale of Consultants’ interest in the Rancho Property did not arise under § 363(f) at all; it only was available under the provisions of § 363(h), which is a statutory exception to the general rule that a bankruptcy court can only approve sales of property of the estate.  However, § 363(h) says nothing about a sale free and clear and certainly does not provide authority to sell free of claims against a nondebtor’s interest, which is not property of the estate.

The BAP also ruled that A&S did not forfeit its secured claim by not filing a counterclaim.  Consultants only involvement in the adversary was as defendant in the cross claim for reformation filed by A&S.  There was no affirmative pleading asserted by Consultants against A&S and therefore nothing to counterclaim against.  In addition, normal enforcement of a deed of trust would be by a nonjudicial foreclosure, which does not require judicial intervention at all.  If it was deemed compulsory under Rule 7013 for A&S to plead an enforcement claim, it would have been restricted to judicial foreclosure.  The federal court has no power to compel a lender to forego the efficient nonjudicial foreclosure procedure allowed by California law.   In sum, no counterclaim was compulsory.

The BAP affirmed that Consultants was required to turn over its net proceeds from the sale to its secured creditor, A&S.

AUTHOR’S COMMENTS

 The BAP was ruling on an issue of first impression, not only in the Ninth Circuit, but elsewhere in the country.  It found only two bankruptcy court cases on the issue, which disagreed with each other, and no appellate authority.  Perhaps this paucity of decisions has occurred because debtors and trustees understand they are not allowed to sell nondebtor property free and clear under § 363(h).  Or perhaps no facts leant themselves to seeking such a sale.  Next time it occurs, the courts and practitioners can look to a well-reasoned and analytical decision on the subject from the BAP, not precedential but certainly helpful.

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.). Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.


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