Creditor Didn’t Look Before It Leaped: Loses Right To Stop 363 Sale and Credit Bid

Linor Shohet

shohetl (2)A June 2013 decision from the United States Bankruptcy Court for the Eastern District of North Carolina Greenville Division, In re L.L. Murphrey Company, 2013 WL 2451368 (Bankr. E.D.N.C. June 6, 2013), highlights the importance of due diligence in connection with assignments of security interests.

L.L. Murphrey Company (the “debtor”) filed a voluntary Chapter 11 petition on June 8, 2000.  In 2000, the debtor was in default to Wachovia Bank, N.A. (“Wachovia”) for approximately $12,800,000 secured by the debtor’s real property and personal property by appropriate loan documents (“PreBankruptcy Loan Documents”).

In July 2001, the court confirmed a plan of reorganization, which restructured the debt  into two notes and provided that:

  1. The debtor and Wachovia will enter into amended and restated loan documents consistent with the plan of reorganization;
  2. The debtor shall execute and deliver such additional agreements, instruments and documents as may reasonably be requested by Wachovia;
  3. The Reorganization required that amended and restated loan documents be executed consistent with the confirmation of the plan; and
  4. All liens in favor of any creditor would be deemed released upon confirmation of the plan.

Post confirmation, Wachovia didn’t redocument the loan. Wachovia sold the loans and assigned the PreBankruptcy Loan Documents to CadleRock Joint Venture, L.P. (“CadleRock”) and CadleRock subsequently sold the loans and assigned the PreBankruptcy Loan Documents to D.A.N. Joint Venture Properties of North Carolina (“DAN”).  DAN relying on the assigned documents filed the requisite notices of assignment, amendments and continuation statements.  When the debtor filed a voluntary Chapter 7 petition in 2012, DAN filed a proof of claim for over $6,000,000 and claimed that over half of such amount was a secured claim.

In January and February 2013, the trustee filed motions requesting the court’s approval to conduct a sale of the debtor’s real and personal property pursuant to Section 363 of the Bankruptcy Code, free and clear of liens, with any such liens transferred to the proceeds of the sale.  DAN tried to block  the trustee’s sale motion, arguing that the trustee failed to establish any of the five separate grounds required under Section 363(f) which would permit a sale free and clear of liens. The Trustee argued that he met the requirements of 363(f)(4), which permits the sale of property free and clear of any interest in the property if the interest is in “bona fide dispute.”

DAN argued that its security interest was not subject to a legal or factual dispute because there were no pending objections to its proof of claim and because the debt underlying its claim and the related liens was explicitly reaffirmed by an order entered by the court in a related proceeding. Further, DAN argued that the confirmed plan only required delivery of amended and restated loan documents reasonably requested by Wachovia, and Wachovia never made any such requests of the debtor.

The court disagreed, determining that the trustee had established the existence of a bona fide dispute as to the validity of DAN’s liens because the confirmed plan explicitly required the parties to execute amended and restated loan documents as a condition precedent for setting the implementation date of the new notes.  Therefore, the court permitted the trustee to sell the property free and clear of any liens pursuant to Section 363(f)(4) of the Bankruptcy Code.

Having allowed the 363 sale, the court then turned to the issue of whether DAN could credit bid at the public sale.  The trustee asserted that the questionable validity of DAN’s liens constituted the requisite cause for the court to revoke DAN’s right to credit bid under Section 363(k) of the Bankruptcy Code and the Bankruptcy Court agreed. In re L.L. Murphrey Company serves as a reminder to debt purchasers that as they rarely get any representations from debt sellers they need to undertake appropriate e due diligence before purchasing.   DAN may well end up with an unsecured claim for the entire amount due. That result could have been avoided  had it performed the proper diligence.

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