We recently helped a client purchase several commercial properties from a seller who had filed for bankruptcy. Our transaction involved a sale of properties under Bankruptcy Code 363 (b) (1) which governs sales not in the ordinary course of the debtor’s business and not subject to a plan of reorganization. When purchasing this type of real estate, buyers should be aware of the following.

BIDDING PROCEDURES

These types of sales usually involve a public auction with detailed, court-approved bidding procedures, competing offers, “stalking horse” bidders, and other unique factors. Buyers need to familiarize themselves with these critical aspects of the bidding and sales process.

BANKRUPTCY COURT APPROVAL

If you are the successful bidder at a bankruptcy auction, the process is not over. The sale still requires the approval of the bankruptcy court. Until such approval is given, a buyer is at risk of higher bids and other considerations that could impact or negate the sale.

SALES ORDER/FREE AND CLEAR

The bankruptcy court will issue an order authorizing the sale of the property free and clear of liens and other interests in the property. Our sales order provided in relevant part: “Pursuant to sections 105(a) and 363(f) of the Bankruptcy Code, the assets shall be transferred to the purchaser…free and clear of all interests, liens, claims and encumbrances of any kind or nature whatsoever, other than the expressly assumed obligations, with all such interests of any kind or nature whatsoever to attach to the net proceeds of the Sale in the order of their priority, with the same validity, force and effect which they now have as against the [real estate].” The proper scope and interpretation of this broad language are subject to judicial debate. Three common issues are mentioned below.

1. Real Estate Taxes. Some municipalities refuse to release recorded tax liens notwithstanding the issuance of a “free and clear” sales order. Our title insurance company required that a portion of the sales proceeds be held in escrow and used to pay past-due real estate taxes because of this.
2. Easements and Other Non-Monetary Encumbrances. We had vigorous debate with the debtor’s counsel as to whether the sales order allowed the property to be sold free and clear of several pre-existing undesirable easement agreements and restrictive covenants. Debtor’s counsel asserted that these were executory contracts, were fully dischargeable under the Bankruptcy Code, and that the sales order conveyed the real estate free and clear of them. Our title insurance company’s position was that the a “free and clear” order could not extinguish prior matters of record unless all affected parties had received notice of the proposed sale and the order specifically authorized the sale to be made free and clear of the particular encumbrance. The prevailing view is that the Bankruptcy Code does not authorize sales of real estate free and clear of pre-existing easements, restrictions, and other matters of record that run with the land under state law other than monetary liens and encumbrances (such as attachments, mechanics liens, and mortgages).
3. Environmental Claims. Our sales order provided in part that the real estate would be transferred free of all environmental claims and any claims based on any successor or transferee liability. Debtor’s counsel asserted that the sales order, as written, resulted in the property being transferred free of any going-forward responsibility or liability for then existing environmental conditions and claims. Environmental regulatory authorities did not agree with this interpretation and took the position that a new buyer would take title to the real estate free of pending fines and enforcement actions but would be responsible to promptly address known environmental problems as the new owner/operator of the property. The prevailing view is that the Bankruptcy Code does not authorize a sale of real estate completely free from liability for pre-existing environmental problems. Therefore, buyers must perform appropriate environmental due diligence and make sure they understand the expectations of environmental agencies for known environmental issues.

AS-IS, WHERE-IS

These types of sales are typically “as-is, where-is.” A buyer should do as much advance homework as possible about the condition of the property and should have its due diligence team ready to go as soon as its bid is approved by the Bankruptcy Court.

OPERATION OF PROPERTY

Given that the seller is in bankruptcy, funds to operate the property may be limited. Therefore, buyers need to make sure they understand how the real estate will be managed and maintained between the auction and closing. For example, winter conditions (snow, ice, heat, etc.) cannot be ignored in the interim.

These are just a few of the special considerations associated with buying real estate in a bankruptcy proceeding.