Monday, September 8, 2008

New 9th Circuit Opinion Adjusts the Line Between Void & Voidable Transfers in Violation of the Automatic Stay: Bona Fide Purchaser Defeats Trustee

by Andrew Toth-Fejel, of Bankruptcy Litigation Support for Attorneys,

Burkart v. Coleman (In re Tippett), 9th Circuit Case No. 6-15411
Sept. 4, 2008

In this Opinion published last week the Ninth Circuit addressed one point of conflict between two very basic principles: the automatic stay and the bona fide purchaser, specifically the automatic stay's voiding of "any act to . . . exercise control over property of the estate" (§ 362(a)(3)), and the rights of a bona fide purchaser of such property of the estate. If, as the 9th Circuit had held in its seminal 1992 opinion, Schwartz v. United States (In re Schwartz), 954 F.2d 569, 571, "violations of the automatic stay [are] void, not voidable," then wouldn't a Chapter 7 debtor's post-petition wrongful sale of property of the estate be void, even to a bona fide purchaser ("BFP"), allowing the Chapter 7 trustee to take that property back into the estate? In last Thursday's opinion the 9th Circuit said no, a BFP prevails against a trustee.

How did the Court come to this result in spite of its 16-year old "void, not voidable" standard? Mostly by closely analyzing its 1992 Schwartz opinion. It's rationale is important to the bankruptcy practitioner beyond the simple "BFP beats trustee" holding because it provides a better understanding of the automatic stay, a concept that is part of every bankruptcy attorney's daily practice.

In this Chapter 7 case the debtors listed their residence for sale, about 18 months after their case was filed, without permission from the trustee or the bankruptcy court and without informing their real estate broker of their bankruptcy. Indeed around this same time the trustee sent them and their attorney a letter requesting their cooperation in his intended sale of the property for the bankruptcy estate, to which they did not respond. A few months later they sold the residence, for $85,000 more than had been stated on their schedules, to a purchaser who did not know about their bankruptcy, and who financed the purchase with two loans secured by trust deeds. The deed transferring ownership and the trust deeds were duly recorded. The debtors received sale proceeds well in excess of their homestead and any other applicable exemptions.

In the adversary proceeding by the trustee against the purchaser and his lenders to regain title of the property, the bankruptcy court ruled in favor of the trustee, while granting the lenders equitable liens to be paid out of the trustee's sale of the property. On appeal the BAP reversed, and the trustee appealed.

The 9th Circuit affirmed the BAP holding, in favor of the BFP. After getting past the trustee's argument that the Bankruptcy Code's automatic stay preempts the state bona fide purchaser statute (to be discussed in an upcoming (9/15/08) Litigation Report on this website), the Court arrived at its ruling in two steps.

1) The trustee argued that upon the filing of a bankruptcy all of debtors' property vested in the bankruptcy estate, and so the debtors no longer had any interest in the real estate and the deed purporting to sell their real estate thus had no legal effect. The Court reasoned that this reflects a misunderstanding of the California bona fide purchaser ("BFP") statute (which is effectively the same as Oregon's--see below). The whole point of BFP statutes is to give effect to transfers in which the record owner's title is defective because of a prior unrecorded transfer, thereby nullifying that unrecorded transfer in favor of the BFP. The unrecorded transfer here is the residence's transfer into the bankruptcy estate resulting from the filing of the bankruptcy case. So, the Court held that this transfer to the estate is nullified in favor of the BFP.

2) The trustee then argued that "the automatic stay triggered by the [debtors'] petition rendered their deed to [the purchaser] a nullity ab initio, which conveyed nothing to [the purchaser] despite his status as a bona fide purchaser." He cited § 362(a)(3) that the petition "operates as a stay, applicable to all entities, of . . . any act to . . . exercise control over property of the estate." Indeed the Court acknowledged the "surface plausibility" of this argument, which was after all largely based on its own "void, not voidable" Schwartz opinion referred to above.

The Court's interpretation of its own Schwartz opinion turned on whether a particular part of that opinion was dicta, as the trustee argued, or not. In Schwartz the 9th Circuit had analyzed what it now called the "important potential conflict" between the automatic stay provision of § 362(a) and the trustee's special avoidance power in § 549(a), which provides that "the trustee may avoid a transfer of property of the estate . . . that occurs after the commencement of the case; and . . . that is not authorized under [the Bankruptcy Code] or by the court." But § 549 creates an exception for BFP's, not permitting the trustee's avoidance of transfers to BFP's. The Court in Schwartz had reasoned that § 549(a) and § 362(a) can be read together such that "§ 549 applies to transfers in which the debtor is a willing participant" whereas "[s]ection 362's automatic stay does not apply to sales or transfers of property initiated by the debtor." So in the present case, the Court, after rejecting trustee's argument that the above discussion in Schwartz was only dicta, instead determined that Schwartz was both binding precedent and well reasoned, and thus held that the automatic stay does not render void the debtors' sale of their residence.

Lastly, I mentioned above that Oregon's BFP statute is effectively the same as California's. This is important in considering the applicability to this opinion to Oregon. Here are the two pertinent statutes for the readers' own comparison:
  • Cal. Civ. Code § 1214: "Every conveyance of real property . . . is void as against any subsequent purchaser or mortgagee of the same property, or any part thereof, in good faith and for a valuable consideration, whose conveyance is first duly recorded . . . ."
  • ORS 93.640: "Every conveyance . . . affecting the title of real property within this state which is not recorded as provided by law is void as against any subsequent purchaser in good faith and for a valuable consideration of the same real property, or any portion thereof, whose conveyance . . . thereof is first filed for record . . . ."

  • The 9th Circuit twice noted that the "Trustee in bankruptcy had not recorded the [debtors'] Chapter 7 petition in the office of the . . . County Recorder . . . ." Clearly that would have yielded the opposite result, indeed would have avoided the entire issue because there would not have been a BFP without notice of the trustee's interest. But is the Court trying to say that trustee's should be bearing the expense of recording petitions or notices of bankruptcy? Apparently so, in cases where the trustee believes there is equity beyond the homestead exemption.
  • Why didn't the title company in the sale to the BFP report the debtor's bankruptcy? It's a matter of public record and referred to by title companies generally.,even if the bankruptcy is not recorded in the county real estate records. Could it be that the sale here was not stopped by the title company because the Chapter 7 case had by that time been discharged and closed, the sale being 23 months after the case was filed?

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

© 2008 Bankruptcy Litigation Support for Attorneys