United States: Trustee Could Not Challenge Sale Proceeds Disbursement Nearly One Year After Preconversion Sale

The Bankruptcy Court for the Eastern District of Michigan recently ruled that a chapter 7 bankruptcy trustee could not, nearly one year after a sale of debtor’s real property that occurred prior to the conversion of the case, challenge the disbursement of the sale proceeds to the first mortgagee. The case is one of first impression within the jurisdiction of the U.S. Court of Appeals for the Sixth Circuit.

In In re Hi Tech Fleet Serv., Inc. v. TCF Nat’l Bank, 339 B.R. 428 (Bankr.E.D.Mich. 2006), High Tech filed a voluntary chapter 11 bankruptcy petition on Nov. 12, 2004. The debtor’s biggest asset at the time of the filing was real property valued at $1.4 million, with outstanding mortgages of $954,688. The mortgages were held by TCF National Bank, which filed a secured claim against the estate in the amount of $919,018.87.

On May 7, 2004, Hi Tech Fleet filed a motion for sale of the real property under section 363(f) of the Bankruptcy Code. As part of its the motion, the debtor listed TCF as a lienholder with property rights that would be affected by the sale, and $980,000 as the amount of its lien. The certificate of service filed with the motion reflected that it was served on all parties listed on the bankruptcy matrix. On May 14, 2004, the court entered an order authorizing a sale and providing for application of the sale proceeds, which was stipulated to by counsel for the debtor, TCF Bank, and the United States Trustee.

On June 24, 2004, the debtor filed an offer to purchase the real property received by Gordon Mobley. On June 29, 2004 the court held a hearing on the debtor’s motion to approve the sale and granted the motion on the record. A written order granting the motion was entered July 15. No appeal or motion for reconsideration was filed after the order was entered. The sale closed July 27, 2004. According to the closing statement, TCF ultimately received $990,226.84 from the sale proceeds, which included interest, attorney fees "and other charges incurred by the Bank in order to enforce its mortgage lien on the property."

On Aug. 24, 2004, at the debtor’s request, the court entered an order converting debtor’s chapter 11 case to one under chapter 7. A chapter 7 trustee was appointed Sept. 8, 2004.

On June 10, 2005, almost one year after the sale, the trustee filed a complaint against TCF Bank seeking to recover some of the amounts paid to TCF from the sale of the real property. Specifically, the trustee asserted that TCF’s post-sale

The court rejected the lenders’ contract claim after a detailed review of the applicable provisions of the loan agreements, concluding that such provisions failed to explicitly provide that the interest rate could be automatically and retroactively adjusted as a remedy in the event of falsely reported financial information.

"[T]hat is not one of the contractual remedies that any of the bank lenders bargained for," the court stated.

While the loan agreements did provide for the automatic readjustment of the interest rate in the event that Adelphia failed to provide any financial information, they did not provide for any adjustment if such information proved to be inaccurate. Instead, if the financial information was incorrect, the loan agreements provided that the lenders had the right to declare a default and charge the default rate of interest as a remedy. Default interest would exceed the grid interest received if the financial information was correct. However, in connection with providing debtor-in-possession financing to Adelphia, the lenders waived any claim for default interest arising from prepetition defaults.

Accordingly, the court held that the loan agreements failed to provide a contractual remedy for the retroactive adjustment of interest sought by the lenders.

The court maintained that its holding was not meant to "condone defrauding bank lenders, . . .it is only to say that, particularly in a case where the recoveries of the bank lenders come at the expense of other creditors, no party can make a contractual claim that goes beyond its contractual rights."

The lenders also argued that they were entitled to the additional grid interest on tort theories of fraud or misrepresentation. The court agreed that, if proven, Adelphia would be liable for such claims. The court, however, went on to explain that claims based in tort, as opposed to contract, do not give rise to secured claims under section 506(b). Furthermore, the court held that the tort claims gave rise only to compensatory damages for the lenders’ actual out-of-pocket loss and not the profits they would have realized in the absence of fraud. The court equated the lenders’ actual out-of-pocket loss to the outstanding principal amount of the lenders’ claims. Because the principal amount of the lenders’ claims is to be paid in full upon confirmation of Adelphia’s plan, the court found that the lenders will suffer no compensable damages.

Lastly, because the court found that the secured lenders were not entitled to the additional interest, it did not address the objecting parties’ remaining contentions that the lenders waived the additional interest claims because they failed to include such amounts in their proofs payoff of $990,226.84 wrongly included interest, fees, costs and other charges totaling $117,555.95.

Count I of the trustee’s complaint sought a finding that TCF’s secured claim prior to the July 27, 2004 closing did not exceed $872,650.89, and a refund of the alleged overpayment of $117,555.95 pursuant to Bankruptcy Code section 542. Count II claimed that the "overpayment of interest and the default interest, fees, costs and charges paid to TCF" constituted post-petition transfers of property not authorized by the court or the Code, and that they were avoidable under sections 549(a)(1) and (a)(2)(B).

The trustee moved for summary judgment on the claims on Dec. 28, 2005. In response, TCF argued that the $990,226.84 payoff was made "in full compliance with and under the authority of this court’s orders."

In considering the trustee’s motion, the court noted that the U.S. Court of Appeals for the Seventh Circuit had ruled on similar facts that "[s]ale orders are final, appealable orders" and "once the time for appeal from a bankruptcy court’s sale order has expired, res judicata precludes a party to the sale proceeding from attacking the sale order by way of a new lawsuit." (Citing Boyer v. Gildea, 2005 WL 2648673 (N.D.Ind. Oct. 17, 2005), quoting In re Met-L-Wood Corp., 861 F.2d 1012, 1016 (7th Cir.1988)).

In Met-L-Wood, a bankruptcy judge approved the auction sale of a chapter 11 debtor’s assets under section 363. After the case converted to a chapter 7, the chapter 7 trustee sued the auction bidders, the debtor, and others involved in the sale under RICO and state law for fraudulently rigging the auction. The trustee also filed a motion under Federal Rule of Civil Procedure 60(b) to vacate the judgment approving the sale The district court held that the trustee’s fraud claims were barred by res judicata and dismissed the Rule 60(b) motion because it was not timely filed. The trustee appealed and the appellate court affirmed, holding that the bankruptcy court’s order approving the auction was an appealable order and a final judgment for res judicata purposes.

Addressing the case at bar, the Hi Tech court noted that a party has 10 days to appeal entry of a judgment, order or decree under Federal Rule of Bankruptcy Procedure 8002, and further that every party with an alleged interest in the property, as well as every creditor listed on the matrix, was provided with notice of the motion to sell the real property in question. The court also pointed out that the debtor’s sale motion stated that TCF Bank was owed approximately $980,000, and therefore all interested parties were on notice that the estimated amount being sought by TCF was substantially higher than its original claim of $919,000.

Because all parties with a vested interest in challenging the sale proceeds paid to TCF had notice and an opportunity to object, the court dismissed Counts I and II, holding that the trustee (acting on behalf of creditors) could not, almost a year after the sale, raise an objection.

This article is presented for informational purposes only and is not intended to constitute legal advice.