Yours, Mine, and Ours: May a Bankruptcy Court Authorize the Sale of a Co-Owner's Interest Free and Clear of Its Creditors' Claims?

• Date: 01 March 2023
• Author: Etlinger, Daniel

Few sections of the Bankruptcy Code (1) have received as much attention as [section]363(f). Yet, surprisingly, only a handful of decisions have evaluated whether a bankruptcy court may authorize a sale free and clear of a non-debtor's creditors' claims. As a whole, [section]363 is designed to strike a balance between the competing needs for debtors' continuing operations with protecting secured creditors from dissipating collateral. This equation is complicated further when the interests of co-owners must be accounted for. To understand how the pertinent sections operate in conjunction it is necessary to first examine how [section][section]363(f)(4) and (h) operate separately.

Section 363 Background

A Ch. 11 debtor may use or sell property in the ordinary course of business if 1) the business of the debtor is authorized; 2) the court has not previously ordered otherwise; and 3) as for cash collateral, certain conditions are met. (2)

But a debtor may sell property not in the ordinary course of business only after notice and a hearing. (3)

Approval of[section]363(b) transactions requires that the bankruptcy court find that the debtor justify [ ] the proposed transaction. That is, for the debtor-in-possession...to satisfy its fiduciary duty to the debtor, creditors and equity holders, there must be some articulated business justification for using, selling, or leasing the property outside the ordinary course of business. (4) In determining whether a transaction is in the ordinary course of business, courts typically analyze the matter across two dimensions--vertical and horizontal. (5) The vertical dimension focuses internally, comparing the debtor's own pre-petition and post-petition conduct. (6) In contrast, the horizontal dimension focuses externally, comparing the debtor's operations to those industry-wide. (7)

Whether or not the sale is in the ordinary course, to carry out Congress' objectives, the Bankruptcy Code contains two important sections that allow for the sale to be free and clear of interests.

First, [section]363(f)(4) facilitates a free-and-clear sale of any interests that are in bona fide dispute. (8) The rationale is straight forward--unencumbered property will generate a higher sales price while the released interest is still protected (for example, by a claim to the sales proceeds). The Bankruptcy Code does not define what a bona fide dispute is.9 "However, bankruptcy courts have held that the standard for determining if such a dispute exists is, whether there is an objective basis for either a factual or a legal dispute as to the validity of the asserted interest." (10) "Clearly this standard does not require the Court to resolve the underlying dispute, just determine its existence." (11) Indeed, the debtor need not have even filed an adversary proceeding to show a bona fide dispute. (12)

Second, [section]363(h) permits a trustee may sell not only the estate's interest in property but that of a co-owner as well. (13) The co-owner's interest must be that of a tenant in common, joint tenant, or tenant by the entirety. (14) And even then, the co-owner's interest may be extinguished only if:

1) partition in kind of such property among the estate and such coowners is impracticable;

2) sale of the estate's undivided interest in such property would realize significantly less for the estate than sale of such property free of the interests of such co-owners;

3) the benefit to the estate of a sale of such property free of the interests of co-owners outweighs the detriment, if any, to such co-owners; and

4) such property is not used in the production, transmission, or distribution, for...