In melodramatic movie weddings, guests are urged, before the couple is joined in matrimony, to “speak now or forever hold their peace” (although this phrase never seems to work its way into actual wedding ceremonies – presumably because there are no longer legitimate objections to a marriage that guests should be voicing at the wedding).

What about the proposed union of buyer and seller in bankruptcy sales?  Does the silence of a holder of an interest in property to be sold under section 363(f)(2) constitute consent that can pave the way for a sale “free and clear” of all interests in the property?  That is a question the Bankruptcy Court for the Western District of New York recently answered in In re Arch Hospitality, Inc., where the court found that a failure to object to an asset sale “free and clear” of claims and interests does not constitute consent under section 363(f)(2) of the Bankruptcy Code. 

Background

Rashmikant Patel was the president and sole stockholder of Arch Hospitality, Inc., which owned as its principal asset a hotel.  In May 2012, Patel and Arch each filed a chapter 11 petition.  Subsequently, the debtors obtained court authority to engage a broker to market the hotel.  After a year and a half, the broker located a prospective buyer to purchase the hotel for $1.75 million.  The purchase price was significantly less than the total of outstanding liens:  (i) real property taxes in the amount of $234,000; (ii) TD Bank’s first mortgage on the real estate and security interest on personalty, securing outstanding indebtedness of $2.9 million; (iii) Buffalo Realty Corp.’s second mortgage on the real estate, securing indebtedness in excess of $477,000; (iv) New York State Department of Taxation and Finance liens for over $40,000 on real and personal property, on account of unpaid sales taxes; and (v) a $2,500 judgment of the New York State Worker’s Compensation Board.

Nonetheless, the debtors filed two motions to proceed with the sale.  The first sought a declaration that the liens of Buffalo Realty Corp., the New York State Department of Taxation and Finance, and the Worker’s Compensation Board were wholly unsecured pursuant to sections 506(a) of the Bankruptcy Code and void pursuant to section 506(d) of the Bankruptcy Code.  The second motion sought authority under sections 363(b) and 363(f) of the Bankruptcy Code to sell the hotel property free and clear of all liens.

The proposed sale would generate sufficient proceeds to pay in full the real property taxes.  TD Bank, the first mortgagee, expressly consented to the sale.  The New York State Department of Taxation and Finance initially filed a statement opposing the sale, but after receiving adequate assurances of payment of its claim by a third party, withdrew its objection, and, therefore, impliedly consented to a sale.

Neither Buffalo Realty Corp. nor the Worker’s Compensation Board responded to the debtors’ motions.  It does not appear that there was any question that those two creditors received notice of the motions.  The debtors argued that by failing to respond, those creditors gave their implied consent to the sale under section 363(f)(2).

Holding

The bankruptcy court denied both motions.  As to the debtors’ argument that Buffalo Realty and the Workers’ Compensation Board should be deemed unsecured, the court found that even if it were to hold that those creditors’ claims were unsecured, they would still retain a property interest under section 349(b)(1) of the Bankruptcy Code because dismissal of the debtors’ chapter 11 cases would reinstate any lien voided under section 506(d) of the Bankruptcy Code (i.e., the possibility of lien reinstatement constitutes a property interest).  Thus, declaring that those creditors’ claims were wholly unsecured would not operate to diminish the restrictions on a sale free and clear of their rights, and the debtors would still need to meet one of the conditions under section 363(f) of the Bankruptcy Code.

The bankruptcy court also found that the conditions for a sale free and clear of liens under section 363(f)(2) of the Bankruptcy Code were not met, given the absence of express consent from Buffalo Realty and the Workers’ Compensation Board.  The court relied on the reasoning in two decisions:  In re Roberts and In re DeCelis.

In Roberts, the Bankruptcy Court for the Western District of Michigan concluded that the consent required under section 363(f)(2) cannot be implied from a failure to object, even where the lienholder receives adequate notice, because the word “consent” means “to give assent or approval” and is not synonymous with “fails to object;” therefore, express consent is required under section 363(f)(2).  The Roberts court further found that it is incumbent upon the debtor or trustee to go out and obtain the lienholder’s assent to a sale free and clear of the lien to comply with the requirements of section 363(f)(2).

Similarly, in DeCelis, the Bankruptcy Court for the Eastern District of Virginia determined that a property could not be sold free and clear of a co-owner’s interest because the co-owner did not affirmatively consent to the sale of assets, and the co-owner’s failure to respond to the motion to sell did not constitute consent to the sale.  Agreeing with Roberts, the DeCelis court found the Bankruptcy Code imposes no duty to respond to notices, and if Congress had intended silence to constitute consent in the context of section 363(f)(2), it would have so stated.

The Arch Hospitality court also held that, as a general rule, section 363(f)(2) requires a consent that is expressed and not merely implied.  Therefore, Buffalo Realty and the Workers’ Compensation Board had not impliedly consented to a sale free and clear of their interests under section 363(f)(2) by reason of their failure to respond to the debtors’ sale motion.

Acknowledging that there might be some circumstances where silence could indicate consent, the Arch Hospitality court found that the sale of real property pursuant to section 363(f)(2) was not the type of circumstance that warranted such a conclusion.  In particular, the court found persuasive that Buffalo Realty was a mortgagee of record and the Workers’ Compensation Board had a recorded judgment:

Both creditors took the necessary steps to perfect their liens.  Having perfected their liens, both could understandably expect that their interests would survive any subsequent transfer of title.  Under these circumstances, the more reasonable inference is that silence would here imply the absence of consent.

As a result, the court denied the motion to sell property free and clear, by reason of the absence of consent from creditors having an interest in the property.

Conclusion

Courts are split as to whether consent under section 363(f)(2) can be implied.  The majority of courts have found that where adequate notice of the sale was provided, failure to object may constitute consent to a “free and clear” sale under section 363(f)(2).  This reasoning takes into account the transaction costs that an estate might have to incur if everyone with an interest in estate assets to be sold had to execute a formal consent prior to the sale.

Courts, however, adopting the reasoning in Roberts, such as the Arch Hospitality court, reject the proposition that lienholders have the obligation to come forward and object, even if they are given notice of the sale; their silence should be sufficient.  The Roberts court also noted that a lienholder’s failure to object could be unrelated to actual consent to the proposed act, especially given the possibility that the recipient of a mass mailing such as those sent out to a debtor’s creditor matrix can mistake the notice for junk mail and dispose of it without having read it.

Because courts continue to be divided on the question of implied consent under section 363(f)(2) of the Bankruptcy Code, practitioners should be aware of the views within their relevant jurisdiction.  In addition, because of the split among courts, lienholders and other parties with an interest in a debtor’s property would be well-advised to carefully review all notices in the bankruptcy related to sales of the debtor’s assets.

Moreover, a debtor seeking to sell assets free and clear should look to alternatives under section 363(f).  Notably, the Arch Hospitality debtors relied exclusively on subdivision (2) of section 363 of the Bankruptcy Code, which permits a sale free and clear of any interest of an entity that consents.  The order does not explain, for example, why the debtors did not seek approval of a sale free and clear under section 363(f)(5), which requires a showing that the holder of an interest “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”