Frequently a debtor’s assets are sold out of bankruptcy “free and clear” of liens and claims under §363(f).  While the Bankruptcy Code imposes limits on this ability to sell assets, it does allow the sale free and clear if “such interest is in bona fide dispute” or if the price is high enough or the holder of the adverse interest “could be compelled ... to accept a money satisfaction of such interest” or if nonbankruptcy law permits such sale free and clear of such interest.

One of the attractions of buying assets from a bankruptcy estate is that the purchaser can be assured that there are no liens, encumbrances or other claims burdening the acquired property.

But can a debtor sell assets that are subject to a preferential purchase right? Generally, an agreement with obligations still to be performed is an executory contract and can be rejected under §§363(f)(1) (sales) or 365(f)(1) (assignments).  But where there is a preferential purchase right in a contract, the answer is not so clear.  A fundamental problem is that courts, generally, may not allow debtors to reject some parts of an agreement while assuming others.

An impediment to a sale free and clear of a pref right is that the sale must meet one of 5 tests in §363(f) such as consent or state or other law permitting such sale but the two most relevant seem to be that the property may be sold free of the pref right if “such interest is in bona fide dispute” or “such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”  The Fifth Circuit addressed the latter test in the Energytec case, noting that it has yet to consider what constitutes a “qualifying proceeding” for this purpose.  Some courts have held that a cram down is such a proceeding while others have rejected that interpretation and have instead decided the issue based on whether proceedings under nonbankruptcy law could force an owner to accept monetization of its claim.  As a result, and other than in a condemnation proceeding, it is difficult to see how a court could force monetization of a pref right.

Another fundamental rule of bankruptcy law is that the debtor’s estate succeeds to no more interest than that which existed as of date of filing, and the estate takes its property rights subject to any conditions or existing burdens.  Thus the distinction between a covenant running with the land (i.e., a burden on the debtor's title) and a personal contractual obligation is significant both in bankruptcy and otherwise.  Although determined by applicable non-bankruptcy law, a covenant running with the land typically is a limitation on and an integral part of the title.  Recently, however, the bankruptcy court in the Southern District of New York, in Sabine held that a dedication of leases under a gas gathering agreement did not run with the land.  The bankruptcy court in the Western District of Texas (In re Dune Energy Inc.) recently ruled that consent rights relating to the sale of property can be a covenant which runs with the land.  If such a covenant does not run with the land, then it is likely personal and not binding on successors and assigns.

If a debtor attempts to reject a preferential right which exists as a provision in an executory contract, one line of authority suggests that a preferential right (properly created and perfected and enforceable under applicable nonbankruptcy law) is not rendered unenforceable by rejection of the contract under section 365(a). The court in In re Bergt, sustained the viability of a preferential right and noted that section 365(a) “is not an avoiding power that repudiates, cancels, or terminates the [right].”  It seems fairly well established, notwithstanding decisions with casual language to the contrary, that rejection of an executory contract under section 365 does not unwind rights provided by contract which existed on the date of filing.  Collier (and most academics) subscribe to this approach and opine that “rejection” is simply a “breach” but the contract is not terminated.  Following that same logic (at least in some instances), a preferential purchase right may remain enforceable.

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