The U.S. Court of Appeals for the Ninth Circuit has held that a bankruptcy trustee could not avoid an unauthorized sale of real estate to a bona fide purchaser— although the proceeds of the sale did belong to the estate.

The court ruled that an unauthorized postpetition transfer of real property in California could be avoided only if the buyer had actual knowledge of a bankruptcy filing, or if the trustee recorded the transfer of title to the property from the debtor to the estate in the land records of the applicable county, In re Tippett, 542 F.3d 684 (9th Cir. 2008).

After filing a joint chapter 7 petition, Craig and Christine Tippett retained a realtor and sold their home without the chapter 7 trustee’s knowledge. The home was sold to a bona fide purchaser under California law, unaware of the Tippetts’ pending bankruptcy case. The trustee filed an adversary action to avoid the unauthorized postpetition transfer.

The bankruptcy court ruled in the trustee’s favor. The Bankruptcy Appellate Panel for the Ninth Circuit, however, reversed and entered judgment in favor of the purchaser and its mortgagee. The Ninth Circuit Court of Appeals affirmed the panel decision and upheld the postpetition transfer.

Bona Fide Purchaser

In In re Tippett, the Trustee filed an adversary action to recover the sale proceeds, avoid the liens of the purchaser’s mortgage lenders, and to quiet title.

In affirming the Ninth Circuit BAP, the Court of Appeals examined three issues: the effectiveness of the deed to the buyer, federal preemption of state law, and application of the automatic stay.

The court rejected the trustee’s argument that because all property of the debtor becomes property of the estate by operation of law when the bankruptcy case is filed, the debtor lacked the power to convey property by deed to the buyer. California’s bona fide purchaser statute is meant to address just such a situation, the court reasoned. The state statute protects parties such as the buyer, whose title to real estate is defective because of some unrecorded conveyance. Because the bankruptcy filing was not recorded in the real estate records of the appropriate county, the court held that the transfer of title from the debtors to the trustee that happens by operation of law when a bankruptcy case is filed was not effective against the buyer.

Federal Preemption

The court next examined whether federal bankruptcy laws preempted application of California’s bona fide purchase statute. The court held that while federal bankruptcy laws clearly preempt state laws with respect to bankruptcy, federal bankruptcy laws nonetheless frequently coexist with other state laws, and often expressly incorporate state laws regulating the rights and obligations of debtors and creditors.

Whether California’s bona fide purchase statute was preempted depended on whether it was inconsistent with the “essential goals and purposes of federal bankruptcy law.”

The court found that the essential goals and purposes of federal bankruptcy law in a chapter 7 case include: (1) giving the individual debtor a fresh start through a discharge of most pre-petition debt; and (2) equitably distributing a debtor’s assets among competing competitors.

The court determined that the first goal was unaffected by the state statute. The court then determined that because the proceeds of a sale protected by California’s statute are brought into the estate, the equitable distribution among creditors of estate assets is not adversely impacted if the state statute is enforced.

Moreover, the Bankruptcy Code contains provisions similar to California’s bona fide purchase statute. For example, Section 549(a) of the Bankruptcy Code protects bona fide purchasers from avoidance of unauthorized postpetition transfers, much like California’s statute protects bona fide purchasers from unrecorded transfers. Therefore, California’s bona fide purchaser’s statute is not inconsistent with federal bankruptcy law and is not preempted.  

Other Issues

The court dispensed with the trustee’s final argument stating that transfers initiated by the debtor do not constitute violations of the automatic stay imposed by Section 362(a) of the Bankruptcy Code. As such, a postpetition transfer initiated by the debtor will not be void ab initio.  

The court highlights the distinction between Section 362(a) transfers that are void because they protect the debtor, from actions taken by creditors and Section 549(a) transfers that are voidable to protect creditors from actions taken by the debtor. Under Section 549(a)–and California law–an unauthorized transfer to a bona fide purchaser is unavoidable.

Accordingly, while the proceeds of the sale certainly must be turned over to the estate, the sale itself was valid and unavoidable.