As seen in The Community Banker

Lenders that exercise their rights to foreclose upon collateral are often met with a bankruptcy filing near or shortly after the date of sale. Obviously, if a lender learns of a bankruptcy prior to the foreclosure, the sale should not proceed unless and until relief from the bankruptcy stay is granted by the Bankruptcy Court. But, what are the lender’s rights when a foreclosure sale is held with a bankruptcy filing occurring hours or days after the sale? Based upon a recent bankruptcy court decision, it appears that part of the answer depends on whether the bankruptcy is in the Northern or Southern District of West Virginia. 

Until recently, lenders throughout West Virginia typically relied on In re Bardell1, a Northern District bankruptcy court decision, for the proposition that real property sold at a foreclosure sale was not part of the bankruptcy estate after “the hammer fell” and the trustee executed a memorandum of sale. This was true even if the deed had not been issued. 

Bardell involved a foreclosure sale held December 29, 2005. The foreclosure trustee and the successful bidder executed a Trustee’s Memorandum of Sale the same day. The debtor filed bankruptcy on December 31, 2005, before the trustee had the opportunity to execute a trustee’s deed. The Court held that the December 29 Sale transferred all equitable rights in the property to the purchaser and thereby completed the foreclosure. As a result, the property was not considered part of the bankruptcy estate and the sale was deemed final. 

Lenders throughout West Virginia have relied on Bardell for the proposition that a post-auction bankruptcy would not upset or unwind a properly held foreclosure sale where a memorandum or contract was executed prior to the filing of the bankruptcy petition. Because this case was decided in the Bankruptcy Court for the Northern District of West Virginia and affirmed by the District Court, Bardell likely remains the law in the Northern District of West Virginia. 

However, the Bankruptcy Court in the Southern District of West Virginia recently ruled differently in the In re Bell2 case. In that case, the Court adopted a position contrary toBardell, holding that the recording of a trustee’s deed is necessary to transfer equitable rights in the property and finalize the foreclosure. Bell involved a foreclosure sale held at 10:30 a.m. on November 2, 2012. At 10:50 a.m., the Trustee and buyer executed a Memorandum of Sale. Later, at 4:00 p.m. on the same day, the borrowers filed bankruptcy. Under these facts, the Bell court held that the equitable rights to the property remained in the borrower at the time the bankruptcy was filed and that a recorded trustee’s deed would have been necessary to terminate the borrower’s equitable rights. Since the deed was not issued, the Court found that the property was included in the bankruptcy estate. 

Interestingly, the contrary holdings reached by the Bardell and Bell courts are based on the same line of state court precedent. The West Virginia Supreme Court of Appeals’ Atkinson v. Washington & Jefferson College3 case held:

A contract of sale between a trustee in a deed of trust and a purchaser is complete when the trustee, selling at auction, knocks the land down to the bidder, makes a memorandum of the sale and its terms, and signs the same.

Bardell and Bell disagree over the effect of the memorandum of sale. Bardell’s interpretation is that this contract passes all equitable rights to the buyer. And, since the legal title was given to the trustee upon execution of the deed of trust, the borrower has no rights in the property once the memorandum is made. Bell’s interpretation of this ruling is that while the memorandum vests the buyer with the contractual right to receive a deed, the equitable rights in the property remain in the borrower. Further, because the bankruptcy estate consists of all legal and equitable rights of the debtor, the debtor has the right to include the property in the bankruptcy until a trustee’s deed is recorded. 

The Bell case is currently under appeal to the United States District Court.4 Therefore, it is possible that the decision could be overturned and/or that the District Court may provide additional guidance on this issue. But, as long as Bell remains the law, lenders faced with a post-foreclosure bankruptcy filing before the execution of a deed should remain conscious of whether the real property lies within the jurisdiction of the Northern District or Southern District of West Virginia in determining whether a foreclosure sale is final. 
No matter the jurisdiction, it is advisable to work to have both the memorandum of sale and trustee’s deed finalized as soon as possible after the sale to avoid the potential of having the sale set aside by a subsequent bankruptcy filing.