The United States Bankruptcy Court for the Western District of Kentucky recently found that a vendor’s filing of a prepetition notice of lis pendens served to place any hypothetical judicial lien creditor, execution creditor, or purchaser of real property on notice of its equitable lien against the property for the unpaid portion of the purchase price. This prepetition notice of lis pendens prevented the debtors-in-possession from avoiding the vendor’s lien in exercise of their strong-arm powers under 11 U.S.C. § 544.

In In re The Dynamis Group, LLC, 441 B.R. 841 (Bankr. W.D.Ky. 2011), the Plaintiff, Naja, LLC, sought an adjudication that it had a first priority equitable lien on the real estate transferred pursuant to an Asset Purchase Agreement between it, W.P.B. Oil Company, Inc. (“WPB”), and three of the Debtors/Defendants, The Dynamis Group, LLC, Molly Company, LLC, and Helmick Oil Company, LLC. Jack Helmick (“Mr. Helmick”) was the sole member and manager of these three entities, along with another Debtor/Defendant, Jack’s Company (these four entities are collectively referred to as the “Dynamis Defendants”).

Mr. Helmick had been hired as CEO of Plaintiff’s affiliate WPB for the purpose of helping turn the financially failing company around. When WPB continued to fail, Mr. Helmick proposed the purchase of Plaintiff’s and WPB’s assets by his companies, and the purchase was structured so as to allow him to take advantage of certain loan guarantees from the U.S. Department of Agriculture, meaning the USDA would guarantee a large percentage of the loans that permitted Mr. Helmick’s companies to purchase the assets.

A portion of the purchase price was paid by an ostensibly unsecured $1.8 million note given by Jack’s Company (“Jack’s Note). Jack’s Company would not actually have any of the assets and would not generate income of its own. Instead, the three operating entities, Dynamis, Molly and Helmick Oil, would provide Jack’s Company with the funds necessary to pay Jack’s Note, and Jack’s Company would simply act as a conduit of funds.

Jack’s Company ultimately defaulted on Jack’s Note, and Plaintiff filed suit, seeking rescission of the Asset Purchase Agreement and return of the transferred assets. At the same time, Plaintiff recorded lis pendens notices regarding the suit and the property in question. When the Defendant/s Debtors later filed Chapter 11 bankruptcy petitions, which were jointly administered, Plaintiff filed an Adversary Proceeding seeking a determination that it had a first priority equitable lien on the real estate transferred pursuant to the Asset Purchase Agreement for the unpaid portion of Jack’s Note.

The Dynamis Defendants’ argued that Plaintiff did not hold an equitable lien because it received full consideration for the real property as Jack’s Note in itself constituted consideration whether or not it was ultimately paid. The Court rejected this argument, finding that

The Court rejected the Dynamis Defendants’ argument that Plaintiff did not hold an equitable lien because it received full consideration for the real property, Plaintiff failed to receive full consideration for the real estate because Jack’s Note was not itself full and final payment but simply suspended the remaining purchase obligation. The Court also took no issue with the fact that the consideration was to be supplied by Jack’s Company, a third-party and not one of the record purchasers, because the supplier of consideration makes no difference from the perspective of the vendor. Accordingly, the Plaintiff had an equitable lien on the real property.

The Court also found that the debtors-in-possession could not avoid the lien under 11 U.S.C. §544 because the Plaintiff’s lis pendens notices, filed well before the bankruptcy petitions, served to place a hypothetical judicial lien creditor, execution creditor and purchaser of real property on notice of the equitable lien, rendering §544 unavailable to the debtors-in-possession with respect to that lien. The Court advanced two reasons for this holding: (1) under Kentucky law, a properly filed lis pendens notice places a subsequent purchaser of the affected real estate on notice of the interest asserted in the lis pendens and, therefore, a bankruptcy trustee cannot be treated as a bona fide purchaser of that real estate for purposes of §544; and (2) the filing of a lis pendens notice also serves to “perfect” the property interest referred to in the notice as against subsequent judicial lien and execution creditors, and a bankruptcy trustee’s hypothetical position as a judicial lien holder or execution creditor as of the filing of the bankruptcy petition would be subordinate to the lien “perfected” by the previously filed lis pendens notice.

For these reasons, the Plaintiff was adjudged to hold a first priority equitable lien against the real property transferred under the Asset Purchase Agreement for the unpaid portion of the $1.8 million note given by Jack’s Company as part of the consideration for the purchase of the property.