In In re TOUSA, Inc., the Bankruptcy Court for the Southern District of Florida considered whether to enforce a restrictive real estate covenant that set a price floor for the sale of house lots in a residential development.1 The Court held that due to an unprecedented decline in Florida real estate values, the restrictive covenant was unenforceable as an unreasonable restraint on the alienation of property.2 The Court accordingly allowed the debtor to proceed with the sale of several lots,3 despite the fact that the sale violated the precise terms of the restrictive real estate covenant.
The TOUSA Court took particular note of the unprecedented volatility of the Florida real estate market. Since the “sky high” valuations of 2005-2006, Florida residential real estate prices have fallen dramatically. Due to pressure from the crumbling market, TOUSA, one of Florida’s largest home builder corporations, has filed one of the largest bankruptcies in Florida history: the TOUSA chapter 11 includes thirtyeight debtor companies and has over $2.2 billion in liabilities.4 In re TOUSA, Inc. demonstrates a reasoned attempt by the Bankruptcy Court to come to terms with the legal and equitable consequences of the meltdown in the Florida residential real estate market.
Factual Summary and Case Analysis
TOUSA, Inc. and its affiliated debtors (“TOUSA”) requested permission to enter into a sale agreement under section 363 of the Bankruptcy Code for twenty residential lots located in the Meadow Run housing development in Martin County, Florida. TOUSA proposed to sell the property in bulk for $3 million, which equaled a per-lot price of $150,000. The creditors committee supported the proposed sale, and evidence in the record supported that $150,000 per lot was a fair sale price given market conditions.5
TOUSA, however, had entered into an agreement in 2006 with a developer named Zuckerman (the “Zuckerman Agreement”) which stated that for as long as Zuckerman owned any lot within the Meadow Run development, TOUSA would not sell any other lot in Meadow Run for less than $325,000.6 The Zuckerman Agreement was not recorded in the real estate records, but under Florida law nonetheless operated as a restrictive covenant that would generally entitle its beneficiary to injunctive relief.7 Because a restrictive real estate covenant creates an interest with a significant non-monetary component (i.e. the ability to control the type or pace of land development), a restrictive covenant is generally not a “claim” of a creditor under Florida law; as a result, a bankruptcy court may lack the power under section 363 of the bankruptcy code to authorize the sale of the subject land “free and clear” of all liens, claims, and encumbrances.8
Despite the non-monetary nature of the interest created by a restrictive real estate covenant under Florida law, another principle is implicated by these sorts of covenants. Under Florida law, unreasonable restraints on alienation of property are unenforceable,9 due to the policy goal of making land reasonably alienable. Florida case law dictates that in determining the validity of restraints on alienation, a court should consider whether the terms of a restrictive covenant are “of such duration that they prevent the free alienation of property.”10 Another case states that “courts must measure such restraints in terms of their duration, type of alienation precluded, or the size of the class precluded from taking.”11
The Court found that the Zuckerman Agreement was reasonable when entered into by the parties, especially because while TOUSA is a large corporation, Zuckerman ran a “Mom and Pop” business and reasonably believed the price restraints were necessary to ensure a competitive market.12 Changed circumstances, however, had made the Zuckerman Agreement
an unmanageable burden for TOUSA. The Court stated: “Given the current economic downturn and the debilitating effects it has had on the real estate markets, this restrictive covenant has morphed into a mechanism by which Zuckerman has indentured the debtors to indefinitely maintain their ownership of the property. The result is the debtors’ inability to sell the property while Zuckerman has free reign [sic] to market and sell his parcels at the deteriorating market rate, thus creating a tremendous competitive edge.”13
In reaching its conclusion, the Court entered into an extensive analysis of Port St. Joe Dock & Terminal Ry. Co. v. Maddox, a 1939 Florida Supreme Court case that upheld a lower court ruling that a restrictive development covenant was unenforceable due to a neighborhood shift from residential to industrial use during an intervening interval of over a decade.14 The Port St. Joe court stated that when the land contract had been entered into in 1925, a restriction to residential development only was reasonable because the waterfront land was pristine and there was no industrial development in the vicinity.15 Over the intervening years, however, several adjacent parcels were sold with no similar development restrictions and a paper mill opened up nearby, polluting the waterfront and making the area unfit for swimming or bathing.16 Because the waterfront had become suitable only for industrial use, the Florida Supreme Court found that the lower court’s decision not to enforce the restrictive residential use covenant was justified.17
In addition to the Port St. Joe case, the Court’s rationale was buttressed by another, nearly contemporaneous, decision, In re George Walker, in which the Bankruptcy Court for the Southern District of Florida (with a different judge presiding than in In re TOUSA, Inc.) authorized a debtor to sell property free and clear of an overly burdensome restrictive covenant.18 In the Walker case, a debtor sought permission to sell a townhouse located in a South Florida residential development.19 The Homeowners’ Association (the “HOA”) claimed the right to stop the sale because the debtor had not followed approval procedures to the HOA’s satisfaction.20 The Walker court found that the HOA claimed the right to reject a buyer “for even the most amorphous of reasons, thereby creating . . . an arbitrary standard of review,” “with no limit or condition imposed on the HOA’s right to void a sale.”21 Finding that the claimed powers of the HOA were unreasonably broad and arbitrary, the Walker court approved the debtor’s motion for an emergency sale despite the objections of the HOA.22
Citing these cases and equitable principles, and with particular emphasis on the precipitous decline in value in the Florida real estate market, the TOUSA court found that enforcing the Zuckerman Agreement would be an unreasonable restraint on the alienation of real property.23 The Court was careful, however, to limit its rationale for invalidating the restrictive covenant to very significant economic and/or land use shifts, stating “this is not to say that regular real estate market swings would necessarily render such a covenant unenforceable.”24 Ultimately, however, the Court found that the consequences to the Florida real estate market attendant to the current economic turmoil were sufficient to invalidate the Zuckerman Agreement: “The collapse of the Florida residential real estate market over the past year has had the effect of transforming the competitive pricing restriction into a de facto prohibition on alienation. The restrictive covenant is therefore unenforceable.”25 The Court thus invalidated the restrictive covenant, and allowed the sale of the parcels of land under section 363 of the Bankruptcy Code. The Court did not address either the issue of whether Zuckerman was allowed a claim against TOUSA, or whether the restrictive covenant might still restrict future sales by the purchaser of these lots.
Current economic turmoil and financial uncertainty is engendering legal change as courts grapple with the proper response to an unprecedented economic downturn. If In re TOUSA, Inc. proves to be suggestive of the near-term future, chapter 11 debtors may enjoy expanded opportunities for rehabilitation via the bankruptcy courts’ equitable powers. Parties who bargained for restrictions on debtors’ activities in the prior economic climate may suddenly find themselves out of luck as their once-reasonable restrictions are deemed unreasonable today. An attempt to balance these bargainedfor rights against the desire to reorganize distressed businesses promises to be a theme in many cases as they work their way through the bankruptcy courts.