Restructuring

Contributed by Amy B. Price
This month, our “Breaking the Code” random-topic-generating wheel of fortune (or terror, as the case may be) has landed on section 363(j) of the Bankruptcy Code. This section reminds us that the reluctant cast of characters in any bankruptcy case may include non-debtor individuals or entities that co-own property with the debtor and, accordingly, may have rights in property that becomes part of the bankruptcy estate upon the commencement of the debtor’s case.  Under certain circumstances, the Bankruptcy Code permits the trustee to sell jointly-owned property free and clear of a non-debtor’s ownership interest in such property, and section 363(j), in turn, governs the distribution of proceeds and the allocation of costs of the sale.
When It Applies
Section 363(j) directs the distribution of proceeds from sales under sections 363(g) and (h) of the Bankruptcy Code and provides as follows:

After a sale of property to which subsection (g) or (h) of this section applies, the trustee shall distribute to the debtor’s spouse or the co-owners of such property, as the case may be, and to the estate, the proceeds of such sale, less the costs and expenses, not including any compensation of the trustee, of such sale, according to the interests of such spouse or co-owners, and of the estate.

Sections 363(g) and (h) grant the trustee considerable power to sell estate property free and clear of a non-debtor co-owner’s or spouse’s interest, even without the non-debtor’s consent.  Note that sections 363(g) and (h) are distinguishable from section 363(f), which allows the trustee to sell property free and clear of a third party’s “interest” in such property, under certain circumstances.  Whereas section 363(f) is mainly (albeit not exclusively) used to sell property free and clear of a third party’s lien, section 363(h) applies only when the third party’s interest in estate property is that of a co-owner.  Specifically, the trustee may sell property under section 363(h) only if, at the commencement of the case, the debtor holds an undivided interest in the property as a tenant in common, joint tenant, or tenant by the entirety and if four enumerated conditions are met.  Further, section 363(g) applies only when the third party is the debtor’s spouse with an interest in estate property “in the nature of a dower or curtesy.”  Section 363(i), which grants the non-debtor co-owner or spouse a right of first refusal to purchase the property in a sale pursuant to section 363(g) or (h), is also worth noting here.
Why We Need It
Taken together, sections 363(g)-(j) enable the trustee to sell estate property free and clear of five types of common law property interests, subject to certain protections for the non-debtor co-owner or spouse, in order to realize value for the estate.  The trustee’s right to conduct a forced sale of jointly-owned property is necessary in part because of the practical problems attendant to the co-ownership of property.  For example, both inside and outside of the bankruptcy context, when co-owners disagree over the desirability of liquidating jointly-owned assets, physical partition of the assets is not always a possible or practicable solution, especially where partitioning the property will decrease its value.  Additionally, the non-debtor’s Fifth Amendment rights are implicated by forced sales under 363(g) and (h).  Thus, the statutory scheme in sections 363(g)-(j) balances the benefits of a 363 sale to a debtor’s estate and creditors against the rights and interests of the non-debtor co-owner or spouse. 
To What It Applies
To be sure, section 363(j) applies only in limited circumstances.  Courts have made clear that a trustee’s right to sell property free and clear under sections 363(g) and (h) applies to only the expressly enumerated property estates (dower, curtesy, tenancy in common, tenancy by entirety, joint tenancy).  Furthermore, those who over-studied for the multi-state bar exam will recall that dower, curtesy, and tenancy by the entirety are common law estates that arise only in the context of married spouses (as defined by state law), further limiting the applicability of section 363(j) in corporate bankruptcies.
Nevertheless, section 363(j) has its place in commercial bankruptcies, particularly because tenancy in common persists as a form of concurrent ownership in various contexts, including commercial real estate, see, e.g., Official Comm. of Unsecured Creditors v. Anderson Senior Living Prop., LLC (In re Nashville Sr. Living, LLC), 620 F.3d 584 (6^th Cir. 2010), and, as section 363(h)(4) makes clear, the utility industry.
How It Works
Section 363(j) directs that, before distributing the sale proceeds, the trustee must first deduct from the proceeds the costs and expenses of the sale.  Thus, the costs of the sale are pro-rated among the co-owners or spouse and the estate.  Although this formula appears straightforward, disputes over cost allocation may arise.  For example, parties have litigated whether a co-owner who exercises his right of first refusal under section 363(i) remains liable for his pro rata share of the sale costs.  At least one court held in the affirmative, notwithstanding that a third party purchaser would not incur the sale costs.  See Marion v. Xuereb (In re Marino), 794 F.2d 1367 (9^th Cir. 1986).
Next, in order to distribute the sale proceeds “according to the interests of such spouse or co-owners, and of the estate,” as required by section 363(j), the trustee or court must look to applicable non-bankruptcy law (generally state law) or contracts to determine the interests of the debtor and non-debtors relative to each other.  Although section 363(j) does not mention other interests in the property, the trustee or court also must consider mortgagees or holders of other encumbrances on the property and sometimes other joint creditors of the co-owners, whose interests are taken off the top before proceeds get distributed according to the respective equity interests of the co-owners and the debtor.
The Takeaway
As section 363 sales, large and small, are ever present in bankruptcy practice, a rudimentary understanding of section 363(j) and its related provisions couldn’t hurt.  What’s more, these provisions underscore the burdens attendant to certain forms of co-ownership of property and, accordingly, why estate planning and other professionals have gravitated towards trusts in lieu of common law estates.