Restructuring

Recently, in In re L.L. Murphrey Co., No. 12-03837-8-JRL, 2013 WL 2451368 (Bankr. E.D.N.C. June 6, 2013), the court held that, under section 363(f)(4), the trustee established the existence of a “bona fide dispute” regarding the validity of a creditor’s liens arising from security instruments on tracts of real property and associated personal property and, thus, could sell the property free and clear of those liens.  Because of the aforementioned dispute, there was also sufficient “cause” to deny such creditor’s right to credit bid at the proposed sale under section 363(k).  For creditors, In re L.L. Murphrey Co. demonstrates the importance of ensuring that liens are properly and indisputably perfected and avoiding subsequent disputes related to such interests that may jeopardize the creditor’s recovery of its claims against a future debtor-counterparty.
Background
This matter came before the United States Bankruptcy Court for the Eastern District of North Carolina by the trustee’s motion to sell certain of L.L. Murphrey Co.’s assets free and clear of liens and to transfer such liens to the proceeds of the sale, which motion was opposed by D.A.N. Joint Venture Properties of North Carolina, LLC.  Murphrey operated swine production and finishing facilities in Greene County, North Carolina and filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code in May 2012.  DAN was the assignee to the liens on certain of Murphrey’s assets following a sale by the original lender, Wachovia.
Prior Chapter 11 Filing
In June 2000, long before Murphrey’s 2012 chapter 7 filing, Murphrey filed for chapter 11.  At that time, Murphrey was in default to Wachovia Bank, N.A. for over $12.7 million pursuant to five separate promissory notes.  All five notes were secured by a deed of trust, assignment of rents, security agreement and financing statement in favor of Wachovia.  Wachovia also perfected a security interest in Murphrey’s fixtures and personal property.  In July 2001, the court confirmed Murphrey’s fourth amended plan of reorganization which split the five promissory notes into two:  Note A and Note B.  Each note had different terms, but both were secured by the collateral pledged to Wachovia by Murphrey and were guaranteed by guaranty agreements executed by Murphrey’s principals. Pursuant to the plan, Murphrey and Wachovia would enter into amended and restated loan documents and Murphrey would execute and deliver such agreements “as may be reasonably requested by Wachovia.”  Assuming all conditions precedent were satisfied, the implementation date for the notes would be October 2001.  One of such conditions was amending and restating the loan documents.  The plan further provided that “[a]ll liens remaining in favor of any creditor in this action against the real property conveyed prior to the filing of the petition shall be deemed . . . released upon confirmation of the Plan.”  Post-confirmation, Wachovia’s claim and any liens it held were acquired by CadleRock Joint Venture, L.P. and then subsequently assigned to DAN in August 2008.
Section 363 Sale
After Murphrey filed for chapter 7 in May 2012, DAN filed a proof of claim for over $6 million: (i) $3.5 million was asserted as secured based on the value of certain tracts of real property and related personal property, which DAN alleged were perfected by a mortgage, security agreement, and UCC-1; and (ii) the balance was to be treated as a general unsecured claim.  Thereafter, the trustee filed a motion requesting approval of a public sale of Murphrey’s real and personal property free and clear of liens, with any such liens transferred to the proceeds of the sale.
In its motion, the trustee argued that the security instruments which formed the basis of DAN’s liens on the property at issue were avoidable under section 544(a)(3) which provides that:

[t]he trustee . . . may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by—(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.

The trustee asserted that the instruments were invalid because they were released upon confirmation of the plan of reorganization in the earlier chapter 11 case that Murphrey had filed in June 2001, and that the instruments failed to accurately describe the underlying obligations.
DAN objected, arguing that the trustee failed to establish any of the five grounds under section 363(f) required for such a sale.  DAN also asserted that the previous confirmed plan did not require the execution of new deeds of trust—only those that were reasonably requested by Wachovia (the original lender).  Thus, DAN asserted, any argument that the liens were released upon confirmation was without merit and could not constitute the basis for a bona fide dispute.
Section 363(b) of the Bankruptcy Code permits a trustee, after notice and a hearing, to use, sell or lease property of the estate outside the ordinary course of the debtor’s business. Specifically, section 363(f) provides that:

[t]he trustee may sell property . . . free and clear of any interest in such property of an entity other than the estate, only if—(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

The court held that a bona fide dispute existed as to the validity of DAN’s liens.  The language of the prior confirmed plan of reorganization was umambiguous and imposed an obligation on the parties, Murphrey, and Wachovia to execute amended and restated agreements, instruments and other loan documents consistent with the terms of the plan.  The mandatory nature of this term, the court explained, was supported by the plan’s provisions making execution and delivery of amended and restate loan documents one of the conditions precedent for setting the implementation date for the notes.  Thus, DAN’s arguments that such provisions were not mandatory, but rather discretionary, failed.  Without the amended and restated loan documents, the court found that the description of the notes and their terms, obligations, and treatment of Wachovia were insufficient to be deemed negotiable instruments (as defined by Article 3 of the Uniform Commercial Code).  Thus, the court explained, the trustee demonstrated an objective basis for avoidance of DAN’s liens pursuant to section 544(a)(3).
Through a series of citations to circuit and bankruptcy court opinions, the court explained that “bona fide dispute” does not have a precise meaning, but entails some sort of “meritorious, existing conflict,” and courts have found such a conflict when “there is an objective basis for either factual or legal dispute as to the validity of the asserted interest.”  Pursuant to this guidance, the court found that the failure to execute and deliver the amended and restated loan documents created a “bona fide dispute” as to DAN’s interest in the property, and permitted the trustee to avoid DAN’s liens under section 544(a)(3) and sell the property free and clear of such liens.
Credit Bidding
Moreover, the trustee asserted that the dispute regarding the extent and validity of DAN’s liens was sufficient “cause” to deny DAN the ability to credit bid at the proposed public sale.  Section 363(k) grants the court the discretion to deny a creditor’s right to credit bid only for “cause.”  Credit bidding allows secured creditors to bid for the collateral securing their claim(s) using the debt they are owed to offset the purchase price.  Essentially, credit bidding is used, among other things, to outbid third parties that bid less than a secured creditor’s claim, allowing the secured creditor to take possession of the collateral rather than be left under-compensated by the proceeds from the sale to a third party.
Specifically, section 363(k) provides that:

At a sale under [section 363(b)] of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

(emphasis added).  “Cause” is not defined by the Bankruptcy Code and is determined by courts on a case-by-case basis.  However, courts have found cause to deny credit bidding when a sufficient dispute exists regarding the validity of the lien forming the basis for the credit bid.  For reasons that supported the court’s decision to permit a 363 sale—a bona dispute as to the validity of DAN’s underlying liens—the court also denied DAN permission to credit bid at the sale.
Conclusion
In re L.L. Murphrey Co. serves as an important reminder that even seemingly minor defects in the documentation of a secured credit may give rise to a successful challenge of a lien.  Here, even though the liens survived the debtor’s prior confirmed plan of reorganization, they were nonetheless successfully challenged.  The lienholder’s predecessor’s failure to accomplish the simple task of amending and restating loan documents was a misstep sufficient to create a bona fide dispute as to validity of the creditor’s liens, allowing the trustee to move forward with a section 363 sale and providing “cause” to deny the creditor permission to credit bid at such sale.  The Murphrey lesson to secured creditors: Dot your “Is” and cross your “Ts” . . . and make sure your predecessor did too.