United States: Right Of First Refusal Survives Bankruptcy Where Seller Failed To Give Notice Of Sale

A seller's failure to give notice of a bankruptcy sale of real property to a party who had a right of first refusal led a bankruptcy court to rule that the right of first refusal survived the seller's bankruptcy and was enforceable against the new owner of the property. The case posed a test balancing a bankruptcy buyer's interest in the finality of a sale order against the affected party's due process rights. The court found that the seller and the buyer had failed to give proper notice of the sale, and that the buyer had knowledge of the right of first refusal.  The ruling is a rare case, one where a bankruptcy court's "free and clear" sale order is successfully challenged after the fact.

In In re David A. Olsen et al, 1 the bankruptcy court considered "whether a final non-appealable order approving a real estate sale could extinguish a right of first refusal without affording the holder of the right formal notice and the opportunity to object."  The court held that because the debtors had failed to give notice to the party with the right of first refusal, and because the buyer had actual and constructive knowledge of the first refusal right, the order confirming the debtors' sale of the property did not extinguish the right of first refusal.

Archer-Daniels-Midland Company ("ADM") purchased assets under the debtors' plan of reorganization, including a parcel of real estate known as the Ripon Property, as to which Country Visions Cooperative ("CVC"), had a right of first refusal that was recorded in the county land records where the Ripon Property was located.

When ADM later sold the Ripon Property, CVC sued ADM in state court, asserting a right to purchase the Ripon Property. ADM moved to reopen the bankruptcy case and enforce the confirmation order, contending that it had purchased the Ripon Property free and clear of CVC's right of first refusal. After briefing, the Court determined that CVC had not received formal notice of the debtors' chapter 11 case, nor had it received a notice of the sale of the Ripon Property or the notice required under the right of first refusal itself.

ADM argued that CVC's challenge failed under the Seventh Circuit's decision in In re Edwards, a case where a lienholder who did not receive notice of a sale of real property sought to vacate the sale. In Edwards, the lienholder did not receive notice because the debtor had an old and in correct notice for the lienholder, and notices were sent to the prior address. The lienholder learned of the sale when it received a check representing its share of the proceeds of sale. It moved for relief of the sale under Rule 60 of the Federal Rules of Civil Procedure, but the bankruptcy court refused to vacate the sale and the Seventh Circuit affirmed. In Edwards, the Seventh Circuit noted the "strong policy of finality of bankruptcy sales embodied in section 363(m)" and a "strict rule in favor of the bona fide purchaser at the bankruptcy sale."

ADM focused on the language used by the Seventh Circuit in Edwards, and argued that Edwards controlled the result in this case because it was a bona fide purchaser. ADM argued that CVC had actual notice of the sale, but the Court found that, at most, the debtors' counsel had had a telephone conversation with CVC warning of a "potential sale." In contrast, CVC's right of first refusal was recorded in the local land records, which the Court said gave ADM and the debtors constructive knowledge of CVC's interest in the Ripon Property. Moreover, a title report delivered to ADM disclosed the right of first refusal and in-house counsel had alerted ADM executives about a right of first refusal on the property, leading the Court to conclude that "ADM's attempt to paint CVC as the party who knew about and ignored the sale is incongruous...ADM knew about CVC's interest in the Ripon Property before the sale, but ADM chose not to ensure that CVC's interest was dealt with in the sale."

The key to the Olsen decision was the Court's determination that ADM was not a bona fide purchaser. The Court said that under Wisconsin law, ADM was charged with constructive knowledge of documents recorded in the land records. Coupled with the evidence of the title report and the in-house email advising of the right of first refusal, the Court held that ADM was not a bona fide purchaser with respect to CVC. Moreover, it said, given ADM's knowledge of CVC's interest, it could have insisted that the debtors provide proper notice of the sale to CVC.

The lesson of Olsen is clear: buyers of property in bankruptcy sales need to ensure that all parties with an interest in the property have received timely and appropriate notice of a sale. The corollary lesson is that a buyer cannot rely solely on the debtor's efforts to provide notice, particularly where it has actual and constructive of an adverse interest. Buyers must take an active role in making sure that proper notice is given. In this case, the sale of the Ripon Property, if it had been handled correctly, would have extinguished CVC's right of first refusal. But the failure to provide proper notice resulted in the rare step of a bankruptcy court voiding a sale order.

Footnote

1. 2017 WL 663522 (Bankr. E.D. Wis. 2017)

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