A state port authority (1) challenged sale of property free and clear of its road easement on Eleventh Amendment grounds and (2) sought revocation of a Chapter 11 plan confirmation order arguing that it was obtained by fraud. The bankruptcy court rejected these claims; the district court affirmed; and the port authority appealed to the Fifth Circuit.
Originally the port authority bought property adjacent to the debtor’s land, together with an easement granting use and access to a private road on the debtor’s property. Fifteen years later the parties modified the easement to give the port authority nonexclusive access along a specific portion of the road and across a drainage ditch. The easement provided the primary commercial access to the port authority’s property.
Three years later the debtor filed a Chapter 11 bankruptcy. Its plan of reorganization proposed to sell property of the debtor “free and clear of all Liens, Claims, charges and other encumbrances” under section 363(f) of the Bankruptcy Code. The debtor held an auction and sold the property to a third party. Although there were subsequent negotiations about encumbrances that would be “permitted,” at no time was the port authority easement classified as a permitted encumbrance.
During the final stages of obtaining a confirmation order that included approval of the sale, the debtor proposed “extensive modifications” to the order. However, it “d[id]n’t believe that they are material in any real way.” The order was entered, the plan went into effect, the debtor sold its property, and the confirmation order became final and nonappealable.
The buyer resold a relevant portion of the property acquired from the debtor. The new buyer informed the port authority that the sale free and clear extinguished its easement. Since it was too late to appeal the confirmation order, the port authority filed a complaint collaterally attacking the order as having been procured by fraud, barred by sovereign immunity, and the denial of due process based on a lack of notice. The bankruptcy court dismissed the fraud and sovereign immunity claims, so the port authority appealed.
The Eleventh Amendment of the U.S. Constitution provides that federal courts do not have jurisdiction over “any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State” or by a state’s own citizens. Nevertheless, states may still be bound by some judicial actions without their consent, including in a bankruptcy proceeding.
Under the Constitution, Congress has the power to establish “uniform Laws on the subject of Bankruptcies throughout the United States.” The Supreme Court has interpreted this to mean that there can be limited subordination of state sovereign immunity in the bankruptcy context. In particular, Supreme Court precedent provides (footnotes omitted):
The federal court’s disposition of a bankruptcy estate within which a state has interests, where the proceeding is principally in rem and avoids coercive judicial process against the estate, does not implicate, let alone violate the Eleventh Amendment.
Under state law the port authority easement was a non-possessory property interest in the debtor’s land. Exercising jurisdiction over the bankruptcy estate, including the land, the bankruptcy court approved the sale “free and clear” of encumbrance including the easement. The bankruptcy court did not award affirmative relief or exercise in personam jurisdiction over the port authority. Thus, the bankruptcy court’s action was not prohibited by the Eleventh Amendment.
The port authority argued that the easement was its property and not part of the bankruptcy estate. However, the Fifth Circuit held that the bankruptcy court’s in rem jurisdiction over the debtor’s estate allowed it to extinguish interests burdening the estate’s res.
The port authority further argued that the sale “free and clear” did not comply with the requirements of section 363(f). However, this argument had to be raised in a direct appeal of the confirmation order and could not subsequently be raised in a collateral attack on the order.
Thus, the Fifth Circuit affirmed dismissal of the Eleventh Amendment claim.
As for the fraud claim, under section 1144 of the Bankruptcy Code, within 180 days after entry of a confirmation order a court may revoke the order “if and only if such order was procured by fraud.”
The elements of a claim for fraud are (1) that the debtor or proponent made a materially false representation or omission to the court; (2) that the representation was made with knowledge of its falsity or reckless disregard for the truth; (3) that the representation was made to induce the court’s reliance; (4) that the court actually relied upon the representation; and (5) the court entered the confirmation order in reliance on the representation.
The Fifth Circuit did not go past the first element. The port authority argued that the debtor’s representation that the last-minute changes were not material was a misrepresentation because for the first time its easement was stripped. However, the court noted that from the very beginning the general terms of the proposed sale would extinguish the easement.
So, the last-minute changes carving out exceptions from encumbrances to be extinguished was not misleading because they were not changes with respect to the port authority’s easement. It remained subject to the same general rule that it would be stripped under the free and clear sale. Accordingly, dismissal of the fraud claim was also affirmed.
Parties are often fairly cavalier about the status of easements in a “free and clear” sale of real estate. Sometimes easements, such as utility easements, need to be preserved. In that case, there should be an explicit carveout for the easements to assure the desired result. On the other hand, if the buyer would like to extinguish the easement, that probably requires more than a general statement that the property is being sold free and clear of encumbrances. After all, in this case the port authority was going to be allowed to proceed with its claim that it was denied due process because of the lack of notice.
And from the easement holder’s perspective, it ignores a general statement that the sale is free and clear of encumbrances at its peril.
Vicki R Harding, Esq.