Court Decides Bankruptcy doesn’t make Title “Free and Clear”

Many title agents and abstractors have looked at their fair share of real estate transactions surrounding a bankruptcy in the recent years.  The Great Recession caused many Americans to enter into short sales of their homes or even declare bankruptcy due to lost jobs and an expense load they couldn’t carry.  While tragic for the nation, this was the situation many real estate deals have and do occur in.

Section 363 of the Bankruptcy Code deals with property liens and other judgments.  This section make a provision for a “free and clear” sale of the property out of bankruptcy.  However, a recent District Court in California added some important clarification to this.

In a case dealing in an auto mall in the city of West Covina, the trustee sought to sell a property “free and clear” of all liens – but also of all encumbrances.  The particular parcel was under an operating agreement with the city for them to approve any future operators of the dealerships.  The trustee and even court initially allowed the sale to proceed without the city’s approval.  Later the appeal court reversed this decisions, stating that Section 363 would not apply.

Title agents who deal with bankruptcies are often asked to issue a title that has been cleared under this section.  However, it is important to note that the court clarified that only judgments and liens that can be monetized can be cleared.  Other issues such as covenants, restrictions, easements and even some taxes cannot be cleared because of a bankruptcy.

This case highlights the need to make the seller aware of these items even when a court approves the bankruptcy.  Buyers who purchase a parcel and then later discover that there are restriction on it after all will most likely turn to the title agent and abstractor for compensation of damages.  Title firms need to protect themselves from these allegations by carefully researching just what restrictions exist and continue in such matters.

It is also prudent for title firms to purchase professional liability insurance to protect against such lawsuits.  If your firm does not yet have this insurance in place or would like a review of your current coverage, contact us today.