Is Your Bankruptcy Asset Purchase Lien Free? Why?

Posted by Matthew C. Lein, Esq. on February 18, 2015

Guest Post By Matthew C. Lein, Esq.
Lein Law Offices

The purpose of this article is to help investors (from beginner to advanced) understand what it means to buy an asset lien free through the bankruptcy court.  To do so, I will explain what a lien is, and how a lien can be satisfied both outside of and through the bankruptcy court.  To help explain the above, I will use a simple example where Ivan Investor would like to purchase a home owned by Harry Homeowner.  I will then end with a real world example where an investor was able to purchase an asset lien free from a seller through the bankruptcy court.  My hope is that potential investors will then understand how value can be created in some instances by buying assets through the bankruptcy court.  

A lien is a “legal right or interest that a creditor has in another's property, lasting usually until a debt or duty that it secures is satisfied.”  Black's Law Dictionary (9th ed. 2009).  The person whom owns or has control of said lien against property is the Lien Creditor or Lienholder.  

Liens can come in a variety of forms.  Such forms include, but are not limited to: Mortgages, IRS Liens, Judgment Liens, Mechanic’s Liens, and Child Support Liens.

The above types of liens can be further classified into two distinct categories: secured and unsecured. A secured lienholder is often given an interest in an asset used as collateral in return for borrowing money to a buyer (E.g. when a debtor buys a home or car using funds given by a bank).  An unsecured creditor extends credit to a debtor without collateral (E.g. Credit Cards).  

In most non-bankruptcy sales, liens are satisfied depending on their unsecured or secured status, and when the lien filed.  

Consider the following situation: Harry Homeowner wants to sell his home to Ivan Investor for the assumed fair market value of $100,000 and Ivan Investor will not be financing the purchase – Ivan Investor will pay cash. The following liens are against Harry Homeowner’s home: (1) first mortgage owed to “Alpha Bank” in the amount of $43,000; (2) line of credit owed to “Butternut Bank” in the amount of $17,000; and, a judgment in the amount of $10,000 is owed to Christopher Creditor.  

When the property is sold, the proceeds from the sale will be used to satisfy the creditors in the following order: (1) Alpha Bank; (2) Butternut Bank; and, (3) Cristopher Creditor.  Harry Homeowner will receive $30,000.  Most importantly, however, Ivan Investor will receive the property lien free because the liens to Alpha Bank, Butternut Bank, and Christopher Creditor have been satisfied.  

Fair Market Value              $100,000
Alpha Bank                          ($43,000)
Butternut Bank                   ($17,000)
Christopher Creditor         ($10,000)
Harry Homeowner             $30,000

The short answer is yes.  Now let’s assume the same hypothetical as above except now the fair market value of the home is $60,000 and Harry Homeowner has now filed for bankruptcy relief.  Ivan Investor wants Harry Homeowner’s home, but as a shrewd investor, will not pay $70,000 for a home that is worth only $60,000.  The question becomes: Can Ivan Investor buy Harry Homeowner’s home for its fair market value of $60,000?  

Ivan Investor can contact the bankruptcy trustee who is responsible for administrating the bankruptcy estate with an offer.  The bankruptcy trustee will file a notice of motion and motion with the court disclosing the terms of the sale with the court and all interested parties.  If no interested party objects (including Christopher Creditor), the court will likely approve of the sale.  Assuming no transaction costs are involved (which are almost always involved), Ivan Investor’s $60,000 will be disbursed to Alpha Bank and Butternut Bank.  No proceeds will be given to Christopher Creditor or Harry Homeowner.  

Fair Market Value                 $60,000
Alpha Bank                            ($43,000)
Butternut Bank                     ($17,000)
Christopher Creditor                          -
Harry Homeowner                           $0

Applying the above principle in other instances.

The example above is simple, but the principle above is powerful and can be applied in other instances.   For example, not long ago Hostess Brands (the previous owner of the Twinkies pastry), could not “stay current on its $700 million in outstanding loans and keep contributing to the unions’ pension plans.”  The above principle was applied (but in a far more complex situation), and Hostess Brands sold many of its businesses’ assets to various investors with the consent of the bankruptcy court to overcome the concerns facing the company.   Today the company that owns what were the assets of Hostess Brands are owned by a new company, but without the concerns that once faced Hostess Brands.

Purchasing assets through the bankruptcy courts can create value for investors like Ivan Investor purchasing a single asset or a group of investors purchasing assets from a larger distressed company.  The value created for an investor is having the ability to purchase an asset free of any liens and encumbrances via court approval in instances when potential lienholders, like Christopher Creditor, may claim otherwise.


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