The U.S Court of Appeals for the Tenth Circuit recently affirmed a district court's order denying a debtor relief under 11 U.S.C. § 547(b), holding that a lis pendens recorded in Colorado is not a preferential transfer under the Bankruptcy Code because the lis pendens merely serves as notice of pending litigation.
A copy of the Court's opinion is available at: http://www.ca10.uscourts.gov/opinions/12/12-1134.pdf
The case concerns a real estate development company in Colorado. In October 2007, the developer received a $12 million loan from a bank to finance the construction of a single family home on property it owned in Colorado. To secure the loan, the bank prepared a deed of trust that incorrectly identified the developer's sole member as the owner rather than the development company itself. However, because the grantor under the deed of trust was not the owner of the property, the deed of trust did not give the Bank a lien on the property.
The bank brought suit in Colorado state court on May 19, 2010 seeking reformation of the deed of trust to make it effective, and a declaration that it had a first priority lien on the property. Two days after filing suit, the bank filed a notice of lis pendens in the local County's real property records.
Soon thereafter, on August 13, 2010, the developer filed a petition for Chapter 11 bankruptcy relief. The developer continued as debtor in possession of the property. The developer then filed an adversary proceeding against the bank in April 2011 seeking to avoid the lis pendens as a preferential transfer.
The bank moved to dismiss on the grounds that a lis pendens was not a preferential transfer of property under 11 U.S.C. § 547(b). The bankruptcy court granted the bank's motion to dismiss, and the federal district court affirmed. This appeal followed.
At issue in the appeal was whether a notice of lis pendens filed in Colorado constitutes a preferential transfer under 11 U.S.C. § 547(b). The Tenth Circuit determined that the district court's dismissal was correct and affirmed the district court's decision.
The Tenth Circuit began by addressing the developer's argument that a "transfer of an interest of the debtor in property" under 11 U.S.C. § 547 occurs when a bona fide purchaser cannot acquire an interest superior to that of a creditor.
As you may recall, under the Bankruptcy Code, a debtor in possession "may avoid any transfer of an interest of the debtor in property, to or for the benefit of a creditor," if that transfer occurs within 90 days prior to the filing of the bankruptcy petition. 11 U.S.C. §§ 547(b)(1), (4). To be an avoidable "preferential transfer," that transfer must meet certain statutory requirements (11 U.S.C. § 547 (b)(1)–(5)). In pertinent part, the Bankruptcy Code defines a "transfer" as: each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with — (i) property; or (ii) an interest in property. 11 U.S.C. § 101(54)(D).
Significantly, the Bankruptcy Code, does not define "property" or "interest in property." As the Tenth Circuit noted, "property" and "interests in property" in this instance are therefore governed by state law.
In Colorado, a party may record a notice of lis pendens against real property after filing suit "wherein relief is claimed affecting the title to real property." Colo. Rev. Stat. § 38-35-110(1). This provides "notice to any person thereafter acquiring, by, through or under any party named in such notice, an interest in the real property . . . that the interest so acquired may be affected by the action described in the notice." Id.
The Tenth Circuit observed that under Colorado case law a lis pendens only serves the limited purpose of notice and is not a transfer eliminating an interest in the property pursuant to 11 U.S.C. § 101(54). A judgment lien does not arise against real property until the "transcript of judgment" is recorded. Colo. Rev. Stat § 13-52-102(1). Consequently, when the bank filed a lis pendens, the Tenth Circuit held, no preferential transfer occurred and the developer could not avoid the lis pendens.
The Tenth Circuit next addressed the developer's argument that even if the lis pendens did not transfer its property per se, it did transfer its right to convey fee simple title free of the bank's interests. The Tenth Circuit rejected this argument because it did not see how clouding an owner's title constituted "disposing of or parting with" an interest of the debtor in property within the Bankruptcy Code's definition of a "transfer." 11 U.S.C. § 101(54)(D).
Further, the Tenth Circuit noted that the Colorado Supreme Court has addressed and rejected this very argument. See Hammersley v. District Court In and For Routt Cnty., 610 P.2d 94, 96 n.2 (Colo. 1980). In Hammersley, the property owner sought to vacate a notice of lis pendens because it would cloud the title and would impair its marketability. The Colorado Supreme Court held that a lis pendens "harm[s] no legitimate interest of the owner." Id. at 96. In other words, although the lis pendens may diminish the marketability of the title, it only means that a subsequent purchaser is bound by the outcome of the litigation and until the litigation outcome is certain the purchaser may be discouraged.
Thus, under Colorado law, even though a lis pendens may devalue the right to convey property, it has not been "disposed of" or "parted with" so as to qualify as a "transfer" under the Bankruptcy Code.
The Tenth Circuit next addressed whether 11 U.S.C. § 547(e)(1)(A) also plays a determinative role in whether a "transfer of an interest of the debtor in property" has occurred under 11 U.S.C. § 547(b). The developer argued that 11 U.S.C § 547(e)(2)(B) sets the date of the transfer as the date of the filing of the lis pendens, because the lis pendens was recorded more than thirty days after the bank made its loan.
As you may recall, Section 547(e)(1)(A) of the Bankruptcy Code provides that a transfer of real property is perfected when a bona fide purchaser of such property from the debtor cannot acquire an interest that is superior to the interest of the transferee. 11 U.S.C. § 547(e)(1)(A).
Additionally, Section 547(e)(2)(B) provides in pertinent part that a transfer is made at the time such transfer is perfected, if such transfer is perfected after [30 days after such transfer takes effect]. 11 U.S.C. § 547(e)(2)(B).
The Tenth Circuit determined that the developer's reliance on 11 U.S.C. § 547(e)(1)(A) in this context conflated perfection of a transfer with the existence of a transfer. Section 547(e)(1)(A) merely determines whether a transfer of an interest in property "is perfected." Likewise, 11 U.S.C. § 547(e)(2)(B) only determines the timing of a transfer for preference purposes; it does not establish whether a transfer actually occurred.
The Tenth Circuit also dismissed the developer's reliance on a Ninth Circuit case, Hurst Concrete Prods., Inc. v. Lane (In re Lane), 980 F.2d 601 (9th Cir. 1992), to argue that "perfection" of an interest equates to "transfer" of an interest under 11 U.S.C. § 547. In contrast to this case, the creditor in In re Lane had already recorded a judgment against the debtors before the debtors filed their bankruptcy petition. The Tenth Circuit found In re Lane inapposite because in this case the bank did not receive a favorable judgment in the state court action before the developer filed its Chapter 11 petition.
The Tenth Circuit also noted that other decisions supported its conclusion that "perfection" and "transfer" are distinct inquiries for preferential transfer purposes. Perfection is only a "preliminary determination" that must be made to determine the date on which a transfer occurred, but does not control whether a transfer actually occurred. Grover v. Gulino (In re Gulino), 779 F.2d 546, 549 (9th Cir. 1985). Also, in Saghi v. Walsh, 34 B.R. 755, 757 (B.A.P. 9th Cir. 1983), the Bankruptcy Appellate Panel of the Ninth Circuit held that the filing of a lis pendens is not a transfer of the debtor's property. Simply put, 11 U.S.C. § 547(b) has no effect where there has been "perfection, but no transfer." Freedom Grp., Inc. v. Lapham-Hickey Steel Corp., 50 F.3d 408, 412 (7th Cir. 1995).
Accordingly, the Tenth Circuit affirmed the district court's dismissal, because in this instance a lis pendens merely serves as notice of pending litigation and did not qualify as a preferential transfer under 11 U.S.C. § 547(b).
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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