In a recent Blog Article I discussed how a purchaser of real property might use the Bankruptcy Code to prevent a default under a time of the essence provision of a contract to purchase real property. In that instance the Bankruptcy Code helped the purchaser. Conversely, the provisions of the Bankruptcy Code could result in abrogation of a purchaser’s contract rights where the seller files for bankruptcy protection.
Consider the following scenario. Purchaser contracts to purchase real property, and Seller refuses to close the transaction. Because of the unique nature of real property one remedy available to a purchaser under state law is to obtain title by compelling specific performance of the contract. What happens, however, if the seller files for bankruptcy protection? That situation occurred in a recent case in which I was involved. The purchaser negotiated a favorable purchase price ($875,000) for a commercial property. For whatever reason, (perhaps realizing it had made a bad deal) the seller refused to close. The purchaser hired an attorney who commenced proceedings in state court to compel specific performance. Multiple motions for specific performance were made and denied due to infirmities in the purchaser’s papers. Nearly 5 years after the contract was signed, the purchaser’s motion for specific performance remained unresolved. Then the seller filed for bankruptcy.
The debtor’s ability to reject an executory contract means that the non-debtor party to the contract is limited to recovery of money damages only for the breach. In the scenario described above, the state court proceedings were stayed and the purchaser lost its right to compel specific performance in or out of bankruptcy court. The purchaser was relegated to file a general unsecured claim for damages, essentially calculated by the difference between the contact price and the fair market value of the property at the time of the breach plus out of pocket costs associated with the breach. The purchaser was also entitled to separately recover its down payment which was held in escrow.
The general unsecured claim, as calculated above, however, is not necessarily paid dollar for dollar. In fact, most bankruptcy cases result in only a percentage distribution being made to general unsecured creditors. In this case, the purchaser obtained an appraisal of the fair market value of the property at the time of the breach. That appraisal was for $1.1 million – some $225,000 more than the contract price.
From the buyer’s perspective however, a claim for damages (even if for the difference between the contract price and fair market value at the time of the breach) did not adequately compensate him because he owned adjoining property which made the property more valuable to him than third parties. Moreover the purchaser, being attuned to the area and market, knew that the value of the property was likely to increase rapidly over a relatively short period of time. In fact, the trustee sold the property approximately six years from the date of the purchaser’s contract for $2 million, well more than twice the $875,000 contract price. Because of the bankruptcy, the purchaser in this case will only receive an estimated percentage of between 30-50% of its general unsecured claim. The debtor/seller on the other hand has benefitted because it now has more money to pay its other unsecured creditors. Payment on the claim could be even lower as the distribution percentage to unsecured creditors depends on the total amount of other similarly situated claims against the debtor sharing the same pot– something over which the purchaser has no control.
This case was somewhat extraordinary in that the action for specific performance remained unresolved nearly 5 years. However, it illustrates the manner in which the bankruptcy code can dramatically alter the rights of a contract vendee. The takeaway for a purchaser is to obtain title to the property as quickly as possible. For a seller, bankruptcy can permit the debtor to walk away from a bad deal and only have to pay a claim for breach of contract damages at a smaller percentage of the actual claim thus leaving more money for the debtor’s reorganization and its other creditors.
Andrew M. Thaler is founding partner of Thaler Law Firm PLLC, a panel Chapter 7 Bankruptcy Trustee E.D.N.Y. He is rated “AV Preeminent” by Martindale-Hubbell, the highest professional excellence, and selected to the Super Lawyers list in the category bankruptcy & creditor/debtor rights in the NY Metro area.