One of the most powerful and oft used devices in bankruptcy is the sale of assets “free and clear” of liens, claims and interests. One issue a buyer at a bankruptcy sale must consider, however, is whether due process has been met with respect to parties whose liens, claims and/or interests are released through such sale.  Indeed, a lack of due process could foil a “free and clear” sale, leaving a buyer with an encumbered purchase and nowhere to turn for recourse.

In In re Olsen, a Wisconsin bankruptcy court considered whether the failure to provide formal notice to a party with a right of first refusal (ROFR) on certain of the debtor’s real estate (Property) voided the court’s “free and clear” sale order. The court held that the sale process did violate due process and that the effective remedy was honoring the ROFR in a subsequent (post bankruptcy) sale of the Property.

In order to maximize the going concern value of its grain facility business, the debtor sought to sell substantially all of its assets in conjunction with its plan of reorganization. Archer-Daniels-Midland (Purchaser) purchased the assets, including the Property.  Subsequent to the conclusion of the bankruptcy case, the Purchaser sold the Property to a third party.  Country Visions Cooperative (Objector), the holder of the ROFR, sued the Purchaser in state court and asserted its ROFR.  The Purchaser countered by moving to reopen the bankruptcy case to enforce the confirmation order and bar the Objector’s state court proceeding.

In upholding the ROFR, the bankruptcy court found three important undisputed facts: (i) the Objector was not listed as a creditor of the debtor, and did not receive formal notice of the bankruptcy case, (ii) the Objector never received formal notice that the Property was to be sold free and clear of the ROFR, and (iii) the Objector never received the contractual notice that the Property was being sold as required by the ROFR.

Notably, the Objector did receive informal notice of the bankruptcy case and may have even learned about the sale shortly before closing. However, such notice was not “notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections”—as due process requires.  Thus, the bankruptcy court concluded that the Objector did not receive sufficient notice before its ROFR was purportedly extinguished.

The Purchaser argued that notwithstanding the faulty notice, the court should enforce the confirmation order to strip the ROFR because the Purchaser was a bona fide purchaser that acquired the Property in good faith under section 363(m) of the Bankruptcy Code. The court rejected this argument, explaining that a bona fide purchaser cannot have notice of a prior adverse claim.

Here, the Purchaser did have prior notice of the ROFR (even if the notice was constructive) because the ROFR was properly recorded. The Purchaser also had received an email indicating that someone had a ROFR on the Property.  The court explained that the Purchaser easily could have commissioned a title report and ensured that all parties in interest received due notice.   The court acknowledged that the debtor should have properly noticed all parties in interest, including the Objector, but also found that the Purchaser could not “cloak itself with the mantle of a bona fide purchaser when it ignored information suggesting the [Objector’s] rights were not addressed in the sale.”  Thus, the court approved the Objector’s request to enforce its ROFR in the Purchaser’s post-bankruptcy sale of the Property.

In sum, a buyer in bankruptcy should consider independently ensuring that all parties with purported liens, claims or interests in the sale assets receive proper notice of the sale; hoping that the debtor provides proper notice may not be sufficient.  A little effort up front can save time, money and aggravation in the end.