THE VALIDITY OF POST-PETITION TRANSFERS OF REAL PROPERTY: WHO DOES THE BANKRUPTCY CODE S SECTION 549(c) PROTECT?

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1 THE VALIDITY OF POST-PETITION TRANSFERS OF REAL PROPERTY: WHO DOES THE BANKRUPTCY CODE S SECTION 549(c) PROTECT? Kelly Culpin * Editors Synopsis: This Article discusses whether a good faith purchaser s post-petition purchase of a debtor s real property will be protected under Bankruptcy Code section 549 in light of recent case law denying protection based on a violation of Bankruptcy Code section 362 s automatic stay. To address this question, the author traces the history of early bankruptcy law, including the development of and the policy behind the automatic stay. Examining recent case law, the author concludes that the good faith purchaser should be protected, in certain circumstances, despite a violation of the automatic stay. This conclusion is supported by the author s analysis of the interplay between the relevant Bankruptcy Code sections, as well as a review of legislative history of the Code sections. Finally, the author suggests that courts should use a fact-intensive approach when determining whether the good faith purchaser exception should apply and provides a framework with which courts could make this determination. I. INTRODUCTION II. EARLY BANKRUPTCY APPROACHES A. The Bankruptcy Court s Exclusive Jurisdiction and the Evolution of the Automatic Stay B. Development of the Good Faith Purchaser Exception 157 III PRESENT LAW A. Description and Functions of the Automatic Stay, Section 362(a) B. The Purpose of the Good Faith Purchaser Exception, Section 549(c) * J.D., Emory University School of Law, Ms. Culpin will be clerking for the Honorable Douglas O. Tice in the Bankruptcy Court for the Eastern Division of Virginia. She is grateful to Professor Frank S. Alexander for his inspiration and guidance throughout the writing process and to the ABA Real Property, Probate and Trust Law Journal editorial staff for their hard work. She wishes to thank her father, Boyd McKeown, for his support and encouragement in all her endeavors and the ABA Real Property, Probate and Trust Section for selecting this Article as the first place winner of the 2004 Jacques T. Schlenger Student Writing Contest.

2 REAL PROPERTY, PROBATE AND TRUST JOURNAL III. INTERPLAY BETWEEN THE AUTOMATIC STAY AND THE GOOD FAITH PURCHASER EXCEPTION A. Actions Taken in Violation of the Stay: Void, Voidable... or Does it Matter? How a Violation Occurs Effectiveness of Actions Taken in Violation of the Stay a. The Void Doctrine b. The Voidable Doctrine The Void/Voidable Distinction Is One Without Substance B. The Growing Minority Trend Lusardi Signals the Change in the Growing Minority Trend The Courts New Approach to the Relationship Between Sections 362(a) and 549(c) These Courts Have Misinterpreted the Scope of Sections 362(a) and 549(c) a. The Statutory Text and Structure of the Code Allow Section 362 and Section 549 to Overlap b. Legislative History Shows Congress Intended Section 549(c) to Protect Innocent Purchasers IV. PROPOSAL: A RETURN TO A FACT-INTENSIVE ANALYSIS V. CONCLUSION I. INTRODUCTION Post-petition purchasers of a debtor s real property have long faced uncertainty with regard to what protection, if any, the bankruptcy laws afford them. The introduction of a statutory automatic stay prohibiting any transfer of the debtor s property after commencement of the case has exacerbated this uncertainty. In theory, the automatic stay halts all postpetition transfers made without permission of the bankruptcy court and allows courts to hold violators in contempt. In practice, however, creditors

3 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 151 often proceed with involuntary foreclosure sales or tax sales of the debtor s real property, creating the opportunity for an innocent party one without knowledge of the pending bankruptcy case to purchase the property. In all likelihood, the bankruptcy court will declare such a purchase void as a transaction conducted in violation of the automatic stay. Fortunately, the Bankruptcy Code (the Code ) 1 provides a mechanism that courts have used for decades to protect the innocent purchaser from this eventuality. Code section 549, which governs a debtor s post-petition transactions, provides in subsection (c) an express exception to the trustee s powers to avoid unauthorized post-petition transfers of property. 2 This exception permits a person who has purchased the debtor s real property in good faith with no knowledge of a pending proceeding and who has paid fair and equivalent value, to obtain the debtor s interest in the property. 3 In the past, some courts have interpreted this subsection to work as an exception to the voiding effect of the automatic stay, which protects the transaction in cases in which the purchaser meets the subsection s requirements. 4 In a growing trend, however, bankruptcy courts are holding a transaction cannot be both in violation of the stay and controlled by section 549. These holdings make section 549(c) s good faith purchaser protection inapplicable to a transfer made in violation of the automatic stay U.S.C (2000). 2 Section 549(c) provides, in pertinent part: (c) The trustee may not avoid under subsection (a) of this section a transfer of real property to a good faith purchaser without knowledge of the commencement of the case and for present fair equivalent value unless a copy or notice of the petition was filed, where a transfer of such real property may be recorded to perfect such transfer, before such transfer is so perfected that a bona fide purchaser of such property, against whom applicable law permits such transfer to be perfected, could not acquire an interest that is superior to the interest of such good faith purchaser. Id. 549(c). 3 See id. 549(c). 4 See, e.g., In re Siciliano, 13 F.3d 748, 751 (3d Cir. 1994); Shaw v. County of San Bernardino (In re Shaw), 157 B.R. 151, (B.A.P. 9th Cir. 1993); Jones v. Wingo (In re Wingo), 89 B.R. 54, (B.A.P. 9th Cir. 1988); In re Shah, No DWS, 2001 Bankr. LEXIS 380, *15 (Bankr. E.D. Pa. 2001); Carpio v. Smith (In re Carpio), 213 B.R. 744, (Bankr. W.D. Mo. 1997); Groupe v. Hill (In re Hill), 156 B.R. 998, 1007 (Bankr. N.D. Ill. 1993); Little v. Bago (In re Bago), 149 B.R. 610 (Bankr. C.D. Cal. 1993); In re King, 35 B.R. 530, 533 (Bankr. N.D. Ga. 1983). 5 See, e.g., Value T Sales, Inc. v. Mitchell (In re Mitchell), 279 B.R. 839, (B.A.P. 9th Cir. 2002); Glendenning v. Bowen (In re Glendenning), 243 B.R. 629, (Bankr. E.D. Pa. 2000); Smith v. London (In re Smith), 224 B.R. 44, 47 (Bankr. E.D.

4 REAL PROPERTY, PROBATE AND TRUST JOURNAL In its recent decision in Washington Street Corp. v. Lusardi, 6 the Ninth Circuit became the first appellate court to deny the Code s protection to a post-petition good faith purchaser of real property based on this theory. 7 The Lusardi court held the exception to the trustee s power to avoid post-petition transfers did not apply to a post-petition tax sale of the debtor s property because the sale violated the section 362(a) automatic stay and was therefore void. 8 The court reasoned that any void act, deemed not to have taken place, never could qualify as a transfer within the meaning of section The court found Congress designed subsection (c), an exception to the bankruptcy trustee s power to avoid post-petition transfers, only to protect innocent parties from being defrauded in a debtorinitiated transaction, and that Congress intended the automatic stay to protect the debtor and his creditors. 10 The court reasoned that because Congress designed the sections to protect different parties, an exception to one would not apply to the other. 11 Although the court attempted to reconcile the two Code sections by assigning independently meaningful functions, the Ninth Circuit s conclusion actually cut against an integrated Mich. 1998); New Orleans Airport Motel Assocs. v. Lee (In re Servico, Inc.), 144 B.R. 933, 936 (Bankr. S.D. Fla. 1992) F.3d 1076 (9th Cir. 2003), cert. denied, 540 U.S. 983 (2003). 7 Since Lusardi, the Fifth Circuit is the only other appellate court to find against a purchaser of a debtor s real property at foreclosure based on this reasoning. See Bustamante v. Cueva (In re Cueva), 371 F.3d 232, 238 (5th Cir. 2004). In support of its decision to deny the protection of section 549(c), the court cited Texas law, which has long held that foreclosures in violation of the automatic stay are invalid... unless retroactive relief from the stay is granted by the court. Id. at 237. The court further reasoned that when a transfer is retroactively validated by this means, section 549(c) is unnecessary. Id. (discussing Jones v. Garcia (In re Jones), 63 F.3d 411, 412 (5th Cir. 1995)). As in Lusardi, the Fifth Circuit found that Congress intended section 549(c) solely as an exception to the trustee s avoiding powers, and section 549(c) was not an exception to the automatic stay. Id. at 238; see infra note 202 (discussing the Lusardi court s interpretation of Congress s intent); infra Part III.A (discussing the voiding principle of the automatic stay and relief from the stay); infra Part III.B (analyzing the Lusardi court s reasoning). 8 Lusardi, 329 F.3d at See infra notes and accompanying text (explaining the reasoning of this view). 10 Lusardi, 329 F.3d at The court distinguished between the debtor s voluntary transfers, which it felt section 549 would govern, and a third party s involuntary transfers, e.g., a foreclosure sale initiated by a mortgagee. Id. The discrepancy in the application of section 549 fails precisely because both types of transactions are postpetition transfers within the meaning of section 549 and violations of the automatic stay of section 362. See infra notes and accompanying text (discussing a textual interpretation of the statute). 11 Lusardi, 329 F.3d at 1082.

5 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 153 Bankruptcy Code. Because the United States Supreme Court denied certiorari to the Ninth Circuit s decision and bankruptcy courts have followed the Lusardi interpretation, 12 the issue of the Code s protection of good faith purchasers is ripe for examination and resolution. This Article proposes that for reasons of certainty and predictability, and based on the plain meaning of the Code, courts should abandon the new trend, which seeks to retract the protection afforded good faith purchasers of real property in post-petition transfers that violate the automatic stay. Part I of this Article offers an overview of the early bankruptcy law provisions that preserved the bankruptcy estate, thus protecting both debtors and creditors via the automatic stay. Part I also introduces Congress s response to the stay s potential unfairness through the introduction of a limited form of statutory protection for good faith purchasers of real estate. Part II considers how the enactment of the 1978 Code solidified these protections for parties on either side of the transaction in the form of the section 362(a) automatic stay and the section 549(c) good faith purchaser exception. Part III examines the inherent problems and interplay between the current Code sections at issue and the recent judicial treatment of the good faith purchaser defense when invoked for transfers in violation of the stay. This Part also suggests two reasons the Code should provide active protection for good faith purchasers vis-à-vis the automatic stay. First, the statutory text does not prevent the good faith purchaser exception from providing relief from the automatic stay via court-ordered retroactive annulment. Second, the history of the exception s development evinces a congressional intent to protect good faith purchasers. Finally, Part IV proposes courts should return to a fact-intensive analysis when determining whether the good faith purchaser exception applies to the party petitioning for protection. Part IV also provides an example of the framework in which this assessment could proceed. 12 See, e.g., Ford v. A.C. Luftin (In re Ford), 296 B.R. 537, 545 (Bankr. N.D. Ga. 2003) (following the Lusardi court s holding for policy, textual, and conceptual reasons); In re Hull, No , WL , at *1, *41 (Bankr. D. Del. Aug. 19, 2003) (citing Lusardi for the proposition that post-petition transfers of property of the estate are void if in violation of the automatic stay).

6 REAL PROPERTY, PROBATE AND TRUST JOURNAL II. EARLY BANKRUPTCY APPROACHES A. The Bankruptcy Court s Exclusive Jurisdiction and the Evolution of the Automatic Stay To ensure a fair and equal distribution among creditors, the bankruptcy court, as a court of exclusive jurisdiction over the property of the estate, 13 must maintain control over all the debtor s non-exempt assets pending resolution of the case. 14 A common law automatic stay, founded on these principles of exclusive in rem jurisdiction, 15 developed in early bankruptcy jurisprudence. [T]he filing of the petition [was] a caveat to all the world, and in effect an attachment and injunction against any action taken to exert control over the debtor s property. 16 Title to the debtor s property became vested in the trustee with actual or constructive possession, and placed in the custody of the bankruptcy court. 17 Although any interference with the court s exclusive possession was considered contempt of court, creditors easily could find themselves in a precarious position, already having exercised control over the property of the estate. 18 Oftentimes, creditors already had repossessed the debtor s property or a lien enforcement was pending at the time the case commenced. 19 Creditors soon found they could not ignore the role of the bankruptcy court and resort to state law collection remedies, which allowed them to seize and sell the debtor s property involuntarily. The Supreme Court did not hesitate to reverse state law decisions allowing these actions. 20 Like 13 See 28 U.S.C. 1334(e) (2000). ( The district court in which a case under title 11 is commenced or pending shall have exclusive jurisdiction of all of the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate. ). The statute vests jurisdiction in the federal district courts; the bankruptcy court then exercises that jurisdiction by referral from the district courts pursuant to 28 U.S.C. 157(a). 14 See In re Prudence-Bonds Corp., 77 F.2d 328, 330 (2d Cir. 1935) (advising that in reorganization cases, the court should maintain control over the debtor s property to administer it in a way that will achieve the desired rehabilitation). 15 Ralph Brubaker, Does 549(c) Protect a Good Faith Purchaser in a Post-Petition Foreclosure Sale Conducted in Violation of the Automatic Stay?, BANKR. LAW LETTER, Aug. 2003, at 4 [hereinafter Brubaker 2003]. 16 Mueller v. Nugent, 184 U.S. 1, 14 (1902). 17 Id. 18 See id COLLIER ON BANKRUPTCY 362.LH (Alan N. Resnick & Henry J. Sommer, eds., 15th ed rev.). 20 Isaacs v. Hobbs Tie & Timber Co., 282 U.S. 734 (1931) (reversing a state court s judgment allowing foreclosure because of the bankruptcy court s exclusive jurisdiction over the property of the estate); White v. Schloerb, 178 U.S. 542 (1900) (holding that the

7 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 155 wise, the bankruptcy court s exclusive right to possess and control a debtor s property prohibited the debtor from transferring any rights in his property post-petition. 21 The Supreme Court, in two early decisions, recognized a bankruptcy court could protect its jurisdiction by enjoining actions against property of the estate not only when the debtor s assets were in the court s custody or control (in custodia legis), but also when the assets were in the physical custody of secured creditors. The Court reached its first decision along these lines in Ex Parte Christy, 22 a case heard under the Bankruptcy Act of Although the Bankruptcy Act made no mention of secured creditors, the Court held the bankruptcy court had the power to enjoin a secured creditor action even in the absence of statutory authority. 24 Justice Story rationalized this implied judicial power in his opinion, solidifying the assumption during this period that a bankruptcy court had power to maintain control over all property of the estate: From this brief review of these enactments it is manifest that the purposes so essential to the just operation of the bankrupt[cy] system, could scarcely be accomplished except by clothing the courts of the United States sitting in bankruptcy with the most ample powers and jurisdiction to accomplish them; and it would be a matter of extreme surprise if, when Congress had thus required the end, they should at the same time have withheld the means by which alone it could be successfully reached. 25 In Continental Illinois National Bank & Trust Co. v. Chicago, Rock Island & Pacific Railway Co., a case heard under the Bankruptcy Act almost one hundred years later, the Supreme Court issued an injunction against a secured creditor s threatened sale of pledged collateral in the secured creditor s custody. 26 The Court based its finding of authority for enjoining the action in section 2 of the Bankruptcy Act, which vested the bankruptcy court with equitable and legal jurisdiction. The Court further bankruptcy court had jurisdiction to compel a return of debtor s property seized in replevin to the bankruptcy estate); see Brubaker 2003, supra note 15, at Bank v. Sherman, 101 U.S. 403, 406 (1879) U.S. 292, 321 (1845). 23 Bankruptcy Act of 1841, ch. 9, 5 Stat. 440 (repealed 1843). The Bankruptcy Act of 1841 and the Bankruptcy Act of 1898, ch. 541, 30 Stat. 544 (repealed 1978), are hereinafter collectively referred to as the Bankruptcy Act. 24 Christy, 44 U.S. at Id. at U.S. 648, 649 (1935).

8 REAL PROPERTY, PROBATE AND TRUST JOURNAL reasoned that, as a court of equity, it had inherent power to issue an injunction to prevent interference with reorganization. 27 Though this holding was certainly a progression in the effort to preserve the property of the estate, such early grants of injunctive power were not self-executing but rather required an affirmative request for relief from the trustee, receiver, or debtor. 28 Congress passed the Chandler Act in 1938, which added new chapters to the Bankruptcy Act of The additional restraints provided relief similar to an automatic stay 30 but were deficient in many respects. In particular, one restraint applied only to the enforcement of liens on real property, and another required a showing of a reasonable likelihood of successful reorganization before the court could issue an injunction. 31 Therefore, in the latter case, the stay was not effective until the court entered an order approving the debtor s petition. 32 Thus, a long delay might occur before this happened, during which time a creditor easily could have seized control of the estate s property. Immediate relief against creditor action was vital to preserve the estate, and a need arose for a stay that would become effective automatically upon commencement of the case. 33 The former Rules of Bankruptcy Procedure attempted to correct defi- 27 Id. at See, e.g., Clarke v. Larremore, 188 U.S. 486, 490 (1903) (affirming a district court s injunction against a sheriff from turning over proceeds to a judgment creditor from levy on debtor s property, and holding that the money goes to bankruptcy trustee under section 67(f) of the Bankruptcy Act when a debtor files bankruptcy before completed execution) Stat (1938). 30 Section 148 of Chapter X provided: Until otherwise ordered by the judge, an order approving a petition shall operate as a stay of a prior pending bankruptcy, mortgage foreclosure, or equity receivership proceeding, and of any act or other proceeding to enforce a lien against the debtor s property. Id. at 888. Section 428 of Chapter XII provided: Unless and until otherwise ordered by the court, upon hearing and after notice to the debtor and all other parties in interest, the filing of a petition under this chapter shall operate as a stay of any act or proceeding to enforce any lien upon the real property or chattel real of a debtor. Id. at Stat. 840, 888, 819 (Section 428 of Chapter XII and section 148 of Chapter X refer to these limitations respectively.); see In re Bermec Corp., 445 F.2d 367 (2d Cir. 1971) (explaining a contested confirmation of a reorganization plan under Chapter X of the Act); see also Grubbs v. Pettit, 282 F.2d 557 (2d Cir. 1960); In re Castle Beach Apartments, Inc., 113 F.2d 762 (2d Cir. 1940) COLLIER, supra note 19, at 362.LH (citing Bankruptcy Act section 148). 33 Id. at 3.

9 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 157 ciencies by providing various stays that became effective upon the filing of a petition. 34 These stays operated without requiring notice to creditors and generally lasted throughout the proceedings unless vacated or modified by the court, 35 but debtors did not receive the statutory automatic protection they sought until the enactment of the Code in Through the enactment of section 362(a), Congress provided a stay that is automatic in nature arising instantly upon the commencement of the case. 36 Any willful violation is subject to sanctions, 37 and courts generally interpret a transfer made in violation as void. 38 With the enactment of the automatic stay, Congress continued to expand the bankruptcy court s jurisdiction by creating a powerful mechanism for preserving the estate. B. Development of the Good Faith Purchaser Exception In the period of early bankruptcy law, courts became increasingly concerned to protect those who purchased a debtor s real property after the commencement of the case. 39 Prior to 1938, a post-petition purchaser of real property had no guarantee of receiving clear title to that property. 40 As a general principle, anyone who purchased the debtor s property postpetition would receive only avoidable title because of the common law version of the stay and its consequences. 41 The court possibly could order a purchaser to reconvey title to the purchased property to the bankruptcy trustee without guaranteeing the debtor could refund the purchase price. 42 Acknowledging considerations of justice, equity, and the importance of protecting purchasers from losing their investments, courts began to make exceptions for buyers who purchased property in good faith for present 34 Former Rules 401, 601, , 11-44, and The Rules of Bankruptcy Procedure were promulgated by the Supreme Court pursuant to 28 U.S.C (1970). See 3 COLLIER, supra note 19, at 362.LH[3]. 35 Id. 36 See infra note 76 for the text of 11 U.S.C. 362(a) (2000) U.S.C. 362(h) provides: An individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys fees, and, in appropriate circumstances, may recover punitive damages. 38 See infra notes and accompanying text for a discussion of courts that hold violations of the stay are void. 39 William J. Rochelle, III & Gwen L. Feder, Unauthorized Sales of a Debtor s Property: The Rights of a Purchaser Under Section 549 of the Bankruptcy Code, AM. BANKR. L.J., Winter 1983, at Id. at Id. 42 Id.; see, e.g., Mueller, 184 U.S. at 14.

10 REAL PROPERTY, PROBATE AND TRUST JOURNAL value after a debtor filed a bankruptcy petition. 43 Consequently, buyers could not predict whether courts, on a case by case basis, would elect to protect an innocent purchaser or require reconveyance of the property to maintain the integrity of the bankruptcy estate and to retain the assets for future distribution to creditors. 44 Based in large part on a Harvard Law Review article written in 1927, 45 Congress attempted in 1938 to clarify this confusing area of judge-made law by adding a new paragraph to the Bankruptcy Act that would protect bona fide transferees of property. 46 However, this addition, codified as section 70d, dealt only with personal property and did not explain what protection, if any, would be given to transferees of real property. 47 Thus, Congress added a separate section, section 21g, as part of the 1938 Amendments to supplement section 70d, which extended a similar protection to purchasers of real property. Section 21g 48 of the Bankruptcy Act introduced a method for provid 43 Rochelle & Feder, supra note 39, at 26 (citing 4B COLLIER ON BANKRUPTCY [2], at (14th ed. 1978)). 44 Id. at James A. McLaughlin, Amendment of the Bankruptcy Act, 40 HARV. L. REV. 341, 583 (1927). The proposal was based on the English Bankruptcy Acts, which protected transfers for present fair equivalent value, by or for the bankrupt, made before the qualification of a receiver or trustee, whichever qualified first, and made to transferees without the knowledge of or reasonable cause to believe that a petition in bankruptcy had been filed. See also Rochelle & Feder, supra note 39, at 26 (summarizing the proposal). 46 STAFF OF HOUSE COMM. ON THE JUDICIARY, 74TH CONG. ANALYSIS OF H.R , at 229 (1936). The notes to this addition stated [t]his new subdivision in Section 70 is suggested by the uncertainty as to whether bona fide transactions for adequate present value after bankruptcy can in any case be protected. Id. 47 Section 70d provided: After bankruptcy and either before adjudication or before a receiver takes possession of the property of the bankrupt, whichever first occurs (1) A transfer of any of the property of the bankrupt, other than real estate, made to a person acting in good faith shall be valid against the trustee if made for a present fair equivalent value or U.S.C. 110 (1970); see also Rochelle & Feder, supra note 39, at Section 21g provided in pertinent part: A certified copy of the petition... may be recorded at any time in the office where conveyances of real property are recorded, in every county where the bankrupt owns or has an interest in real property. Such certified copy may be recorded by the bankrupt, trustee, receiver, custodian, referee, or any creditor... Unless a certified copy of the petition... has been recorded in such office, in any county wherein the bankrupt owns or has an interest in real property... the commencement of a proceeding under this Act shall not be constructive notice to or affect the title of any subsequent bona-fide purchaser or lienor of real property

11 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 159 ing constructive notice of the bankruptcy proceeding to potential purchasers of the debtor s real property, lessening the opportunity for a debtor to make fraudulent conveyances. 49 For cases in which a debtor s real estate was located outside the county where the case was pending, the debtor possibly could convey his interest to an innocent purchaser who had no knowledge, nor means of obtaining any knowledge, of the commencement of the case. 50 This section permitted the trustee (or anyone who had an interest in the estate) to record a copy of the petition in the recorder s office in every county where the debtor owned or had an interest in real property. 51 Moreover, if no certified copy of the petition was filed, a purchaser or a lienor for a present fair consideration, who ha[d] no actual knowledge of the pendency of the proceedings, [wa]s not charged with constructive notice. 52 This section provided that in a jurisdiction that recognized such a recording, filing notice of the petition in the county s real estate records before the purchaser recorded his deed (and thus perfected his interest) was the only means by which a judicial sale of real property could be disturbed and reconveyance could be demanded. 53 Through this section, Congress specifically validated post-petition ju- in such county for a present fair equivalent value and without actual notice of the pendency of such proceeding: Provided, however, That where such purchaser or lienor has given less than such value, he shall nevertheless have a lien upon such property, but only to the extent of the consideration actually given by him. The exercise by any court of the United States or of any State of jurisdiction to authorize or effect a judicial sale of real property of the bankrupt within any county in any State whose laws authorize the recording aforesaid shall not be impaired by the pendency of such proceeding unless such copy be recorded in such county, as aforesaid, prior to the consummation of such judicial sale.... Bankruptcy Act of 1898, ch. 541, 21g, 30 Stat. 544 (repealed 1978), reprinted in 2 COLLIER ON BANKRUPTCY 21, at (James Wm. Moore ed., 14th ed. 1976) (emphasis added). 49 In re Penfil, 40 B.R. 474, (Bankr. D. Mich. 1984) (citing 2 COLLIER, supra note 48, 21.30). 50 Id.; see, e.g.,vombrack v. Wavra, 163 N.E. 340, 342 (Ill. 1928) (discussing the requirement of the filing notice of bankruptcy in counties when the debtor s property is held outside of the county where he commenced his case to prevent fraudulent debtor transactions); Derryberry v. Matterson, 192 So. 78, 82 (La. 1939). 51 STAFF OF HOUSE COMM. ON THE JUDICIARY, 74TH CONG., ANALYSIS OF H.R , at 262 (1936). 52 Id. 53 See supra note 48 for the text of section 21g. By its language, this section applied only to judicial sales conducted post-petition, as did section 549(c) when it was enacted. COLLIER, supra note 19, at 549.LH[4]. The 1984 Amendments changed the application of 21g to incorporate protection for good faith purchasers at judicial sales and non-judicial sales alike, provided they met the section s requirements for invocation. Id. 549.LH[5].

12 REAL PROPERTY, PROBATE AND TRUST JOURNAL dicial sales that were consummated prior to the recordation of a notice of the debtor s bankruptcy proceeding. 54 By enacting section 549(c) of the Bankruptcy Code, Congress provided certainty and predictability to the bankruptcy laws with regard to good faith purchasers of real property. III. PRESENT LAW In 1970, Congress created the Commission on the Bankruptcy Laws of the United States ( Bankruptcy Commission ) to evaluate the prior Bankruptcy Act and to recommend changes so that Congress could create a new act reflecting current societal demands. 55 Three years later, the Bankruptcy Commission s report recommended a complete overhaul of the bankruptcy laws, and provided a draft of a proposed new bankruptcy statute, 56 which eventually and after much debate became the Bankruptcy Reform Act of 1978 ( Reform Act ). 57 The Reform Act imposed many sweeping changes to the existing bankruptcy system. Most notably, the Code expanded the bankruptcy courts jurisdiction and, as a tool for that expansion, provided a statutory automatic stay. 58 Though many viewed the Code as substantially more debtor-friendly than the prior laws, protecting post-petition good faith purchasers of real property remained an essential element of Congress s overall scheme. 59 A. Description and Functions of the Automatic Stay, Section 362(a) Upon the filing of a petition, the Code prohibits all acts to collect, assess, or recover a claim outside of the bankruptcy forum. 60 The automatic stay is a stay against, or a halting of, creditor collection efforts once a bankruptcy case is commenced. 61 As its name suggests, the stay automatically arises the moment the debtor files a bankruptcy petition. 62 More 54 Brubaker 2003, supra note 15, at S.J. Res. 88, 91st Cong. 84 Stat. 468 (1970). 56 REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, H.R. DOC. NO. 137, at pts. I-II (1973) [hereinafter COMMISSION REPORT]. 57 Pub. L. No , 92 Stat (1978). 58 See generally id. 59 See COMMISSION REPORT, supra note 56, at Donna Renee Tobar, Comment, The Need for a Uniform Void Ab Initio Standard for Violations of the Automatic Stay, WHITTIER L. REV., Fall 2002, at 3, 5; (quoting In re McLouth, 257 B.R. 316, 319 (Bankr. D. Mont. 2000) (quoting 11 U.S.C. 362(a)(6) (2000)). 61 See generally CHARLES JORDAN TABB, THE LAW OF BANKRUPTCY 3.1 (1997) COLLIER, supra note 19, at Section 301 of the Code covers the procedure for filing an involuntary case. Section 302 governs filing a joint case, and section 303 governs the filing of an involuntary petition under Chapters 7 and U.S.C. 301-

13 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 161 over, the stay protects the property of the estate without requiring the debtor to initiate a request for an injunction. 63 The automatic stay is essential to implement the dual aims of bankruptcy: the debtor s fresh start and creditor equality. 64 The automatic stay works hand in hand with the policy of encouraging an honest debtor s fresh start by providing a respite from creditor collection efforts. 65 Congress confirmed the automatic stay s importance, calling the stay one of the fundamental debtor protection[s] provided by the bankruptcy law. 66 In considering the Reform Act, the House of Representatives described this debtor protection: [The stay] gives the debtor a breathing spell from his creditors. It stops all collection efforts, all harassment, and all foreclosure actions. It permits the debtor to attempt a repayment or reorganization plan, or simply to be relieved of the financial pressures that drove him into bankruptcy. 67 A breathing spell facilitates a fresh start and gives individual debtors an opportunity to regain their financial footing. 68 The stay also protects corporate debtors by allowing them to restructure their financial affairs and submit a plan of reorganization to the court. 69 The stay ensures that no single creditor has an advantage over other creditors because it places all similarly situated creditors on a level playing However, in cases in which the state s interest in enforcing criminal or environmental laws trumps the federal bankruptcy law, actions to enforce these interests are excluded from the automatic stay. 11 U.S.C. 362(b) (listing these and other exceptions). See, e.g., In re Commonwealth Oil Ref. Co., 805 F.2d 1175, (5th Cir. 1986) (permitting the government to compel a debtor-in-possession in a chapter 11 case to bring the polluted site into compliance with the environmental laws); Penn Terra Ltd. v. Dept. of Envtl. Res., 733 F.2d 267, 278 (3d Cir. 1984) (holding that an action compelling the trustee to expend the estate s money to effect a cleanup was not an action to enforce a money judgment within the meaning of section 362(a) and thus not stayed). In such instances, the debtor has the burden of obtaining an injunction from the court to stay these activities. See TABB, supra note 61, 3.11, at TABB, supra note 61, 3.1, at Id. 66 H.R. REP. NO at 340 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, Id. Many courts have relied on this famous language in discussing the policy of the automatic stay. See, e.g., Schwartz v. United States (In re Schwartz), 954 F.2d 569, 571 (9th Cir. 1992); New Orleans Airport Motel Assocs., Ltd. v. Lee (In re Servico), 144 B.R. 933, 935 (Bankr. S.D. Fla. 1992). 68 Robert R. Niccolini, Note, The Voidability of Actions Taken in Violation of the Automatic Stay: Application of the Information-Forcing Paradigm, 45 VAND. L. REV. 1663, 1667 (1992) (quoting Schwartz, 954 F.2d. at 571). 69 Id. at 1667.

14 REAL PROPERTY, PROBATE AND TRUST JOURNAL field and obviates the incentive for a creditor race to the courthouse. 70 The House of Representatives squarely addressed this concern while considering the Reform Act. 71 The House stated that without the creditor protection afforded by the stay, certain creditors would be able to pursue their own remedies against the debtor s property. Those who acted first would obtain payment of the claims in preference to and to the detriment of other creditors. Bankruptcy is designed to provide an orderly liquidation procedure under which all creditors are treated equally. 72 Because the stay prohibits creditor actions without the permission of the bankruptcy court, the property of the estate stays intact for equal distribution in the bankruptcy proceedings. 73 Through its broad scope, the stay achieves protection for both creditors and debtors alike. The stay applies to all entities 74 who take almost any type of formal or informal action... against the debtor or the property of the estate. 75 For example, the stay forbids a creditor from creating, perfecting, or enforcing a lien against the property of the estate or enforcing a prepetition judgment against the debtor. 76 The statute s broad language 70 Outside of bankruptcy law, creditors are able to pursue state collection remedies such as obtaining a judgment against a creditor and then levying on his property to collect the value of the judgment. See TABB, supra note 61, at 1.1, 1.3(a), at 4, Once the debtor s property is extinguished, those creditors with unfulfilled claims end up with nothing. Id. 1.1, at 4. Creditors race to the courthouse to obtain such judgments, because the maxim first come, first served is truly applicable in this situation. See id. 1.1, 1.3(a), at 4, The automatic stay halts the collection efforts, Tobar, supra note 60, at 6-7, and because the Bankruptcy Code is federal law, it trumps state law via the Supremacy Clause. See U.S. CONST. art. VI, cl. 2. By stopping this scramble to be the first in line to obtain a judgment against the debtor, the automatic stay provides an equitable distribution of assets by protecting creditors and making sure that no other parties get more than their fair share of the bankruptcy estate. Tobar, supra note 60, at H.R. REP. NO , at 362 (1978), reprinted in 1978 U.S.C.C.A.N. at (stating that [a] race of diligence by creditors for the debtor s assets prevents [an orderly liquidation procedure] ). 72 Id. 73 Tobar, supra note 60, at U.S.C. 362(a) (2000) COLLIER, supra note 19, at U.S.C. 101(15) defines an entity as including any person, estate, trust, governmental unit, and United States trustee. Furthermore, once property ceases to be property of the estate, there is no longer a stay against that property. See infra note Id. 11 U.S.C. 362(a)(1)-(8) provides:

15 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 163 allows the automatic stay to apply to both judicial and non-judicial foreclosure sales. 77 Furthermore, once the stay arises upon the filing of a case, a creditor who has not completed collection efforts pre-petition forfeits those rights until the bankruptcy proceedings have run their course or the property over which the creditor wishes to exercise control is no longer property of the estate. 78 In this way, the automatic stay maintains the status quo from the commencement of the case until the bankruptcy court s decision. 79 B. The Purpose of the Good Faith Purchaser Exception, Section 549(c) The Code contains several provisions granting the trustee avoiding powers, which were designed to further the policy goals of bankruptcy. 80 (a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302 or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities of (1) the commencement or continuation, including the issuance or employments of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title; (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; (4) any act to create, perfect, or enforce any lien against property of the estate; (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title; (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; (7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and (8) the commencement or continuation of a proceeding before the United States Tax Court concerning the debtor. 77 See 11 U.S.C. 362(a)(1)-(8). 78 The stay terminates under section 524(a) once the court grants a discharge and a permanent statutory injunction against the collection of discharged claims comes into effect. TABB, supra note 61, 3.1, at Id.; see Interstate Comm. Comm n. v. Holmes Transp., Inc., 931 F.2d 984, 987 (1st Cir. 1991). 80 TABB, supra note 61, 6.1, at 334.

16 REAL PROPERTY, PROBATE AND TRUST JOURNAL By providing the trustee with a series of tools to recapture value for the benefit of the estate, the avoiding powers maximize the ultimate distribution to creditors on an equitable basis. 81 These provisions, found in sections 544 through 551 of the Code, 82 enable a bankruptcy trustee to set aside, or invalidate, either a transfer made or obligation owed by the estate. 83 To harness this power, and thus avoid the transfer at issue, the trustee must bring a lawsuit under one of the Code provisions before the expiration of the statute of limitations. 84 Section 549 of the Code embodies one of the many avoiding powers granted to trustees of the bankruptcy estate. As the other avoiding powers do, this section serves a purpose fundamental to bankruptcy law by preserving the debtor's assets once a petition has been filed, thus ensuring that there will be an estate upon which the bankruptcy process can operate. 85 Under certain conditions, the availability of such powers enables the trustee, or the debtor-in-possession in Chapter 11 cases, to avoid transfers of the debtor s property that may undermine this fundamental protection of the bankruptcy estate. 86 However, what sets section 549 apart from the other avoiding powers is that it governs post-petition transfers of property of the estate. 87 Thus, from the moment a petition is filed, all transfers are subject to avoidance unless they fall into a statutory exception. 88 Although section 549 provides the mechanism for avoidance, 89 this 81 Id. 82 See 11 U.S.C TABB, supra note 61, 6.1, at Id. Although the statute of limitations in section 546(a) governs most of the avoiding powers, section 549 has its own statute of limitations. 11 U.S.C. 549(d) provides: An action or proceeding under this section may not be commenced after the earlier of (1) two years after the date of the transfer sought to be avoided; or (2) the time the case is closed or dismissed. 85 Harry M. Fletchner, Preferences, Post-Petition Transfers, and Transactions Involving a Debtor's Downstream Affiliate, 5 BANKR. DEV. J. 1, 18 (1987). 86 TABB, supra note 61, 6.44, at U.S.C TABB, supra note 61, 6.44, at U.S.C. 549 provides: (a) Except as provided in subsection (b) or (c) of this section, the trustee may avoid a transfer of property of the estate (1) that occurs after the commencement of the case; and (2)(A) that is authorized only under section 303(f) or 542(c) of this title; or (B) that is not authorized under this title or by the court.

17 SPRING 2005 The Validity of Post-Petition Transfers of Real Property 165 power is subject to very narrow exceptions, which act as safe harbors in prescribed situations. 90 One scholar has suggested that Congress designed these exceptions to deal with the problems arising in involuntary cases and to protect good faith purchasers of real property respectively. 91 In particular, section 549(c) prohibits the trustee from avoiding a transfer in which a purchaser of real property has purchased in good faith without knowledge of the commencement of the case and has paid fair value. 92 Once a purchaser meets these qualifications, he must properly record his interest, subsequent to transfer, in the real estate records of the county where the property is located before a copy or notice of the bankruptcy petition is filed in those same records. 93 Perfecting an interest in this way prevents a purchaser from being charged with constructive notice, further paving the way for a proper invocation of the good faith purchaser exception. 94 Conversely, failure to perfect an interest could bar a purchaser from the protection of section 549(c) COLLIER, supra note 19 at Fletchner, supra note 85, at U.S.C. 549(c). The Bankruptcy Code does not define good faith. According to Brown v. Third Nat'l Bank (In re Sherman), Good faith is not susceptible of precise definition and is determined on a case-by-case basis. 67 F.3d 1348, 1355 (8th Cir. 1995) (citing Consove v. Cohen (In re Roco Corp.), 701 F.2d 978, 984 (1st Cir. 1983)). To determine whether a transferee acts in good faith, courts look to what the transferee objectively knew or should have known instead of examining the transferee s actual knowledge from a subjective standpoint. Id. (citing Hayes v. Palm Seedlings Partners (In re Agricultural Research & Technology Group, Inc.), 916 F.2d 528, (9th Cir. 1990)). The language of the statute calls for one who has paid present fair equivalent value. 11 U.S.C. 549(c). The term value appears in over thirty sections of the Bankruptcy Code. BFP v. Resolution Trust Corp., 511 U.S. 531, 550 (1993). According to the Supreme Court in BFP, value generally means fair market value. Id. (determining whether trustee could avoid a conveyance under Section 548 of the Code). The Court held that a reasonably equivalent value for foreclosed property is the price in fact received at the foreclosure sale, so long as all the requirements of the State s foreclosure law have been complied with. Id. at 531. The Fifth Circuit, applying the Court s reasoning, addressed the validity of a purchase made at a tax sale held in violation of the automatic stay and affirmed the district court s decision to apply the BFP reasoning in the context of foreclosure sales. The court held that because the tax sale was noncollusive and complied with [state] law, it was for present fair equivalent value as required by 549(c). T.F. Stone Co. v. Harper (In re T.F. Stone Co.), 72 F.3d 466, 467 (5th Cir. 1995) U.S.C. 549(c). 94 See Wingo, 89 B.R. at 58 (B.A.P. 9th Cir. 1988) (stating in dicta that when notice of bankruptcy had not been filed in county recorder s office, purchaser s imputed notice of the case did not constitute knowledge within the meaning of section 549(c)). 95 See 11 U.S.C. 549(c). However, if the purchaser filed first and had no knowledge of the commencement of the case but did not pay present fair equivalent value, the

18 REAL PROPERTY, PROBATE AND TRUST JOURNAL Likewise, for a trustee to prevail over a good faith purchaser, the trustee must exercise the right to record notice of the pendency of the case in the land recording offices in all counties where the debtor holds nonexempt property before a purchaser perfects his interest. 96 The Code authorizes the trustee to record notice in an attempt to put all potential transferees of the debtor s real property on notice. 97 Because a trustee may take steps to record notice at his discretion, the trustee bears the risk of what may follow from neglect. 98 Although section 549(c) allows a postpetition purchaser to acquire rights that are wholly or partially immune 99 from a trustee s avoiding power, the trustee ultimately can prevent a purchaser from acquiring these rights simply by filing a notice of the petition in the records office before a purchaser records the deed. 100 The policy behind this seemingly stringent requirement for filing notice is that purchasers of real estate (especially those purchasing at a foreclosure sale, which is a risky proposition at the best of times) are entitled to rely on the real estate records for notice of any defects in the property s title. 101 Notice of the commencement of a bankruptcy case would put a prospective buyer on notice that the property is untouchable. A diligent purchaser who finds no notice in the real estate records should be able to proceed under the assumption that no defect exists. Under this system, a purchaser is not prevented from obtaining the status of a bona fide purchaser by the mere commencement of the case. 102 Congress designed section 549(c) to protect innocent purchasers, and section 549(c) will never protect a mortgagee s purchasing the debtor s property at his own foreclosure sale. Because of the automatic nature of the stay, all creditors are deemed to be on notice of the commencement of the case. Therefore, purchaser is entitled to a lien against the estate for the extent of the value given. Id.; see TABB, supra note 61, 6.45, at 460; supra note 92 (discussing the definition of present fair equivalent value ). 96 S. REP. NO , at 42 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5828; see NORTON BANKR. L. & PRAC. 2D 59:5 (2003). 97 Fed. R. Bankr. P. 2015(a); see Fed. R. Bank. P. 2015(a) advisory committee s note (1987 Amendments) ( The filing of such notice or a copy of the petition is essential to the protection of the estate from unauthorized post-petition conveyances of real property. ). 98 NORTON BANKR. L. & PRAC. 2d 59:5 (2003). 99 Id. 100 Id B AM. JUR. 2D Bankruptcy 1844 (West 2003). Moreover, this result is consistent with the purpose of the 1898 Act s section 21g which showed Congress s broad concern for protecting the integrity of and reliance upon the record notice system for real property. See Brubaker 2003, supra note 15, at B AM. JUR. 2D Bankruptcy 1844 (West 2003).