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Purchaser Cannot Escape Tax Lien Under Terms of Sale Order Despite Court’s Narrow Interpretation of “Permitted Encumbrances”

In re Joan Fabrics Corporation, No. 07-10479 (CSS) (Bankr. D. Del. May 5, 2014)

On May 5, 2014, the Honorable Christopher S. Sontchi issued an Opinion denying a purchaser’s motion to enforce a sale order and hold a North Carolina county in contempt for pursuing unpaid taxes.  In doing so, the Court considered specific circumstances of the sale and interpreted the terms of the asset purchase agreement under North Carolina law to conclude that the county’s actions did not violate the sale order.

On July 5, 2007, the Court approved a sale of several lots of real estate in Rutherford County, North Carolina from the Joan Fabrics debtors to Fred Godley pursuant to section 363 of the Bankruptcy Code and in accordance with the terms of an asset purchase agreement (the “APA”).  Under the terms of the sale, Godley purchased the properties subject only to “Permitted Encumbrances,” which term was defined in the APA as “[e]asements, liens, restrictions, encumbrances, encroachments, agreements and other matters of record, if any.”  The APA required Godley to obtain title insurance and permitted him to object to certain defects in title.  In the event Godley objected, the objection could be cured by the debtors, or Godley could choose not to proceed with the sale.  Godley obtained title insurance, but did not lodge any objections to defects in title.

The debtors never paid 2007 taxes on the personal property located at the real estate.  Almost four years after entry of the sale order, the county asserted a statutory lien on the property for the unpaid amounts and pursued Godley for payment.

In interpreting the definition of Permitted Encumbrances, the Court applied the canon of ejusdem generis to construe the phrase “of record” to apply to each of the terms preceding it, noting that any other reading would be contrary to allowing asset sales free and clear of liens and encumbrances under § 363(f).  Accordingly, to hold Godley responsible for the unpaid taxes, the county’s lien must have been a “lien of record.”  The Court held that it was.  Under North Carolina law, the county’s lien was created and recorded when the debtors filed their personal property listing with the county tax office prior to the petition date.  Thus, the lien fell within the APA’s definition of Permitted Encumbrances, and the county was not in violation of the sale order in attempting to recover the unpaid taxes from Godley.

The Court also took into account several equitable considerations in denying Godley’s request.  First, Godley never objected to any liens or encumbrances pursuant to the mechanism set forth in the APA.  Second, the title insurance policy Godley obtained specifically stated that he was taking title to the property subject to “taxes for the 2007, and subject years, not yet due and payable.”  Lastly, a funds flow memorandum created before the closing stated that $137,232.20 was to be deposited in escrow by the debtors for “Rutherford County Tax[es] (RE and Personal).”  Accordingly, Godley had notice of the 2007 tax obligations prior to the sale and could not use the sale order to prevent the county from pursuing him.