Seller’s Bankruptcy Does Not Void Sale Of Property To A Bona Fide Buyer

In Burkhart v. Coleman, (— F.3d —, 2008 WL 4070690, C.A.9, September 4, 2008), the United States Court of Appeals considered a challenge by a bankruptcy’s trustee to void the sale of a property from the bankrupt seller to a bona fide buyer. The court ruled that federal bankruptcy law does not preempt California’s protection of bona fide purchasers, and that the title to the property therefore rightfully belonged to the buyer, rather than the bankruptcy estate.

Facts

Craig and Christine Tippett (“Tippets”) filed for Chapter 7 bankruptcy in 2001, and Michael Burkhart (“Trustee”) was appointed trustee. The bankruptcy was never recorded with the county recorder’s office. In 2003, without disclosing their bankruptcy, the Tippetts sold their home to Seitu Coleman for $225,000, which provided them with net proceeds of $76,582.76.

The trustee filed an adversary proceeding against the Tippetts and Coleman seeking to void the sale. The bankruptcy court held that the sale was void and awarded title to the trustee. The Tippetts appealed to the Bankruptcy Appellate Panel, which ruled that bankruptcy law includes a defense for bona fide purchasers, and reversed the bankruptcy court ruling that the sale to Coleman was legal and valid. The trustee appealed.

Decision

California’s bona fide purchaser statute, Civil Code Section 1214, gives effect to a conveyance when the owner’s title is defective because of a prior unrecorded conveyance, such as the Tippetts’ bankruptcy, the court said. The unrecorded bankruptcy was therefore void as to Coleman’s good faith purchase and the transfer of the property to Coleman was effective.

Secondly, the court found federal bankruptcy law does not preempt California’s law. Federal law precludes state laws when “the scheme of federal regulation is so pervasive as to make reasonable the inference that Congress left no room for the States to supplement it,” quoting Gade v. Nat’l Solid Wastes Mgmt Ass’n, 505 U.S. 88 (1992). While federal laws leave no room for states to address bankruptcy directly, the court said, federal law “peacefully coexists” with state laws regarding the rights and obligations of debtors and creditors. In fact, 11 U.S.C. 549(c) specifically carves out an exemption to protect good faith purchasers of property, the court noted. It then follows that California’s bona fide purchaser law is not preempted by federal law.

Finally, the court rejected argument that the sale was voided by the “automatic stay” provision in 11 U.S.C. 362, because, quoting Schwartz v. United States, 954 F.2d 574 (9th Cir. 1992), “Section 362’s automatic stay does not apply to sales or transfers of property initiated by the debtor.” The court found the transfer from the Tippetts to Coleman was therefore not rendered void by the automatic stay.

Since California law protected the bona fide buyer’s good faith transaction, and federal law neither precluded it nor left room for state action, the California law applied and the transaction was effective. The Bankruptcy Appellate Panel ruling upholding it was affirmed.