Legal Updates /

Bankruptcy Court Employs Principles of Contract Construction to Find Purchaser Liable for County Taxes

By Charlene D. Davis

On May 5, 2014, Judge Christopher S. Sontchi of the United States Bankruptcy Court for Delaware issued an opinion in Joan Fabrics Corporation et al. Case No. 07-10479 denying a motion to enforce a bankruptcy sale order and for a contempt order brought by the purchaser of assets in a sale that took place in 2007. The purchaser had sought an order holding that Rutherford County, (the “County”) North Carolina’s attempt to collect personal property taxes from him violated the terms of the sale and sale order. In denying the motion, the Bankruptcy Court concluded that the asserted personal property taxes fell within the definition of “Permitted Encumbrances” and, that since the purchaser bought the property subject to “Permitted Encumbrances”, the County did not violate the sale order by seeking to recover the unpaid 2007 personal property taxes from him.

The Debtors filed voluntary petitions under chapter 11 of the Bankruptcy Code on April 10, 2007. Subsequently on June 4, 2007, the Debtors filed a motion to sell substantially all of their assets with notice to “all applicable federal and state…taxing authorities and their respective attorneys general”. The sale was approved by the Court on July 5, 2007. Pursuant to the sale, the purchaser acquired several lots of real estate in the County (the “Properties”) under the terms of an asset purchase agreement (the “APA”).

The sale specifically provided that the purchaser would acquire the Properties subject to “Permitted Encumbrances”, which the APA defined to include:

“REAL PROPERTY taxes accruing from and after Closing through the date of the DEED DELIVERY… Easements, liens, restrictions, encumbrances, encroachments, agreements and other matters of record, if any, affecting the REAL PROPERTY or any part thereof, provided the same do not materially adversely affect the use of the REAL PROPERTY as presently used…”

The defined term also included any lien or encumbrance on the Properties, as to which the Seller delivered to the purchaser, or the purchasers title company, payment sufficient to satisfy the obligation underlying the lien or encumbrance; as well as any lien or encumbrance as to which a reputable title company would insure against loss, forfeiture of title to or collection from the Properties without additional cost to the purchaser. The APA also provided that the purchaser was to obtain a title commitment for title insurance on the Properties and provide notice to the Debtors of any objections to matters appearing on the commitment. The purchaser did not provide objections to defects in the title for the Properties. Before closing on the sale, a Funds Flow Memorandum had been created which indicated that the sum of $137,232.20 was to be deposited in escrow by the Debtors for “Rutherford County Tax[es] (RE and Person)” relating to one of the Properties, but the Memorandum does not detail whether all or any part of these funds were designated for personal property taxes.

Prior to the bankruptcy filing, in March 2007, the Debtors had submitted its 2007 Business Personal Property listing to the County. The County did not prepare a bill for personal property taxes based on the listing until August 16, 2007, over a month after the Court approved the sale of the Properties. In a letter to the purchaser approximately 4 ½ years later, on December 9, 2011, the County asserted a statutory lien on the Properties for 2007 unpaid personal property taxes in the amount of $111,228.56. A month later, on January 9, 2012, the County garnished rents related to the Properties, but agreed to hold them in escrow pending resolution of the purchaser’s dispute regarding the effect of the Bankruptcy Court sale order.

The Court was asked to address two main issues. The first was whether the purported tax lien is a recorded lien and, thus, a Permitted Encumbrance for which the purchaser is liable. The second was whether in attaching rents from the Properties, the County violated the sale order and should be found in contempt.

In addressing the first issue, the Court engaged in contract construction; employing the principle of ejusdem generis to determine that the phrase “other matters of record” in the definition of Permitted Encumbrances modified each of the terms, “Easements, liens, restrictions, encumbrances, encroachments, agreements” to read “of record”. It then considered North Carolina law to conclude that the tax became a lien on the date that the Debtors submitted their 2007 Business Personal Property listing to the County. In deciding whether the County’s lien for personal property taxes was “of record”, the Court concluded that it had to employ another rule of contract construction to the effect that any undefined, nontechnical word is to be given a meaning consistent with its use in ordinary speech, unless the context clearly requires otherwise. It looked to the definition in Black’s Law Dictionary which defines the term “of record” to mean “recorded in the appropriate records”. Since North Carolina law only requires that the personal property listings and assessments be entered on the county tax records, the Court found that the lien was “of record” and thus a Permitted Encumbrance for which the purchaser was liable. Given the Court’s decision on the first issue, it concluded that the County was not in violation of the sale order.

The Court noted that, in arriving at its decision, it took into consideration the facts that (i) the title insurance policy specifically stated that the purchaser was taking title subject to taxes for the year 2007, but the purchaser did not object to the possible lien as permitted in the APA and (ii) the Funds Flow Memorandum further indicated the purchaser’s knowledge of the real and personal taxes owed the County for 2007.

A copy of the opinion can be found here.

Scroll to top