Envision a scenario in which you purchased a right of first refusal for a parcel of real estate. That right, as bargained for, would let you purchase the parcel if it was put up for sale by matching any competing bidder’s offer. As a diligent prospective purchaser, you would naturally record that right of first refusal in the appropriate land records. So far so good.

But what if your right was ignored? Even worse, what if the property that you had a right of first refusal over had been sold in a bankruptcy court blessed sale, ostensibly free and clear of your right of first refusal?  And what if the sale had occurred years before you eventually became aware of it?

That was the question recently faced by a panel headed by Judge Easterbrook of the Seventh Circuit Court of Appeals in Archer-Daniels-Midland Co. v. Country Visions Coop., 29 F.4th 956, 958 (7th Cir. 2022).

The facts of Country Visions Coop. bring to reality the nightmare scenario envisioned above.  In 2007, the predecessor to Country Visions Cooperative (“CVC”) acquired a ten-year long right of first refusal to purchase real estate located in Wisconsin from Olson Brothers Enterprises LLP.  Olson Brothers dissolved in July of 2010 and in December the former partners each filed for bankruptcy (acts which themselves did not itself trigger nor extinguish CVC’s right of first refusal).  CVC was not alerted to the bankruptcy filing and did not receive any notices or pleadings from the case.

In that Chapter 11 bankruptcy, a plan of reorganization was proposed and approved which sold the Wisconsin property “free and clear” to Archer-Daniels-Midland (“ADM”), an entity which, at the time of the sale, had ordered a title search report on the Wisconsin property and knew of CVC’s right of first refusal.  No party notified CVC of the sale and no party alerted the bankruptcy court to CVC’s right of first refusal.  The sale was consummated with CVC being none the wiser.

That is, until 2015, when ADM attempted to re-sell the Wisconsin property. CVC, now belatedly aware that its rights had been ignored, brought suit against ADM in state court seeking specific performance and damages.  In response, so as to halt CVC’s state court proceeding and legitimize ADM’s “free and clear” purchase, ADM ran to the bankruptcy court in the hopes that the bankruptcy case would be reopened and the Chapter 11 plan confirmation order enforced. The bankruptcy court engaged in the ministerial act of reopening the bankruptcy case.  However, after reopening the case, the bankruptcy court denied ADM’s substantive requests, declining to enforce the Chapter 11 plan confirmation order against CVC and permitting CVC’s state court lawsuit to proceed. ADM appealed and the District Court affirmed.

Once again appealing, ADM took the case to the Seventh Circuit. The Seventh Circuit affirmed. Of central importance to the Seventh Circuit was the language of 11 U.S.C. § 363(m):

(m) The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

11 U.S.C. § 363(m)(emphasis added)

Normally, Section 363(m) offers broad protections to good faith purchasers that, without knowledge of defects in title, buy property out of a bankruptcy sale. See Matter of Edwards, 962 F.2d 641 (7th Cir. 1992). The only problem? ADM was not a good faith purchaser.

Writing for the panel, Judge Easterbrook held that ADM could not be considered a good faith purchaser because it had actual notice of CVC’s right of first refusal. The record on appeal showed that ADM was in physical possession of a title search report showing CVC’s properly and timely recorded right of first refusal. Despite having actual knowledge of CVC’s right, ADM did not raise the issue with the bankruptcy court and did not inform CVC of the sale.

But what if ADM had not ordered a title report?  Is the lesson to be learned that willful ignorance is advisable when purchasing real property out of bankruptcy? No. Judge Easterbrook further expounded that ADM nevertheless had constructive notice because CVC had recorded its right of first refusal in the appropriate land records.

So what then is the lesson to be learned from Country Visions Coop.? It is that before you or your client purchase property out of a bankruptcy sale, you have an obligation to order a title search report and alert the Court to whatever defects you may find. The passage of time will not protect the purchase and the undisclosed encumbrance will not be extinguished.

But there is some good news for cautious prospective bankruptcy purchasers. Judge Easterbrook noted that if CVC had been made a party to the bankruptcy, its right of first refusal could have been extinguished by the sale, at which point ADM would have been protected by Section 363(m). So the real lesson of Country Visions Coop. may simply be this: buyer beware, you must always read your title search reports with diligence and care.

Nelson Mullins attorneys are experienced in handling asset purchases and sales in bankruptcy cases of all sizes and are well equipped to advise debtors and prospective purchasers alike that are faced with trying to sell property which may have encumbrances listed of record.