The Legal Play Podcast

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Under Section 363 of the Bankruptcy Code, interested parties are authorized to buy assets in bankruptcy. By doing so, the purchaser is able to acquire the asset “free and clear,” which means any liens or judgements against the asset are not transferred to the asset (and the party purchasing the asset).

This gives would-be buyers opportunities to acquire valuable assets at a steep discount, but there is a process that must be followed to ensure the transaction is completed in accordance with Section 363.

What Assets Can be Purchased in Bankruptcy?

Few assets are off the table if you’re purchasing them during bankruptcy. What is on sale is a matter of discussion between the debtor company (or individual), the court-appointed bankruptcy trustee and the interested third-party buyer. In general, though, all of the following can be sold or purchased free and clear through bankruptcy:

• Real property (land, buildings)
• Equipment
• Vehicles
• Inventory
• Intellectual property, including trademarks and copyrights
• Client lists
• Trade secrets and processes
• Mortgages and lease agreements

In some cases, buyers can even purchase judgements levied against the debtor company, gaining legal grounds to seek repayment from the debtor company.

What is the Process for Buying Assets in Bankruptcy?

Typically, it’s difficult (or outright impossible) to buy assets in bankruptcy due to the presence of liens or judgements against the assets. Tax liens, first liens, second liens and so on determine the priority in which creditors are paid back, should the asset be liquidated. This means if the asset is sold, the liens would then become the responsibility of the new owner, entangling them with creditors they would otherwise rather not deal with.

Instead, third party buyers typically seek a free and clear transaction by leveraging Section 363 of the Bankruptcy Code. Here’s how such a sale under Section 363 would typically proceed:

• Before bankruptcy is filed – Before the debtor files for bankruptcy, they may start marketing the assets in the pursuit of a “stalking horse.” A stalking horse is the initial bidder willing to enter into a purchase agreement, and like a stalking horse sets the pace for other racehorses, a stalking horse bid sets the terms and structure for subsequent bids on the assets. It also sets the floor for the bid amount, so it gives the debtor a degree of certainty before other potential buyers get involved.

  In addition to seeking a stalking horse, the debtor may also start the selling process before filing bankruptcy to ensure the 363-process can be completed quickly.

• Once bankruptcy is filed – As soon as bankruptcy is filed, a bankruptcy court and trustee will be involved in the process. To carry out the 363-sale, the debtor will first need to obtain approval from the court to move forward with the bidding process.

  To do so, the debtor and their trustee will file a motion with the bankruptcy court. This motion will seek approval for the bidding process, along with the deadlines for the auction and following sale. If no stalking horse bidder is present at this time, one may be selected to start the process.

• Approving the bidding process and sale – Once the bankruptcy court receives the motion for a 363-asset sale, it will schedule a hearing, usually a few weeks from the date of the motion. At this hearing, the debtor must provide evidence that the proposed bidding procedures and structure will optimize the sold asset’s value.

  Another hearing will be scheduled once a buyer is identified for the final transaction. At this hearing, the debtor must provide evidence that the selected buyer provided the best or highest bid, and that the auction process is completed without interference from the debtor.

Once the court approves the sale, it can be performed free and clear, so the buyer walks away with a no-strings-attached asset, and the funds raised from the sale are then used to satisfy the debtor’s creditors.

Why Consider Buying Assets in Bankruptcy?

Underpinning every asset purchase in bankruptcy is the pursuit of a good deal. As assets sold in bankruptcy tend to be sold under tight deadlines, debtors are encouraged to liquidate those assets as efficiently as possible to satisfy creditors. As debtors do not have time to perform an extended buyer search, assets are typically sold at a deep discount.

For the buyers, discounted assets can serve strategic or investment needs, including:

• Acquiring assets to assist with entering the industry – For would-be business owners that want to start a business similar to the debtor company, buying assets in bankruptcy can be used to secure valuable equipment or space at a fraction of the cost.

• Acquiring land to expand current business operations – If a neighboring business is looking to expand their operations, acquiring the real property (land or facilities) can be the first step in this expansion.

• Acquiring assets as an investment to “flip” – Sometimes, the best strategic move is to recognize when assets are being sold at well under the value, purchase them and sell them in arbitrage.

Buying Assets in Bankruptcy is a Potentially Lucrative Option for Alert Investors

Buying assets in bankruptcy offers obvious advantages to the buyer, but it must be done in accordance with the Bankruptcy Code to ensure there are no lien-related complications.

If you are looking to acquire assets at an advantage, purchasing them in bankruptcy is an option. However, given the complexities, it is recommended that would-be buyers first consult with an experienced bankruptcy attorney. Their expertise will ensure the transaction is completed in accordance with Section 363, and can also help with vital parts of the process, such as due diligence and asset valuation.

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It is important for taxpayers to understand how partition agreements and an IRS tax filing status are linked. The connection between the two can impact how a married couple files their tax returns and how it could potentially affect the non-debtor spouse.

In the case of married couples, partition agreements are legal documents that define the terms and conditions of the division of property between the two of them. Property can include real estate, bank accounts, and other valuable goods. Examples of partition agreements are prenuptial and postnuptial agreements. Partition agreements are essentially an agreement between the spouses on how to divide ownership and rights to their property. In Texas, any property that is earned or received, with some exceptions like inheritance, is considered community property, meaning both spouses have ownership rights over the whole. A partition agreement is typically used as a way for the spouses to state that they do not want Texas law to dictate ownership of the property, and they want to decide who owns what.

Today, it is not unusual to see couples entering partition agreements after they have married. The reasoning behind this movement is that it can allow the two individuals to have a say in how their property is divided up instead of letting default Texas community property laws decide. Certain pieces of property are defined as separate. This keeps property as “yours and mine” and eliminates the default “ours” factor.

Entering into a Partition Agreement

One of the most common questions we get about partition agreements is why someone would want to enter into one. The short answer is that there are a number of valid reasons, including:

1. People with a second marriage (who have children from a first marriage) may be worried about the consequences upon death (or the incapacitation) of one of the married partners, such that they want some of their money to go to their children. This may or may not occur if it is community property.

1. Married partners that no longer live together but do not wish to legally divorce.

1. In connection where partners are divorced and perhaps there is a reconciliation where the couple decides to reconcile but wants to have boundaries as to what each owns.

1. Estate planning purposes.

1. For creditor protection purposes so that the debts of a debtor-spouse do not attach to the non-debtor spouse, or the assets of a non-debtor’s spouse are not subject to claims from the creditors of a debtor-spouse. This can work fairly well when you partition them, if at the time you partition them there is no real debt problem. It works best if the spouses enter into a partition agreement prospectively so as to avoid the argument that this was done to defraud creditors.

It is worth noting that it can be hard for a creditor to set a partition aside unless the person already has a judgement against them or the partition agreement was signed well after the debt entered into collection actions.

Entering into Partition Agreement Before Marriage and Its Impact on Filing Taxes

If a partition agreement has already been signed, it is important to decide how to file your federal income taxes, especially if one spouse makes significantly more than the other.

If two spouses enter into a partition agreement that they have signed, executed and notarized, it usually does affect how we would advise them to file their tax returns. For example, if a couple has nothing but community property, community income and few debts, there is little reason not to file jointly. But there are financial complications which may need to be considered.

If you have a married couple with a diverse income in which one spouse makes one million dollars annually and the other spouse makes ten thousand dollars, they can still decide to share the income and it will be reported accordingly. This means they can still file a joint return and pay taxes on the whole amount. The benefit to this is typically money saving. Filing jointly often results in paying less tax than if filing separately. Yet it doesn’t have to be done this way. There may be important reasons for a couple to file separately.

 

Reasons for Changing Filing Status to “Married and Filing Separately” After Signing a Partition Agreement

There are some reasons for a couple to change their filing status to “married and filing separately” when a partition agreement comes into play, including:

• One spouse has a judgement against them that does not include the other spouse

• One spouse files bankruptcy

• One spouse is obligated into making financial disclosures to a government entity or creditor

• If a lesser earning spouse has aggressive creditors pursuing them

The goal is to prevent the debtor-spouse’s creditors from getting to the assets of the non-debtor spouse, especially in a case where the non-debtor spouse earns significantly more than the debtor-spouse. Filing jointly would be unwise in this case as it would give the creditors of the debtor-spouse access to financial information about the non-debtor spouse.

Why is this an issue? When creditors know how much the higher earning spouse makes, they could become much more aggressive in making the lesser earning spouse’s life miserable by threatening to take an annual deposition, demanding they respond to requests for production, or by garnishing what is in known bank accounts that the debtor-spouse may enjoy the benefits of. An aggressive creditor could put extreme pressure on the debtor-spouse to come up with money from somewhere, hoping they will dip into the higher earning spouse’s funds to appease the creditor.

If the creditor is the IRS, it can be a very good idea to file separately, because if the spouses file jointly, the IRS can keep any refund that the couple might have received and apply it towards the debt of the debtor-spouse. This means that any refund the non-debtor spouse would have received for money they alone contributed could be lost and the non-debtor spouse would lose out on the option to receive rightful refunds. By keeping property and debts separate, it can be possible to keep the IRS from withholding or garnishing any funds belonging to the non-debtor spouse.

 

Partition agreements and an IRS tax filing status are interconnected and can have far reaching implications. The best way to ensure your rights and your assets are protected is by enlisting the help of a trusted and reputable tax attorney before it is too late.

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Federal tax liens are a product of the Internal Revenue Service (IRS). Federal tax liens are created and filed in the property records by the IRS when a taxpayer owes the IRS money that the taxpayer hasn’t paid. If you have ever had a federal tax lien against your property, you may wonder if the IRS can foreclose on your property. By understanding how a federal tax lien works, it can equip you to avoid foreclosure or know how to handle it. However, in full disclosure, dealing with a federal tax lien can get messy quickly, which is why the majority of individuals or companies facing this situation turn to successful attorneys for guidance and representation.

Suffice it to say, you do not want a federal tax lien against you. It is the first thing that hits the public record, so creditors and credit reporting agencies will know there is a federal tax lien. A federal tax lien is filed in the county in which the debtor has property and theoretically puts a lien on all the property, real or otherwise, the debtor has in that county. For these reasons and so many more, federal tax liens should always be taken seriously.

Although federal liens are attached to everything a taxpayer owns within that county, there may be some wiggle room. A homeowner with a lien may still be able to sell furniture, such as a couch, to their neighbor without interference from the IRS. However, if a factory with a lien is selling expensive equipment worth millions of dollars, the IRS could come after that equipment and leave the buyer empty handed.

What Happens When a Federal Lien Is Issued on Property with an Existing Mortgage?

In the event that the IRS has a federal tax lien against a house with an outstanding mortgage, the question becomes which is superior? The tax lien or the mortgage? In general, most states have a first come, first serve rule which means that if the mortgage is in existence prior to filing the tax lien (i.e. the deed of trust in favor of the mortgage lender is filed in the public record before the federal tax lien), the mortgage will most likely be superior.

However, it would be a mistake to think that the IRS cannot do anything if there is a current mortgage on the house. For example, if there is a house with an existing mortgage and a federal tax lien is filed, the IRS can still foreclose. A foreclosure requires the IRS to go through some procedural hurdles first, which typically makes this process uncommon, but it can happen.

The Steps the Government Takes to Follow Through with a Foreclosure

For the government to foreclose on a property, there is a procedure they must follow which can generally look like the following:

• The government gives notice by sending intent letters to the taxpayer
• If the taxpayer does not provide a satisfactory answer or any answer at all, then the IRS will do a public notification. This is most often done with commercial property and office buildings, but it may also be done with a house.
• The IRS will prepare to sell their interest in your house, which means they will foreclose on the property if you do nothing to stop them.
• Foreclosure means the IRS will conduct the sale of the property and issue a special kind of deed.

In most cases, the IRS applies the eighty percent rule, which means they are looking to get eighty percent of the value of the house. So, if you have a $300,000 house, $240,000 mortgage and a $60,000 tax lien on it, there is not enough equity.

Right of Redemption

The taxpayer has a right of redemption which can be a specific number of months for the taxpayer to come up with the funds to pay the amount the property sold for, plus a redemption premium, which can be somewhere around twenty percent.

For instance, if a buyer at a foreclosure auction bids $100,000 for the property, the buyer’s right to possess the property isn’t final. There is a window of time in which the taxpayer has an opportunity to redeem the property. The taxpayer would have to pay the buyer $120,000 and then they could redeem the property. If the taxpayer can’t or chooses not to do this, the taxpayer must surrender the property. The buyer would then be the new property owner. Remember, though, there is a mortgage still in place. So, the buyer would own the house, subject to the first mortgage, meaning if they want to keep the house, the buyer would need to make the necessary payments to the mortgage company.

It is worth noting that although mortgage companies do not have to be notified of the property foreclosure sale, most sophisticated mortgage companies and banks have people whose sole job is to look for these federal notices and match them up with properties that are secured by a loan from them. In other words, even if you do not notify the mortgage company about a federal tax lien or IRS foreclosure, they will most likely find out anyway.

Perhaps even more problematic is that the mortgage company can decide that if a federal tax lien goes into place, they can start their own foreclosure. This is because most deeds-of-trust say that an additional lien on the property constitutes a default on the first lien mortgage, freeing the deed-of-trust holder to foreclose on the property. It can get quite complicated quickly, which is why enlisting the help of an attorney can be key to success in cases like these.

 

Ways to Keep the IRS from Foreclosing on a Federal Tax Lien

There are two primary ways to keep the IRS from foreclosing on a federal tax lien, and they are:

1. Pay the lien.
2. Enter into some sort of installment program or offer in compromise. This can happen while the tax lien is in place.

Limited Life Span of a Federal Tax Lien

The fact is that federal tax liens have a ten-year life during which the IRS can collect the debt or reduce it to judgment. To reduce a lien to a judgment means filing in a court with proper jurisdiction and getting a court to issue a judgement against the taxpayer. This comes with its own administrative burdens and costs that the IRS will decide may or may not be worth doing.

The statute of limitation (the 10-year life of the lien) could help some individuals in the long run. There have been cases where taxpayer has simply waited out the ten-year life of the lien and then the IRS released it. Typically, if you owe the IRS a couple hundred thousand dollars and the IRS chooses not to foreclose on their tax lien, you may be able to wait out the ten-year period without much of an issue. However, during that time, you will not be able to sell or refinance the house.

Generally, if the individual is current on payments and taxes, and the mortgage company gets all the required information, most banks are content to do nothing and simply accept their monthly repayment. Yet, if you have a federal tax lien and are behind on payments, the mortgage lender may choose to be strict simply because the risk is now greater.

 

In short, the IRS can foreclose on your property, but by understanding a federal tax lien you are taking steps toward preventing that from happening, or at the very least knowing what to expect if it does become a reality. Whichever situation you find yourself in, enlist the help of a reputable tax attorney to make sure your rights are protected and that the actions you take best serve your interests.