In re Energytec, Inc., 2013 Westlaw 6868618 (5th Cir. 2013)
In re Energytec, Inc., 2013 Westlaw 6868618 (5th Cir. 2013). A sale of pipeline system, which was property of the bankruptcy estate, “free and clear of liens and encumbrances”, in a bankruptcy case, per 11 USC 363(f), might NOT get rid of covenants relating to pipeline system
Facts: In connection with the sale of a pipeline system, the purchaser executed covenants in favor of the vendor. Those covenants required the purchaser to pay a transportation fee based upon the amount of gas flowing through the pipeline and required the purchaser to obtain consent prior to assigning its interest in the pipeline. The agreement stated that the covenants would “run with the land” and would be enforceable by the vendor’s assignees and affiliates.
The vendor’s beneficial interest in the covenants was assigned to an affiliate (the “beneficiary”), and the pipeline itself was assigned to a new purchaser (the “burdened party”), which expressly assumed the obligations under the covenants. Eventually, the burdened party (the new owner of the pipeline) filed a Chapter 11 petition. It later sought to sell the pipeline to a third party free and clear of the burden of the covenants, pursuant to 11 U.S.C.A. § 363(f)(5). The bankruptcy court approved the sale, and the district court affirmed, both holding that the covenants in question were not property interests running with the land.
Reasoning: The Fifth Circuit vacated and remanded, holding that the covenants did run with the land but that there were unresolved issues concerning the effect of the sale on the enforceability of the covenants. After holding that the issue was not moot despite the beneficiary’s failure to obtain a stay, the court discussed whether the covenants ran with the land under applicable state law.
The court first held that there was “vertical privity” between the original covenantor and its successor (the ultimately burdened party), as well as between the original covenantee and its successor (the beneficiary seeking to enforce the covenant); the vertical privity requirement is satisfied where the assignees of both of the original covenanting parties have succeeded to the estates or interests held by those parties.
The court then noted that Texas law was unclear as to whether “horizontal privity” between the original covenanting parties is necessary; the horizontal privity requirement is satisfied when a separate interest in real property has passed between the original covenanting parties at the time of the execution of the accompanying covenants. The court held that even if horizontal privity is required, it did exist in this case, since a property interest passed between the original covenantor and the original covenantee:
[T]he transportation fee and other benefits for [the beneficiary] were created at the time of a conveyance of real property. [The original covenantee] . . . conveyed the pipeline and rights-of-way and carved out of that conveyance the rights at issue in [this case] . . . . [The original covenanting parties] were in horizontal privity, and a later assignment by [the vendor to its assignee] satisfies vertical privity.
The court then discussed whether the covenant in question “touched and concerned” the property; the “touch and concern” requirement imposes an independent subject-matter test to determine whether the covenant really affects the use of the property or is independent of it. The court first acknowledged that the tests of the “touch and concern” requirement were “far from absolute” but that some Texas courts had held that this requirement takes into account the covenant’s impact on the property’s value:
If the promisor’s legal relations in respect to the land in question are lessened—his legal interest as owner rendered less valuable by the promise—the burden of the covenant touches or concerns that land; if the promisee’s legal relations in respect to that land are increased—his legal interest as owner rendered more value by the promise—the benefit of the covenant touches or concerns the land.
The court then held that these covenants did “touch and concern” the pipeline property:
The real property at issue here is a gas pipeline system . . . . [The beneficiary’s] interest in transportation fees is for the use of real property, i.e., the traveling of natural gas from a starting point along the length of the pipeline to an endpoint. The pipeline is a sub-surface road for natural gas, and a fee for the use of that road was retained by [the original covenantee] and assigned to [the beneficiary]. Another restriction on use is that the pipeline cannot be assigned without [the beneficiary’s] consent. These rights impact the owner’s interest in the pipeline. Furthermore, as burdens on the property, they also impact the pipeline’s value in the eyes of prospective buyers. Indeed, the impact on the sale in bankruptcy has been clear, though the financial impact has not been quantified.
Having held that the covenants satisfied all of the requirements, the court held that the lower courts had erred in deciding that the covenants did not “run with the land.” The court then turned to a discussion of §363(f)(5), which provides:
The trustee may sell property . . . free and clear of any interest in such property of an entity other than the estate, only if . . . such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.
The beneficiary of the covenant argued that since the monetary value of its right to future transportation fees was impossible to estimate, monetization of its interest in the transportation fees was impossible. Therefore, no “money satisfaction” was possible, and the statute was inapplicable. The court declined to reach this issue, however, since the lower courts had failed to reach the question of valuation, and it remanded the case on that basis. The court noted a split of authority on that issue and admitted that the Fifth Circuit “has yet to consider what constitutes a qualifying legal or equitable proceeding” for purposes of the statute.”
Comment: Property professors all over the country are rejoicing: the rule in Spencer’s case still lives! “Touch and concern,” horizontal privity, vertical privity: these are precious nuggets of ancient lore revived by the Fifth Circuit in the 21st Century. Alas, the court may have botched the analysis.
First, its discussion of the “touch and concern” requirement is hopelessly circular:
(a) The covenant runs only if it touches and concerns the property.
(b) It touches and concerns only if it affects the property’s value.
(c) It affects the value only if it runs.
(d) See (a).
Second, the court missed the fact that the issue of privity (both horizontal and vertical) may have been dicta. The burdened party in this case (the Chapter 11 debtor) expressly assumed the obligation of the covenant; a contractual assumption is a valid substitute for a failure of privity. And the beneficiary of the covenant was a named third-party beneficiary of the original agreement. Therefore, under ordinary contract doctrine, the beneficiary was entitled to assert the benefit of the agreement, whether vertical privity existed or not.
It is really too bad that the court did not discuss the “monetization” issue, at least to give guidance to the bankruptcy court upon remand. Merely acknowledging the circuit split is not the same thing as providing guidance. For whatever it’s worth, I believe that the claim of the beneficiary will be factually capable of monetization; the bankruptcy court can take testimony on the estimated stream of income and then reduce that stream to a discounted present value. However, that still doesn’t answer the second prong of the statute, an issue of law: could the beneficiary of the covenant “be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest?” Him
Under the facts of this case, the only “legal or equitable proceeding” that I can imagine that would have “compelled” the beneficiary to accept a money satisfaction would have been an eminent domain proceeding. Is that what Congress had in mind: a hypothetical condemnation, deus ex machina? If that is true, isn’t every interest in real property subject to compensable extinguishment?
Certainly, the bankruptcy case itself cannot satisfy the “legal or equitable proceeding” requirement, since that would make the statute completely circular: every time a trustee seeks a sale, the trustee seeks to extinguish claims against the property and to force the holders of those claims to accept money. For the same reason, the theoretical availability of a “cramdown” plan under Chapter 11 should not be sufficient to satisfy the statute, although the court noted that a few bankruptcy courts had so held. I predict that this fascinating case will be back before the Fifth Circuit within 18 months, and some of the unanswered questions will be resolved.
For a discussion of a recent decision holding that a §363 sale cannot be used to extinguish real covenants encumbering the property, see 2013-50 Comm. Fin. News. NL 102, Bankruptcy Trustee Cannot Use Sale “Free and Clear” to Extinguish Equitable Servitudes Because Holder of Servitude Would Not Have Received Any Money If Senior Lienholder Had Foreclosed.
This analysis is from the CA State Bar Insolvency Committee e-newsletter of 1/24/14