Driving a Hard Bargain in Bankruptcy

February 10th, 2016 by Lawrence Hansen

Bankruptcy trustees often sell the interest of a bankrupt estate in property for a price reduced by notional disposal costs, including legal fees and real estate commissions, which will never actually be incurred.  The recent decision of the bankruptcy court in Re Manoharan[1] suggests that such costs should not, as a general rule, be deducted and that trustees should be trying to drive a hard bargain for the ultimate benefit of the bankrupt’s creditors.

In Manoharan,  the bankrupt made a voluntary assignment in bankruptcy.  She had two properties: one was her home; the second was a rental property.  Because of the bankruptcy, her interest in the two properties became vested in the trustee in bankruptcy, forming part of what is called the bankrupt estate.

The trustee obtained appraisals for the properties and resolved the sale of the equity in them on the basis that the bankrupt herself, who was already the registered owner, would simply purchase back the equity.  There would be no need for a real estate agent or any of the expenses that would be incurred if the property were to be sold on the open market.

The transaction, which was never subsequently completed, had not received prior approval from the estate’s inspector, an elected representative of the bankrupt’s creditors.

Reporting to the inspector by letter, the trustee indicated, among other things, that the price of the equity in the properties had been determined by reducing the appraised fair market value by notional expenses which would never actually be incurred, including real estate commission and certain legal fees. The letter, which was copied to the bankrupt’s lawyer, indicated that deductions had also been made for arrears of property tax, mortgage payments and maintenance fees.

The inspector refused to approve the sale, objecting on several grounds, one of which was that it was unreasonable and not in the best interests of the estate (and, in effect, those of the bankrupt’s creditors) to deduct the notional expenses and debt described above.

On a motion, the bankruptcy court effectively agreed with the inspector. In so doing, the court followed Re Brisco[2] and Re Rassell,[3] which, in general terms, set out the following relevant guiding principles:

  • the trustee has a duty to maximize the yield from all assets subject to practicalities and honesty;
  • it is impractical to sell assets at greater than fair market value;
  • special circumstances may require the sale of an asset at less than appraised or fair market value;
  • it is improper for a trustee automatically to reduce fair market value by the full sum of disposal costs; and
  • it is improper for the trustee to announce in advance that all he/she seeks is the fair market value minus debt and disposal costs.

The court also concluded that it was inappropriate to have copied the bankrupt’s lawyer with the letter to the inspector (it had “tipped” the estate’s hand), that it was unreasonable to have deducted tax and other arrears from the fair market value as well as not to have obtained approval and guidance from the inspector before entering into negotiations for the sale of the equity.

The court has confirmed that automatic deduction of notional disposal costs is clearly incorrect in situations like the one in Manoharan.  In maximizing asset yield, trustees are obligated to drive a hard bargain, trying to recover the fair market value of the estate’s interest in property.  In Manoharan and in the other decisions cited above, the court has given clear guidance on how to do that.

Lawrence Hansen acted for the inspector at the hearing in bankruptcy court.

[1]  Re Malathy Manoharan (23 September 2015), Toronto 31-1812407 (ON Bankruptcy Court) [hereinafter Manoharan].

[2] 2006 CarswellOnt 2770 (S.C.J.).

[3] 1999 CarswellAlta 718 (C.A.).

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