Appurtenant Easement Extinguished in Servient Owner’s Bankruptcy

Sherwin Alumina Co., L.L.C. v. Port of Corpus Christi Authority (In re Sherwin Alumina Company, L.L.C.), United States Court of Appeals for the Fifth Circuit No. 18-40557 (August 6, 2019). In 1998 the Port of Corpus Christi Authority purchased 1.1 acres of land from Sherwin Alumina Company that was adjacent to Sherwin Alumina’s property, together with an easement over Sherwin Alumina’s land for a private road known as La Quinta Road for access to the 1.1 acres. In 2016 Sherwin Alumina filed Chapter 11 bankruptcy in the United States Bankruptcy Court for the Southern District of Texas. In the bankruptcy, Sherwin Alumina proposed selling its real property, including the land over which Port’s easement ran, “free and clear of all liens,” other than permitted encumbrances, under Section 363(f) of the Bankruptcy Code. Drafts of the plan and proposed purchase agreement were circulated for months, and none of the drafts identified the Port’s easement over La Quinta Road as a permitted encumbrance. On the morning of the confirmation hearing, February 17, 2017, Sherwin Alumina filed a final confirmation plan that did not list the Port’s easement over La Quinta Road as a permitted encumbrance. On February 27 Sherwin Alumina sold the land over which the easement ran to Corpus Christ Alumina, which in turn sold the land to Cheniere.  The confirmation order became final and non-appealable on March 3, 2017. Cheniere notified the Port that its easement over LaQuinta Road had been extinguished by the “free and clear” sale in the bankruptcy court. Since the time to appeal the confirmation order had run, the Port filed an adversary complaint in the bankruptcy court collaterally attacking the confirmation order as having been procured by fraud, barred by the state’s sovereign immunity, and denial of due process for want of notice. The bankruptcy court denied and the Port’s fraud and Eleventh Amendment claims. On appeal by the Port, the Fifth Circuit, in an opinion by Judge Higginbotham, affirmed. The Port tried to argue that the sale free and clear did not comply with Section 363, but this argument was foreclosed by the Port’s failure to file a timely appeal. The Port argued that under the Eleventh Amendment the federal courts lack jurisdiction over any lawsuit against a state and that the bankruptcy court, therefore, did not have jurisdiction over the easement. The Fifth Circuit wrote that a bankruptcy court can have in rem jurisdiction over the property interest of a state, such as the easement over La Quinta Road, without violating the Eleventh Amendment. The Port argued that the last-minute modification of the plan to not list the easement over La Quinta Road as a permitted exception constituted fraud. The Fifth Circuit wrote that this claim failed because there was no misrepresentation; the easement never had been listed as a permitted encumbrance. The debtor had proposed selling the land free and clear for more than a year before the confirmation hearing, and that filing the final plan without listing the easement as a permitted exception was not a change because easements by their nature are encumbrances.

One might be taken aback to learn that a bankruptcy court can terminate the easement of a third party. But in the counter-intuitive, Twilight Zone world of bankruptcy, this is apparently possible. Section 363 of the Bankruptcy Code provides that under certain circumstances the trustee may sell property of the bankruptcy estate “free and clear of any interest in such property of an entity other than the estate.” Any party whose lien may be extinguished must get notice of the sale. In this case, the Port was actively involved in the bankruptcy. The Port had ample notice of the proposed sale. The Port participated in the bidding for part of Sherwin Alumina’s land, and conditioned its bid on obtaining an easement over La Quinta Road, so the Port was aware that there was a risk that the easement could be lost. The Port participated in the hearing on the confirmation order but did not object. So it appears that all of the elements for a Section 363 sale were met. On the other hand, neither the Fifth Circuit’s decision nor any of the briefs cited a case in which an easement had been extinguished in bankruptcy.

As part of its Eleventh Amendment argument, the Port argued that the easement was its property and not part of the bankruptcy estate, and the bankruptcy court did not have jurisdiction over its easement. The Fifth Circuit distinguished between having jurisdiction over property rights and jurisdiction over the state. Judge Higginbotham wrote that “Section 363(f) specifically provides that, in exercising core in rem jurisdiction over the bankruptcy estate, the court may strip others’ interests—that is property rights—in that res. Specifically, Section 363(f) provides that under certain limited circumstances the trustee may sell estate property “free and clear of any interest in such property of an entity other than the estate.”

A similar case is Precision Industries, Inc. v. Qualitech Industries, Inc., 327 F. 3d 537 (7th Cir. 2003). In this case, Precision Industries had a ground lease over land owned by Qualitech. Qualitech filed bankruptcy and filed a motion to sell the land free and clear of any interests under Section 363(f). The Seventh Circuit held that the purchaser at the Section 363 sale got title to the land free and clear of Precision’s ground lease. As in the Sherwin Alumina case, the owner of the ground lease interest in Precision Industries got notice of the Section 363 sale and had been in negotiations with Qualitech’s creditors prior to the sale about a possible assumption of the ground lease.  

The Sherwin Alumina case was decided in part on Texas law that an easement was an “interest” in the debtor’s land. Is there any reason why a bankruptcy court applying Mississippi law would reach a different result? Is it possible that the nature of an easement as being appurtenant to a benefitted property and running with the land might cause a different result? This issue is not discussed in the Sherwin Alumina case. In Mississippi, an appurtenant easement cannot be conveyed separately from the benefitted estate. Also, a tax sale of land burdened by an appurtenant easement won’t terminate the easement. See Hearn v. Autumn Woods, 757 So. 2d 155 (Miss. 2000). If an appurtenant easement can survive a tax sale, one might wonder, would it survive a Section 363 “free and clear” sale? But the Mississippi Supreme Court in Autumn Woods reasoned that the appurtenant easement increased the value of the adjacent land and was thus included in the assessment of the adjacent land. This rationale doesn’t seem applicable to a Section 363 sale.

What happens next? First, the Port has filed motions for rehearing by the panel and a rehearing by the Fifth Circuit en banc, so these motions have to run their course. The Texas Pipeline Association has filed an amicus curiae brief in support of the Port’s petitions for rehearing. The Association’s brief argues that allowing a bankruptcy to extinguish an easement threatens devastating effects on the pipeline industry. Second, the bankruptcy court ruled on the Port’s Eleventh Amendment and fraud claims but held in abeyance the due process claim made by the Port. So if the Fifth Circuit denies rehearing, or permits a rehearing and affirms the panel’s decision, then the case goes back to the bankruptcy court to address the Port’s due process claim.

So it could be a long time before there is a final resolution to this particular case. Regardless of the resolution of this particular case, the takeaway for owners of easements and their attorneys is to be aware of this case and to be alert if an owner whose land is burdened by an easement seeks to sell his land free and clear of all liens under Section 363 of the Bankruptcy Code.