Gouveia v. Tazbir

• Decision Date: 29 September 1994
• Docket Number: No. 93-3994,93-3994
• Citation: 37 F.3d 295
• Parties: , Bankr. L. Rep. P 76,143 Gordon E. GOUVEIA, Trustee in Bankruptcy for Kathleen Sue Hiles, Plaintiff-Appellant, v. Barbara TAZBIR, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 295

37 F.3d 295

26 Bankr.Ct.Dec. 123, Bankr. L. Rep. P 76,143

Gordon E. GOUVEIA, Trustee in Bankruptcy for Kathleen Sue Hiles, Plaintiff-Appellant, v. Barbara TAZBIR, et al., Defendants-Appellees.

No. 93-3994.

United States Court of Appeals Seventh Circuit.

Argued May 9, 1994.

Decided Sept. 29, 1994.

Daniel L. Freeland (argued), Komyatte & Freeland, Highland, IN, for plaintiff-appellant.

Gerald M. Bishop (argued), Greco, Pera, Bishop & Vernia, Merrillville, IN, for defendant-appellee.

John Smith, pro se.

Betty Smith, pro se.

Evelyn Rosenberger, pro se.

Andrew Silvola, pro se.

Paulette Lauridsen, pro se.

Otto Lauridsen, pro se.

Daniel L. Freeland, pro se.

Before MESKILL, ^* FLAUM and MANION, Circuit Judges.

FLAUM, Circuit Judge.

This is an appeal from a district court's order affirming the bankruptcy court in its holding that a trustee may not sell a debtor's land free of a reciprocal land covenant executed in favor of her neighbor's property. We affirm.

I. Background

Kathleen Sue Hiles ("Debtor") owns property in Scherville, Indiana, within a residential subdivision known as Lincoln Knolls Estates ("Lincoln"). In 1976 the Debtor obtained permission from the city zoning commission to build a commercial music store on her residential property. In response, some of her neighbors filed suit in state court with the hope of enforcing a restrictive, reciprocal land covenant (the "Lincoln Covenant") that was recorded on all the lots of the original Lincoln subdivision. The Covenant restricted the neighborhood to single-story, residential property. In relevant part, the Lincoln Covenant provides as follows:

1. The above and foregoing section of land is made subject to and upon the following restrictions and covenants upon the tracts within the said section, which restrictions and covenants shall operate as and shall be construed to be covenants running with the land.

2. No tract of land shall be used for any purpose other than residential building. No building shall be erected, altered, placed or permitted to remain on any tract other than a single family dwelling not to exceed one story in height and a private garage for not more than two cars. Construction of family dwelling to be of new materials and faced with either face-brick, stone or combination of both.

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16. These covenants are to run with the land and shall be binding on all parties and persons claiming under them for a period of fifty years from the date these covenants are recorded....

17. Enforcement shall be proceedings at law or in equity against any person or persons violating attempting to violate any covenant either to restrain violation or recover damage.

Initially, a state trial court found the Lincoln Covenant unenforceable. A race then ensued--the neighbors immediately appealed while the Debtor rushed to construct her building. Shortly after the debtor finished construction, the state court of appeals found the Lincoln Covenant enforceable and remanded the case with instructions that the Debtor be permanently enjoined from building her music store. Cunningham v. Hiles, 182 Ind.App. 511, 395 N.E.2d 851 (1979). When the Debtor claimed that her completion of store now rendered the matter moot, the appellate court affirmed its prior holding. Cunningham v. Hiles, 402 N.E.2d 17 (1980).

Unable to operate her business and meet her financial obligations, the Debtor filed a Chapter 11 petition for bankruptcy. As part of her bankruptcy, the Debtor sought to sell her music-store property in Lincoln free of the same Lincoln Covenant that had been the basis for the initial injunction. The neighbors, of course, objected to the Debtor's proposed sale. During the subsequent hearing on the sale, the Debtor filed a motion to set aside the Lincoln Covenant as an executory contract. The bankruptcy court rejected the Debtor's petition, holding that under title 11 of the United States Code neither Sec. 363 nor Sec. 105 allowed the Debtor to sell her land free and clear of its restrictive covenant, and that the Lincoln Covenant was not an executory contract under 11 U.S.C. Sec. 365. The Debtor appealed this decision to the Northern District of Indiana. After the district court affirmed, the Debtor filed this appeal. In the interim the Debtor's Chapter 11 petition has been converted to a Chapter 7 liquidation; Gordon E. Gouveia ("Trustee") has been substituted as the party plaintiff.

II. Analysis

The Trustee argues that he has the authority to sell the Debtor's real property free and clear of a reciprocal land covenant (running with the land) for the following reasons: (A) the Lincoln Covenant is an unenforceable executory contract under 11 U.S.C. Sec. 365, (B) it is an interest convertible to monetary damages under 11 U.S.C. Sec. 363(f)(5), and (C) the bankruptcy code otherwise necessitates a sale of the property free and clear of the Lincoln Covenant under 11 U.S.C. Sec. 105. We shall address these arguments serially.

A. Executory Contract

The Trustee contends that the Lincoln Covenant is merely an executory contract, thus entitling the debtor to sell the encumbered property free and clear by the court's equitable powers as provided under 11 U.S.C. Sec. 365(a). The language of this statute reads as follows:

Except as provided in sections 765 and 766 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.

Citing several Indiana cases, the bankruptcy court noted that although restrictive covenants (such as the one here at issue) may contain the characteristics of both a contract and an interest in real estate, the primary nature of such covenants is not contractual but rather a property interest. See Adult Group Properties v. Imler, 505 N.E.2d 459, 464 (Ind.Ct.App.1987) (referring to a restrictive covenant as a "property right," citing Pulos v. James, 261 Ind. 279, 302 N.E.2d 768, 771 (1973) (stating that a restrictive covenant recorded on a plat is a covenant running with the land, and that it creates a "property right" in each grantee and any subsequent grantees of the plat subject to the restriction, citing Wischmeyer v. Finch, 231 Ind. 282, 107 N.E.2d 661 (1952). We agree.

The term "executory contract" is not defined in the bankruptcy code. The Eighth Circuit, however, has defined the term executory contract (in the context of bankruptcy) to mean a contract under which the bankrupt and the other party both are obligated, that such obligation remains unperformed by either party, and that failure of either to complete performance would constitute a material breach excusing the other of performance. In re Knutson, 563 F.2d 916, 917 (8th Cir.1977).

Applying the definition of Knutson, the bankruptcy court concluded that the Lincoln Covenant was not executory for the purposes of Sec. 365. The court reasoned that in the typical executory contract the Debtor's obligation is to do some affirmative act in the future--such that executory contracts typically include leases, employment contracts, and other agreements to buy and sell in the future. See also In re Jolly, 574 F.2d 349 (6th Cir.1978), cert. denied, 439 U.S. 929, 99 S.Ct. 316, 58 L.Ed.2d 322 (1978). Unlike the typical executory contract, however, the Lincoln Covenant requires no affirmative performance in the future. The court then went on to reason that the Lincoln Covenant was properly recorded on the title of the lot at issue, and the deed conveyed to the Debtor was subject to the restrictive covenant. Because at that point, as the court reasoned, there was nothing further to be done by either party, the contract (if it be so characterized) was fully executed.

While almost all agreements to some degree involve unperformed obligation on either side, In re Streets & Beard Farm Partnership, 882 F.2d 233, 235 (7th Cir.1989), such an expansive definition of the term "executory" is not what Congress enacted through its choice of language in Sec. 365. After reading this code section, we find the reasoning of the bankruptcy court persuasive. Like many other real-property interests, the Lincoln Covenant establishes an ongoing right of present (not merely future) enjoyment--the present right to have a commercial-free neighborhood. As noted by the bankruptcy court, restrictive covenants, like restrictive easements, traditionally have been recorded on the title of the encumbered property. While distinguishing between contracts and property rights may seem elusive, the neighbors' present enjoyment of the right, their completion of performance noted by both the bankruptcy and the district court, and the traditional treatment of their rights as running with the land, all indicate to us that the Lincoln Covenant is an interest in real property. As such, Sec. 365 of the bankruptcy code is inapplicable.

B. Cash Convertible Interest

Section 363(f)(5) of the Code permits the sale of the land free of any interest when a party can be compelled to accept money damages in lieu of enforcement. The Code provides the following in relevant part:

The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if--

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(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

11 U.S.C. Sec. 363(f)(5). The Trustee argues that this code section is applicable to remove the Covenant. Having already determined that the Lincoln Covenant is a property interest, we must now decide whether subsection (5) applies to the Lincoln landowners.

In reading the text of the statute we note that an entity must be able to be "compelled " to accept money damages in lieu of equitable enforcement before subsection (5) will apply. From this language we conclude that if the money damages are available upon the consent...