Wisconsin has a strict tax foreclosure procedure in which the tax authority effectively obtains the property without any public or competitive bidding in satisfaction of the delinquent tax bill. Williams was one of several cases where the former property owner challenged the tax foreclosure as a fraudulent transfer. As discussed in a prior blog (TOUSA), one basis for finding that a transfer is a fraudulent conveyance is that the debtor (i) was insolvent and (ii) did not receive “reasonably equivalent value” in connection with the transfer.
So, the key question was whether the property owners received reasonably equivalent value. In the cases discussed in the Williams opinion, the City of Milwaukee foreclosed on properties with delinquent taxes of ~$14,500, ~$8,000 and ~$12,000, where the estimated fair market value of the properties was ~ $206,000, ~$116,000 and ~$82,000, respectively. That certainly doesn’t seem like reasonably equivalent value under any normal sense of the concept.
However, the City argued that the amount received in its regularly conducted tax foreclosures should be deemed to be reasonably equivalent value based on the Supreme Court case of BFP Resolution Trust Corp., 511 U.S. 531, 114 Sup. Ct. 1757, 128 L. Ed. 2d 556 (1994). In BFP the U.S. Supreme Court decided that fair market value was not the appropriate benchmark in a mortgage foreclosure sale. It determined that the price actually received at the foreclosure sale was reasonably equivalent value as long as the state’s foreclosure law requirements were met. However, the BFP court noted in a footnote that it was addressing only mortgage foreclosures, and did not consider forced sales such as tax lien sales.
The bankruptcy court reviewed a number of cases in which a court held that a tax sale could not be avoided as a fraudulent transfer based on the principles found in BFP. However, the Williams court noted that all but one case addressed a procedure that involved some form of competitive bidding. In contrast, strict foreclosure under Wisconsin law does not involve any market testing of the price. Consequently, the court determined that the price from these tax foreclosure sales was not automatically “reasonably equivalent value,” and thus a transfer of property in connection with the foreclosure was susceptible to avoidance as a fraudulent transfer.
In this case, where the value to the debtors (i.e. delinquent taxes satisfied) was less than 8%, 8% and 16%, respectively, of the City’s own assessed values (which were somewhat lower than the fair market values), the transfers of property were avoided and title was returned to the debtors.
The City also made several arguments that relied on policy considerations, including an argument that holding that “strict” foreclosures within two years of a bankruptcy are fraudulent transfers would negatively affect an “essential state interest” and would put all properties subject to the foreclosures “under a federally created black cloud” – which was the foundation for the Supreme Court’s decision in BFP. The bankruptcy court’s response was that (i) an important part of BFP was that there were at least some market forces, and (ii) finding that strict foreclosures are fraudulent transfers would not preclude collection of the taxes under alternate procedures.
It is clear that the approach taken in this decision can introduce a significant amount of uncertainty as to the finality of strict tax foreclosure sales. It is reasonable to expect that more often than not the delinquent taxes will be a relatively small percentage of the value of the property however measured, and that the property owner is quite likely to be insolvent (particularly after loss of any equity in the property). Consequently, there is a significant risk that transfer of a property pursuant to a strict tax foreclosure procedure will be avoidable as a fraudulent transfer.
Note that this uncertainty will exist for more than two years after the tax foreclosure: Although the court and the City focused on a look-back period of two years since these cases were based on the fraudulent transfer provisions in Section 548 of the Bankruptcy Code, similar claims can be pursued using state fraudulent transfer law under Section 544, and state law provisions typically have a look-back period of four years or more. It will be interesting to see what (if anything) tax authorities do to deal with this uncertainty.
It will also be interesting to see how people respond where courts disagree with the Williams court and decide that BFP leads to a conclusion that a regularly conducted strict foreclosure sale should be deemed to be for reasonably equivalent value. One response might be to argue that strict tax foreclosure sales such as those discussed in Williams also constitute an unconstitutional taking without just compensation. BFP does not offer any enlightenment with respect to this question since there was no suggestion that the mortgage foreclosures dealt with in BFP involved state action.
Vicki R. Harding, Esq.