In re Cook, 481 B.R. 265 (Bankr. N.D.N.Y. 2012) –

A couple of hours before the Cooks filed a chapter 13 bankruptcy case, their home was sold at a foreclosure sale as the final step in a foreclosure of the first mortgage.  The debtors argued that the automatic stay applied to prevent further action to take possession of the property, and further that the sale should be avoided as a fraudulent transfer on the basis that they were insolvent and less than reasonably equivalent value was realized at the sale.

With respect to the automatic stay, the threshold question was whether the debtors had any interest in the property.  Finding that under state law the right to redeem was extinguished upon the foreclosure sale, and once the redemption right was lost it could not be revived, the court concluded that the debtors had no interest in the property at the time of the bankruptcy filing.  Thus the foreclosed property did not become property of the estate and was not subject to the automatic stay.

According to the debtors’ schedules, their residence was valued at $129,000 (based on the tax assessment) and was subject to two mortgages – a $59,000.00 first mortgage and a $56,120.00 second mortgage.  With respect to the fraudulent conveyance claim, the debtors argued that they (a) were insolvent and (b) received less than reasonably equivalent value since the purchaser paid only $66,600.  (Note that this was a third party purchaser, not a credit bid by the first mortgagee.)

However, the bankruptcy court concluded that the U.S. Supreme Court “conclusively settled the law in this area” in BFP v. Resolution Trust Corp., 511 U.S. 531, 114 S.Ct. 1757, 128 L.Ed.2d 556 (1994) when it held that reasonably equivalent value meant the foreclosure sale price as long as the state foreclosure requirements were complied with.

The bankruptcy court did acknowledge the comment in BFP that a sale might be set aside under state law if the price was “so low as to ‘shock the conscience or raise a presumption of fraud or unfairness’” but did not find that a sale price of 52% of the estimated fair market value by itself was so inadequate as to allow the sale to be set aside, quoting a case that sales below 10% have consistently been held to be unconscionable, while sales above 50% have consistently been upheld.

Consequently, the court denied both the request to enforce the automatic stay and the request to set aside the sale as a fraudulent conveyance.

Note that this would not necessarily be the result in other jurisdictions.  Although at the time the bankruptcy case was filed the sale had been conducted, a purchaser had been selected, and the purchaser had deposited 10% of the sales price with the state court appointed referee, it is clear that not all of the steps required to transfer the property had been completed.

Under similar circumstances, some other courts have allowed debtors to avoid the foreclosure sale using their “strong arm” powers.  In particular, these courts have found that a bona fide purchaser would have been able to take title free of the interest of the foreclosure sale purchaser up until the point that a deed was recorded.  It may be that under the state law applicable in the Cook case a bona fide purchaser would be subject to the foreclosure sale, so that the sale could not be avoided using strong arm powers.  However, it is not clear that the argument was made in this case, and the result might have been different if it had been made.

If a purchaser at a foreclosure sale (including a mortgagee making a credit bid) has concerns that the mortgagor is about to file bankruptcy, it would be prudent to take all steps necessary to complete the process as quickly as possible, including paying the entire sale price and recording the deed.

Vicki R. Harding, Esq.