Foreclosure Sale As a Preference: “Strong Arm” Powers Strike Again

Nguyen v. Wells Fargo Home Mortgage (In re Nguyen), 490 B.R. 230 (Bankr. S.D. Tex. 2013) –

An individual debtor in a chapter 7 bankruptcy brought an adversary proceeding seeking to recover from a mortgagee for negligent misrepresentation and to set aside a pre-petition foreclosure sale as a preference.  The court held that the debtor did not have standing to bring the negligent misrepresentation claim, but did allow him to pursue the preference claim.  The court then denied the lender’s motion for summary judgment on the preference claim.

The debtor erroneously sent a personal check for payment of overdue amounts (since the lender did not accept personal checks), and claimed that when he spoke to the lender he was told that the payment was being processed.  Instead the lender was proceeding with a foreclosure sale.

The court determined that the debtor did not have standing to pursue a negligent misrepresentation claim based on these facts.  Once he filed for bankruptcy, all of his interest, including the alleged cause of action against the lender for prepetition claims, became property of the bankruptcy estate.  Also, this claim was never included in the debtor’s schedules.  So, although the trustee subsequently abandoned assets of the estate, the claim was not included in the abandoned assets and remained part of the bankruptcy estate.

However, the court found that the debtor did have standing to pursue the argument that the foreclosure sale constituted a preference that could be avoided.  This case involves his home.  Under Section 522(h) of the Bankruptcy Code a debtor can avoid a transfer if (a) he could have claimed an exemption for the property, and (b) the trustee is not attempting to avoid the transfer.  In this case, the debtor could claim a homestead exemption for the property, and the trustee had not made any attempt to avoid the foreclosure sale.

With respect to the preference claim, under Section 547 of the Bankruptcy Code, a trustee may generally avoid a transfer that is (1) to or for the account of a creditor, (2) for or on account of an antecedent debt, (3) made while the debtor is insolvent, (4) made within 90 days before the bankruptcy is filed, and (5) that enables the creditor to receive more than it would in a chapter 7 liquidation.  (See Accepting Payment Before A Construction Lien Is Filed: Catch-22?.)  The only element that was at issue here was whether the lender received more than it would have received in a chapter 7 case.

The parties acknowledged that the home was appraised at ~$110,000 for tax purposes.  The debtor contended that the principal amount of the debt at the time of the foreclosure was less than $80,000.  Thus, the debtor argued that the lender got more (i.e. property valued at ~$110,000) than it would have received in a chapter 7 proceeding (i.e. payment of its debt).

The lender pointed out that it bid ~$91,000 at the foreclosure sale.  The court noted that there was a dispute about whether this was a credit bit (i.e., the lender set off the amount it was owed against the amount it bid), but regardless concluded that these facts provided some evidence that the proceeds of an auction conducted in an orderly manner in a chapter 7 proceeding could have been higher, so that the lender received more than it would have received in a chapter 7 proceeding.

The lender also argued that the reasoning of the Supreme Court in BFP v. Resolution Trust Corp., 511 U.S. 531, 114 Sup. Ct. 1757, 128 L. Ed., 2d 556 (1994) was applicable in the context of a preference claim, so that the proceeds from a regularly conducted foreclosure sale should be deemed to be reasonable value.

However, the bankruptcy court previously rejected this reasoning:  In an earlier case the court held that a preference claim under Section 547 of the Bankruptcy Code is materially different than the fraudulent conveyance claim that was at issue in BFP.   The court found no reason to change its mind.

The lender also attempted to distinguish the prior case:  In that case, the property acquired at the foreclosure sale was valued at $3.25 million, while the foreclosing lender would have received $100,000 in a chapter 7 case.  Thus, there was a difference in the value of the foreclosed property and the amount that would have been paid to the lender in a chapter 7 case of $3.15 million, as opposed to less than $20,000 in the Nguyen case.  However, the court viewed this difference as merely making it more difficult for the debtor to prove that the lender would have received more in a chapter 7 case.

Consequently, the court denied the lender’s motion for summary judgment, and allowed the debtor to proceed with his preference claim.

It is interesting to recognize that court decisions have practical effects.  In this case the lender’s counsel sent a letter to the debtor directing the debtor and his family to vacate the property shortly after issuance of this decision.  However, the debtor was able to obtain a preliminary injunction to prevent eviction pending resolution of the adversary proceeding.  The trial is now set for late February 2014.  During the interim, the debtor committed to making monthly payments, but the lender has no control over a property that it had already foreclosed on prior to the bankruptcy.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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