Foreclosure Sale: In a Race With a Bankruptcy Filing, Who Wins?

RBS, Inc. v. Bell (In re Bell), 507 B.R. 898 (S.D. W.Va. 2014)

The purchaser at a foreclosure sale sought relief from the automatic stay to complete the sale. The bankruptcy court denied the request on the basis that the debtors’ interest in the property was not extinguished prior to the bankruptcy filing. The purchaser appealed, and the district court reversed.

A company affiliated with the debtors (Bell Co.) executed a note in favor of a bank for ~$325,000. When the note was refinanced a couple of years later, the debtors (the Bells) guaranteed the note and secured their guaranty by a deed of trust on property that they owned.

After the note was again refinanced and extended, the Bell Co. defaulted. The bank appointed a substitute trustee under the deed of trust, notices of default were sent, and a foreclosure sale was scheduled. The notice of the sale stated that “The property will be sold for cash in hand on the date of sale to the highest bidder.”

The debtors claimed that their counsel called the trustee the day before the sale to notify him that they would be filing bankruptcy the next day. The events on the day of the foreclosure sale proceeded as follows:

  • 10:30 a.m.: Trustee under deed of trust proceeded with the foreclosure sale.
  • The highest bidder (RBS) bid $255,000, which was ~$50,000 more than the amount due under the note.
  • 10:50 a.m.: After the “hammer dropped,” RBS and the deed of trust trustee signed a “Memorandum of Successor Trustee’s Sale” and RBS delivered a $25,000 deposit, with the remainder of the bid amount due as soon as the trustee delivered a deed and a report of sale.
  • 12:06 p.m.: Debtors completed their mandatory credit counseling.
  • 4:00 p.m.: Debtors filed their bankruptcy petition. They listed the property sold at the foreclosure sale in their schedules with a value ~$190,000, indicating that they intended to retain the property.

The critical question was whether the property was part of the bankruptcy estate given that the bankruptcy petition was filed between the close of the foreclosure sale and delivery of the deed. The bank and RBS argued that the debtors no longer had any interest in the property after it was “hammered down.” The debtors contended that the sale was not complete since (1) the actual sale was different from the terms in the notice (i.e. cash in hand) and (2) equitable title did not transfer until the deed was recorded.

The primary cases considered by the court on appeal were as follows:

  • Bardell v. Branch Banking & Trust Co. (N.D. W.Va. 2007): A district court held that under state law the debtors’ interests in foreclosed property were terminated by the pre-petition foreclosure sale even though the deed was not delivered to the purchaser until after the bankruptcy petition was filed. This court concluded that the equitable interest in the property passed to the purchaser at the sale. The equitable interest lay with the purchaser, and legal title remained with the trustee under the deed of trust. Thus the property was not part of the bankruptcy estate and not subject to the automatic stay.
  • Smith v. Mooney (Bankr. S.D. W.Va. 1993): Property was sold at a foreclosure sale in January; the debtor filed for bankruptcy in February; and the deed of trust was prepared and recorded in March. This court determined that the transfer was not complete until the deed of trust was delivered. Thus the debtor retained an equitable interest and the property was part of the bankruptcy estate.
  • Harper v. Smith (W.Va. Sup. Ct. 2012): Property was sold at a foreclosure sale on July 10. The borrowers filed bankruptcy on July 19. The trustee’s deed was dated July 16, but was not recorded until October 1. The foreclosure sale purchaser defaulted on property taxes. The tax lien was sold and purchased by a third party, which resold to yet another party, who sought to evict the debtors’ son. The debtors challenged whether the purchaser actually obtained title. The West Virginia Supreme Court held that the foreclosure sale purchaser did obtain title because the debtors lost title as a result of the foreclosure sale.

The Bell court was influenced by (1) the fact that the 4th Circuit affirmed the Bardell decision, (2) the “length and depth of the two competing opinions” (i.e. Bardell was more thorough than Smith v. Mooney), and (3) Bardell actually critiqued Smith v. Mooney.

Thus, the Bell court found that (1) the equitable interest of the debtors in the property was terminated when the “hammer was struck down” at the foreclosure sale prior to the bankruptcy filing and (2) the trustee under the deed of trust held legal title, as opposed to the debtors. As a result, the property was not part of the bankruptcy estate and subject to the automatic stay.

The results might have been different if the foreclosure involved a mortgage, as opposed to a deed of trust. In the case of a mortgage, the debtor would hold legal title prior to conveyance instead of the deed of trust trustee. If a bankruptcy was filed after the foreclosure sale but before the foreclosure deed was recorded, it might be argued that a bona fide purchaser as of the bankruptcy filing date would have priority over the unrecorded foreclosure deed so that the deed could be avoided using the Bankruptcy Code’s strong arm powers.

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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