Reverend C.T. Walker Housing Dev. Fund Corp. v City of N.Y., 586 B.R. 534 (E.D.N.Y. 2018) –

A bankruptcy court denied a debtor’s motion to sell real property and granted a motion for relief from the automatic stay in a related case involving property that was sold at a delinquent property tax sale prior to bankruptcy. The debtor appealed both orders to the district court.

The debtor had owned property that was developed for low-income housing. The property was subject to restrictive covenants requiring use of a portion of the property for low-income, rent-stabilized units. The economics of the project depended in part on a property tax exemption that expired and was not renewed. So, the debtor fell behind on several payment of obligations, including property taxes.

The city sold tax lien certificates to a bank, which assigned them to two trusts. The trusts initiated a foreclosure and the state court issued a judgment of foreclosure and sale. A public auction was held and the winning bidder was a third party, who assigned the bid to a newly created entity.

The purchaser sought several adjournments of the closing and a reduction in the sale price due to the difficulty of obtaining title insurance given the restrictive covenants. The selling trusts did not agree to a price reduction and rejected the last request for an adjournment. The day before the scheduled closing the purchaser filed bankruptcy – thus postponing the closing.

The foreclosing trusts, the former owner and the city moved to lift the stay. Subsequently the former owner also filed bankruptcy and filed a motion in its own case to approve a sale to the tax lien purchaser free and clear of all encumbrances except the restrictive covenants. The court issued an order in the owner’s case denying the sale motion and issued an order in the tax lien purchaser’s case granting relief from the automatic stay. The debtor appealed both orders.

The key issue was whether the property became part of the debtor’s bankruptcy estate. The court noted a Second Circuit opinion holding that property subject to a tax lien foreclosure auction before a bankruptcy petition was filed did not become part of the debtor’s bankruptcy estate. The court commented that it was “likely bound” by the Second Circuit’s interpretation, but regardless found its reasoning persuasive.

The court concluded that the debtor had no cognizable interests in the property at the time it filed bankruptcy. First, it lost all interest by operation of the Judgment of Foreclosure and Sale – which explicitly stated that “‘after the filing of [the] notice of pendency of this action,’ the foreclosure defendants – including [the debtor] – were ‘forever barred and foreclosed of all right, claim, lien, title, interest and equity of redemption’ in the Property.”

Second, even if the equity of redemption survived the judgment, it was extinguished by the foreclosure sale. The court quoted a state case holding that the equity of redemption permitted property owners to redeem at any point “before the property is actually sold at a foreclosure sale.” The sale itself extinguishes the right of redemption regardless of whether the deed was delivered to the sale purchaser. Thus, the court concluded that the auction sale prevented the property from becoming part of the bankruptcy estate.

The debtor argued in response that the equity of redemption was cut off not by the public auction but by delivery of the deed to the buyer. However, the court found that the debtor’s supporting cases were inapplicable. The debtor also argued that its continued possession caused the property to become part of the estate. The court rejected this argument on the grounds that the debtor’s limited right of possession was insufficient to bring the property of the estate.

Accordingly, the court held that the property was not part of the debtor’s bankruptcy estate and the bankruptcy court did not err in denying the sale motion.

The court also concluded that granting relief from the automatic stay in the tax lien purchaser’s bankruptcy followed naturally from the fact that the debtor former owner had no interest and the debtor tax lien purchaser abandoned its interest in the property by failing to close the sale.

The equity of redemption can be a very persistent right that is difficult to extinguish. The results in a particular case will depend heavily on local state law. One angle to consider is whether the tax sale would be binding on a subsequent bona fide purchaser. Some cases have turned on whether the deed to the tax sale purchaser was recorded because under the applicable state law foreclosure procedures that step was required to provide constructive notice.

Vicki R Harding, Esq.