Tax Lien Foreclosures: Property Tax Collection Meets Fraudulent Transfers – Who Wins?

Hampton v. Ontario County, New York, 588 B.R. 671 (W.D. N.Y. 2018), 588 B.R. 671 (W.D. N.Y. 2018) –

The debtors sought to set aside prepetition property tax foreclosures as constructively fraudulent transfers. The bankruptcy court granted the government’s motion to dismiss on the grounds that the price paid at a tax foreclosure sale that was regularly conducted in accordance with state law was conclusively presumed to be “reasonably equivalent value” for the property. The debtors appealed to the district court.

In the two cases before the court the debtors owned their homes free and clear of any mortgages. However, they both failed to pay real estate taxes (~$1200 in the first case and ~$5200 in the second case). In both cases the county took steps to enforce the lien for unpaid taxes and obtained a judgment of foreclosure prepetition. The judgments gave the county the right to possession and all equity in the properties.

After the debtors filed bankruptcy and brought adversary proceedings seeking to avoid the transfer of their homes as fraudulent transfers, the county sold the properties at auction ($22,000 in the first case and ~$21,800 in the second case) with the county entitled to retain the entire surplus. Although the county had proceeded with the auction, the buyers were told that title to the properties was in dispute so that they would not be transferred until the bankruptcy litigation was resolved.

A constructively fraudulent transfer claim under section 548 of the Bankruptcy Code requires showing that (1) the debtor had an interest in the property, (2) the transfer occurred within two years prior to bankruptcy, (3) the debtor was insolvent or became insolvent as a result of the transfer, and (4) the debtor received less than a “reasonably equivalent value” for the transfer.

The only dispute was whether the debtors received reasonably equivalent value, and the decision turned on interpretation of the Supreme Court’s BFP decision (BFP v. Resolution Trust Corp., 511 U.S. 531, 114 S.Ct. 1757, 128 L.Ed.2d 556 (1994)).

According to the bankruptcy court, BFP stands for the proposition that the transfer of a debtor’s property in connection with a foreclosure sale is presumed to be for reasonably equivalent value as long as state foreclosure laws are followed. In particular, the substance and characteristics of a state foreclosure law are irrelevant.

The district court disagreed, commenting that the bankruptcy court decision “does not fully heed the context of the BFP opinion and the lead-up to its holding.” Specifically, the district court focused on the point made in BFP that “state foreclosure laws had evolved to ‘avoid the draconian consequences of strict foreclosure.'” The issue with strict foreclosure is that it “does not provide for a pre-seizure auction whereby the debtor may recover equity.”

Although the state foreclosure sale that was the subject of BFP was a forced sale that resulted in a price that was necessarily less than fair market value, there were market forces at work. There was a public auction with prior advertisement. The tax sale procedure in this case started with a foreclosure judgment in favor of the county that entitled it to possession and all of the equity in the property. So, when the county subsequently sold the properties at a public auction, the county and not the debtors was entitled to retain all of the surplus proceeds. This meant that the county received a windfall to the detriment of the debtors’ other creditors. So, and the district court’s view BFP did not apply.

The district court also disagreed with the county’s argument that allowing tax foreclosure sales to be avoided as fraudulent transfers would frustrate the governmental interest in timely collection of property taxes and ensuring clear title to real estate. The court recognized that the county had a legitimate interest in collecting taxes but concluded that this interest must be balanced against the federal bankruptcy policy favoring equal treatment of creditors.

The court also noted that the Supreme Court specifically commented that BFP addressed only mortgage foreclosures of real estate, noting that the considerations relevant to other foreclosures and forced sales “(to satisfy tax liens, for example)” may be different.

Accordingly, the district court held that the county was not entitled to a conclusive presumption that the tax foreclosures provided reasonably equivalent value, reversing the bankruptcy court.

Prior to BFP the circuit court decisions were all over the map. The Supreme Court did resolve some significant issues. However, that does not mean that all foreclosure sales are protected from avoidance. As this case indicates, BFP may not apply to tax lien foreclosures. Similarly, some courts have questioned whether BFP was intended to apply to state mortgage foreclosure laws that use strict foreclosure. Another area for debate is whether a foreclosure can be attacked as a preference rather than a fraudulent transfer. So, 25 years later there are still open questions and a purchaser at a foreclosure sale should be aware of its potential exposure.

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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