Delinquent Property Tax Sales: Is a Purchaser at Risk If a Property Owner Files Bankruptcy?

Hackler v. Arianna Holdings Co., LLC (In re Hackler), 938 F.3d 473 (3d Cir. 2019)

Chapter 13 debtors sought to avoid a prepetition delinquent property tax sale. The bankruptcy court agreed with the debtors that the transfer of title to the property could be avoided as a preference. The district court affirmed, and the purchaser appealed to the Third Circuit.

Under applicable state law, after an owner fails to pay property taxes, the taxing authority holds a public auction of the unpaid tax lien. The parties bid only on the rate of interest on the unpaid taxes, and the lowest bidder wins. If the property owner does not redeem within two years by paying the original unpaid taxes with interest at the bid rate, together with subsequent taxes plus 18%, the tax lien certificate holder may file for a foreclosure judgment that vests title to the property in the certificate holder.

In this case, the purchaser bid 0% interest and paid a premium of $13,500 above the value of the lien. After the debtors failed to redeem, the purchaser obtained title to the property through a final judgment in an uncontested tax foreclosure proceeding. A couple of months after the transfer of title the debtors filed bankruptcy. The value of the property was listed at $335,000, and the tax lien claim was ~$45,000.

The first thing the debtors did after filing was to bring an adversary proceeding seeking to avoid the transfer as a preference under section 547 of the Bankruptcy Code. (They also argued that the transfer was voidable as a fraudulent transfer under section 548. However, the bankruptcy court did not reach this issue since it found that the transfer was a preference.)

It was undisputed that transfer of title to the property was made (1) to the tax certificate holder, (2) for an antecedent debt, (3) while the debtors were insolvent, (4) within 90 days prior to bankruptcy, and (5) gave the certificate holder property worth $335,000 when it would have received only $45,000 in a chapter 7 proceeding. Thus, it was clear that the transfer satisfied the requirements for a voidable preference under section 547.

The Third Circuit noted that when the language of a statute is plain, the court’s only function is to enforce the statute according to its terms (at least if the result required by the text is not absurd). It concluded that the language of section 547 was plain and the result was not absurd. “Thus, our reading of it ends there.”

However, the purchaser raised two arguments “sounding in principles of federalism”: (1) A lawfully conducted state tax foreclosure cannot constitute a voidable preference, relying primarily on BFP v. Resolution Trust Corp., 511 U.S. 531, 114 S.Ct. 1757, 128 L.Ed.2d 556 (1994). (2) Avoidance violated the Tax Injunction Act.

The court acknowledged that in BFP the Supreme Court held that the consideration received in a non—collusive, real estate mortgage foreclosure sale conducted in conformance with applicable state law necessarily constituted “reasonably equivalent value,” so that the sale could not be avoided as a fraudulent transfer under section 548. However, it found two key distinctions: (1) in BFP the Supreme Court was interpreting the fraudulent transfer provision in section 548, not the preference provision in section 547, and (2) BFP involved a mortgage foreclosure, not a tax foreclosure.

Use of the term “reasonably equivalent value” in section 548 left room for interpretation. It was apparent that Congress did not intend to mean market value, so it was reasonable to conclude that whatever consideration was received in a regularly-conducted mortgage foreclosure sale was sufficient. In contrast, application of section 547 was straightforward and did not require interpretation.

As for the nature of the proceeding, the BFP decision itself included a footnote specifically noting that the “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.” The Third Circuit felt that one clear difference in this case was the fact that the winning bid in the tax lien foreclosure sale had nothing to do with the value of the underlying property.

The purchaser further argued that “BFP stands for the proposition that, absent a clear and manifest intent of Congress to displace an area traditionally regulated by the states, the Bankruptcy Code should not be construed to supersede state law.” The court rejected this argument as well for the same reasons. BFP involved interpretation of section 548, while the text of section 547 was plain. Further, cases that extended BFP to tax sale foreclosures typically involved procedures that included a public sale with competitive bidding.

As for the Tax Injunction Act, it provides “‘district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law’ if a remedy exists in state court.” In a prior opinion the Third Circuit held that preventing a private citizen from foreclosing did not affect the government’s ability to collect taxes.

This interpretation was undermined by a state supreme court decision that the tax delinquency survived the sale of the tax certificate. However, the court still reached the conclusion that the Act did not apply since it was well-established that the Act does not prevent a bankruptcy court from enforcing provisions of the Bankruptcy Code just because they affect collection estate taxes.

Accordingly, the court affirmed because the transfer was properly avoided since (1) it met the plain language requirements of section 547, and (2) the arguments raised by the purchaser could not overcome the court’s duty to enforce the Bankruptcy Code.

There is a tendency to believe that a regularly conducted foreclosure sale – whether a mortgage foreclosure or tax sale foreclosure – will be immune from avoidance based on BFP. Putting aside the fact that the BFP footnote specifically suggests that it may not be applicable to tax sale foreclosures, note that Third Circuit’s preference analysis could also be applied to a mortgage foreclosure sale.

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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