Selling a tax lien in Illinois results in a fraudulent transfer, according to the Seventh Circuit.
In addition, the Jan. 20 opinion by Circuit Judge David F. Hamilton is notable because it exposes the purchaser of the tax lien to the possibility of a judgment for the full market value of the property. Title insurers should take notice of the opinion and perhaps rethink the price for insuring a property purchased in an Illinois tax sale.
The opinion once again shows how the Seventh Circuit finds answers by divining “practical concerns about how to let federal bankruptcy law work well,” rather than by teasing the result from the plain language of the statute.
The case involved a homeowner who didn’t pay real estate taxes. Under the Illinois process for collecting delinquent taxes, a purchaser got a Certificate of Purchase by paying about $5,000, or slightly more than the outstanding taxes. The property owner had the right for a period of time to redeem the property by paying the taxes.
Four years later, the buyer sought and recorded a tax deed for the property. Six months after that, the purchaser sold the property for $50,000 to a third party in an arms’-length transaction. An appraiser said the property was worth $110,000.
Filing bankruptcy almost two years after the $5,000 sale, the debtor immediately sued the original buyer and the later purchaser.
Chief Bankruptcy Judge Bruce W. Black in Chicago ruled that the transfer was constructively fraudulent under Section 548(a)(1)(B) for lack of “reasonably equivalent value.” The district court reversed, holding that compliance with state law granted immunity from a fraudulent transfer claim.
Lauding Judge Black’s analysis, Circuit Judge Hamilton reversed the district court.
The case turned on the interpretation of the Supreme Court’s 1994 opinion in BFP v. Resolution Trust Corp., which generally held that a foreclosure sale in compliance with state law establishes “reasonably equivalent value” for fraudulent transfer purposes. Judge Hamilton spent a good part of the opinion explaining why BFP does not apply to Illinois tax lien sales.
He began by noting that the price paid by the initial purchaser is “usually nothing more than the sum of delinquent taxes.” Since state law procedure does not involve an auction where bids will increase, Judge Hamilton said that a price between 3.8% and 8.8% of fair market value “is not reasonably equivalent value.” That conclusion, he said, serves “the broader purposes of the Bankruptcy Code and its fraudulent transfer provisions.”
The bankruptcy court awarded the debtor a $15,000 judgment against the initial purchaser, representing the amount the debtor scheduled as an exemption for the home. The bankruptcy judge dismissed the suit against the subsequent purchaser, who had paid $50,000. The circuit court upheld both.
The debtor was not entitled to a judgment for the value of the property, Judge Hamilton said, because there is no authority for the bankrupt to receive anything beyond the exemption.
The trustee had not joined the debtor in the suit. Significantly, the opinion implies that the trustee could have gotten a larger judgment, but Judge Hamilton does not hint at whether the trustee’s award would have been the $50,000 purchase price or the $110,000 fair market value.
Another intriguing feature of the opinion is the treatment of the debtor’s claim against the eventual third-party purchaser, who could raise the “good faith” defense as an immediate or mediate transferee from the initial transferee under Section 550(b)(2).
The opinion recites familiar law on good faith, saying that the subsequent transferee is “relieved of the responsibility to affirmatively monitor the initial transfer.” For Section 550(b), there is a difference, Judge Hamilton said, between “good faith” and “without knowledge of the voidability of the transfer.”
To tag a subsequent purchaser, there must be facts strongly suggesting the presence of other facts demonstrating fraud. “To be clear,” Judge Hamilton said, there is no duty to investigate because “knowledge is a higher bar than inquiry notice.” Therefore, the later buyer “need not conduct extensive research into the chain of title.”
Although Judge Hamilton said there was no clear error in the bankruptcy court’s good faith finding with respect to the later purchaser, his opinion suggests that another judge “on a similar record” could saddle a subsequent transferee with liability “simply because of the presence of a tax deed or because this was an unoccupied residence.”
The opinion distinguishes opinions from the Fifth and Tenth Circuits because they involved state laws with different procedures calling for auctions in which the price could rise toward fair market value. Consequently, Judge Hamilton’s opinion does not seem like a prime candidate for Supreme Court review.