Bankruptcy courts are divided on whether a transfer at a regularly conducted foreclosure sale can be set aside as a preference even when every element of a preference is present.
Bankruptcy Judge Carlota M. Böhm of Pittsburgh took sides with colleagues on the bankruptcy bench in Pennsylvania by holding that a flawless foreclosure cannot be attacked as a preference.
The facts made out a preference. Before her chapter 11 filing, the individual debtor owned a home allegedly worth $200,000, encumbered by a $90,000 first mortgage and a $25,000 second mortgage. Without objection from the debtor, the holder of the first mortgage got a judgment of foreclosure and conducted a foreclosure sale that was won by the holder of the second mortgage, who bid $90,000 enough to pay the first mortgage in full.
Assuming the property was worth $200,000, the holder of the second mortgage was also paid in full and in addition acquired the debtor’s $85,000 equity in the home.
After filing a chapter 11 petition less than three months later, the debtor mounted a preference suit against the holder of the second mortgage. She admitted there were no defects in the foreclosure.
The elements of a Section 547 preference arguably were present. To satisfy prepetition debt, the second mortgage holder obtained a transfer of the debtor’s property within 90 days of bankruptcy when the debtor was insolvent. Arguably also, the second mortgage holder received more than it would have in chapter 7 because a trustee presumably would have sold the home, in the process paying $25,000 due on the second mortgage and retaining the equity for the estate or the debtor’s exemptions.
In her Jan. 27 opinion granting the lender’s motion to dismiss, Judge Böhm said there was no controlling Third Circuit authority. She cited bankruptcy judges around the country who reached differing conclusions.
Judge Böhm was persuaded by BFP v. Resolution Trust Corp., where the Supreme Court held in 1994 that a properly conducted foreclosure results in reasonably equivalent value as a matter of law.
Building on BFP and agreeing with retired Bankruptcy Judge Bernard Markovitz and Bankruptcy Judge Thomas Agresti, Judge Böhm held that a “valid, legal, and non-collusive sheriff’s sale cannot be undone or otherwise avoided by a preferential transfer action under Section 547 of the Bankruptcy Code.”