Are Foreclosure Sale Purchases Protected from Avoidance Under § 547? It Depends.

A recent decision out of the Western District of Pennsylvania, In re Veltre,[1] added to the split among courts about whether a non-collusive foreclosure sale can be avoided as a preferential transfer under § 547. Judge Carlota Böhm, joining other judges in her district, held that the sale cannot be avoided as a preferential transfer, primarily relying on the reasoning from Supreme Court decision BFP v. Resolution Trust Corporation.[2]

The split among courts largely comes down to whether the reasoning in BFP, which addressed reasonably equivalent value under § 548, is applicable to preference cases under § 547. Veltre, and its companions, hold that BFP does apply and consequently prohibits avoidance under § 547, while the opposition rejects the application of BFP through a textual approach. The determinative issue in all of these cases is whether the lien creditor that purchased the property received more than it would have in a chapter 7 liquidation to satisfy § 547(b)(5).

 In Veltre, the subject property was encumbered by a first lien in favor of Capital One, in the amount of $90,000, and a second lien in favor of Fifth Third Bank, in the amount of $25,000. Pre-petition the Debtor fell behind on payments, Capital One commenced foreclosure proceedings, and ultimately Fifth Third Bank purchased the property at a sheriff’s sale for $90,000. Post-sale the Debtor filed a chapter 11 petition and subsequently initiated the § 547 suit, where she alleged the property was worth $200,000 and that Fifth Third acquired, in excess of its secured claim, approximately $85,000 in value. Fifth Third Bank then filed a motion to dismiss which precipitated the decision from Judge Böhm.

In Veltre, like other cases, the Debtor argued that the court should look to the hypothetical liquidation value for purposes of (b)(5), under the assumption that it would be higher than what the creditor paid at the sale.[3] Ultimately, Judge Böhm was not persuaded by this argument and granted dismissal under Fed. R. Civ. P. § 12(b)(6) primarily relying on two decisions. First, Judge Böhm cited the principle from BFP that “the price obtained at the foreclosure sale constitutes reasonably equivalent value as a matter of law.”[4] Second, she adopted the reasoning in In re Pulcini that this maxim from BFP “compels the conclusion” that a non-collusive pre-petition sheriff sale is not subject to avoidance under § 547.[5] Citing deference to the integrity of the state law foreclosure process, the implicit rationale here is that the sheriff’s sale finalizes the question of value as a matter of law and prohibits any challenge to that valuation.[6] The court in Pulcini expounded on this by offering “we find no ‘clear and manifest’ indication that when it enacted § 547(b) Congress intended to override the long-standing law of Pennsylvania concerning title to real property.” In re Pulcini, 261 B.R. 836, 844–45 (Bankr. W.D. Pa. 2001). Therefore, Judge Böhm held the Debtor-Plaintiff could plead no facts to support § 547(b)(5) since the purchase price did not provide value in excess of Fifth Third’s claim because the property was purchased at a sheriff’s sale.

The Veltre decision did not establish a novel basis for giving preclusive effect to pre-petition non-collusive sheriff’s sales, instead, it reinforced the general reasoning discussed in previous decisions addressing the question.[7]

As mentioned above, the cases permitting foreclosure sales to be avoided under § 547 (“non-BFP cases”) do so primarily based on the text of the statute and reject the application of BFP because the decision addressed value under § 548. The non-BFP decisions conclude that the statutory language in § 548 is sufficiently distinct from that in § 547 to prevent any application by analogy of the reasoning in BFP.[8] However, the non-BFP decisions also distinguish the holding on policy grounds, noting the potential threat to federalism and comity with state laws governing real property is not as substantial for these § 547 cases as it was for those addressed in BFP.[9]

After distinguishing BFP, these courts take look to the plain language of the statue and hold that it permits avoidance of a foreclosure sale transfer to a creditor.[10] The courts highlight that the text requires a “simple question of math,” comparing the value of the property with the price paid at the sale.[11] If the price paid is “substantially lower” than the value of the property then the transfer can be avoided.[12]

In addition to the textual reasons for permitting avoidance, the non-BFP courts cite other policy considerations in support of the outcome, including: it better promotes the goals of the Bankruptcy Code by allowing equitable distribution[13] and preventing a race to the courthouse;[14] the creditor-purchaser still retains all rights it had if the transfer never occurred;[15] risk of disruption is limited to a ninety day look back period;[16] non-creditor purchasers are protected from § 547 claims, unlike those under § 548;[17] any recovery of value under § 547 would come from the creditor-purchaser and not a subsequent third party bona fide purchaser;[18] and the outcome best balances interests of the Code with state law.[19]

In sum, Veltre did not bring the split any closer to resolution. Instead it should serve as a reminder to parties to be prepared to address each of these arguments if they find themselves in a similar situation.