GGI Distinguishes BPF PDQ

When the U.S. Supreme Court decided BFP v. Resolution Trust Corp.,[1] holding that a mortgage foreclosure sale regularly conducted pursuant to state law could not be avoided as a fraudulent transfer under 11 U.S.C. § 548, it expressly left open the question of whether a tax foreclosure by the holder of a tax lien certificate could be avoided as a fraudulent transfer under that same statute.[2]

The recent decision of the U.S. Bankruptcy Court for the District of New Jersey in In re GGI Properties LLC[3] provides an answer in the affirmative. The lengthy decision, careful reasoning and basic economic realities of tax lien foreclosures suggests that the decision in GGI is likely to be followed by other bankruptcy courts whose tax sale regime is similar to the method that the State of New Jersey deploys.

The court reached the same conclusion as two prior bankruptcy cases in New Jersey addressing this issue, Matter of Varquez[4] and Berley Associates Ltd. v. Eckert (In re Berley Associates Ltd.)[5]. Thus, the result is not novel. The result reinforces a trend that is consistent with the differences between mortgage foreclosures and tax lien foreclosures that led to footnote 3 in BFP in the first instance.

Tax Liens: The Process

A brief bit of background regarding tax lien foreclosures is in order to provide perspective on the court’s GGI opinion. In a mortgage foreclosure sale conducted by a public official in a judicial foreclosure state, a sale takes place after a court has determined the amount due and owing to the holder of the mortgage. The sale is conducted by a publicly appointed official and generally takes place after a period of advertising. The sale is usually conducted in a public open auction format. Those facts underlie the policy decision in BFP, supra, holding that regularly conducted foreclosure sales are not avoidable on the grounds of producing transfers for less than reasonably equivalent value.

This is not the case with many tax lien foreclosure regimes, as discussed below. Most significantly, as distinguished from a mortgage foreclosure action, in a foreclosure of a tax lien certificate under New Jersey law, no judicial sale takes place. Title vests without competitive bidding. Thus, no mechanism produces a sale capable of setting market value.

Understanding this background makes it predictable that the GGI court would decide the case before it the way it did. The court’s analysis in GGI, supra, reinforces the prescience of the Supreme Court’s BFP footnote warning that tax lien foreclosures would not receive the same fraudulent transfer treatment as mortgage foreclosure sales.

The Facts

The main facts at issue in GGI, supra, are what one might expect in a case concerning a tax lien foreclosure fraudulent transfer dispute. The property owner failed to pay real property taxes for many years. The city sold a tax lien certificate. Since the city was in New Jersey, and since nobody bid at the sale to acquire the tax lien certificate, by operation of law the city was deemed to be the purchaser, for an amount equal to the outstanding taxes, interest and penalties, such sum to accrue interest at 18% until redeemed.[6]

With the property having been abandoned for many years and constituting an eyesore, and being the subject of an environmental remediation program, the absence of other tax lien certificate sale bidders is understandable. Also unsurprising is that, after the tax lien sale, taxes continued to go unpaid. Ultimately, the municipality foreclosed on the tax lien certificate in an in rem procedure under the tax lien law. Nobody redeemed the certificate, thus under New Jersey law the issuance of a judgment in rem vested title to the property in the municipality.[7]

One interesting sideline to the GGI decision is that the property appears to have been the source of a bitter history between the former property owner and the city. GGI, the debtor, had acquired the property in a bankruptcy proceeding in which it appears that the municipality’s secured tax claim was cut significantly. The current GGI bankruptcy court opinion suggests that GGI’s principal was alleging that the city had actively intervened to thwart efforts by the property owner to sell the property and to discover other potential purchasers. However, the bankruptcy court did not rest any of its decision on any determination as to the viability of a claim that the city had acted on a grudge.[8]

When GGI filed for bankruptcy, other than $51 in cash, its only asset was the avoidance action that it had filed against the city soon after the bankruptcy was filed.[9] The debtor alleged that the tax lien foreclosure was both a fraudulent transfer and a preference, and (as discussed below in further detail) it sought recovery not of the property itself in the first instance, but rather payment of cash from the municipality equal in amount to the alleged loss of value from the in rem tax lien foreclosure.[10]

The amount of outstanding taxes exceeded $420,000.[11] Based on contracts of sale that the debtor attempted to negotiate, the debtor claimed that the market value of the property was $700,000.[12] The city submitted an appraisal contending that the property value was nominal, based on the obsolescence of the buildings, the cost of tearing them down and the pending environmental remediation.[13]

The Avoidance Action Complaint and Summary Judgment Motion

The basis for the fraudulent transfer claim was straightforward. The debtor alleged a value of $700,000 against a tax balance of under $420,000, resulting in the loss of the difference, the debtor’s equity in the property, for no reasonably equivalent value.[14]

The debtor’s assertion that the transfer was preferential rested on the debtor’s claim of insolvency, which in turn rested on its allegation that its principal had made loans in excess of $300,000 to the debtor (which the principal agreed to subordinate to unsecured creditors). Adding those loans to the amount of the city’s taxes produced a total indebtedness in excess of the debtor’s alleged value of the property.[15]

The city moved for summary judgment to dismiss the claims. In addition to disputing the value of the property, the city asserted that the Supreme Court’s decision in BFP, supra, immunized the city’s tax lien foreclosure from attack as conclusively being a transfer for reasonably equivalent value.[16]

Why the Type of Tax Lien Regime Matters

In analyzing the fraudulent transfer and preference claims, the court noted that there are three methods by which states typically collect delinquent property taxes, and the method of collection affects whether or not the analysis of BFP applies to a tax lien foreclosure as well. The methods are the overbid method, the interest rate method and the percentage ownership method.[17]

In the overbid method, a tax lien certificate is sold by auction, with the opening bid being the total amount of taxes and interest due, then parties overbid until the point that, in theory, fair market value is reached, thus ensuring the tax foreclosure vests title (where redemption does not occur) that is a transfer for reasonable equivalent value. In the percentage ownership method, the winning bidder is the one who purchases the tax lien certificate in exchange for the lowest percentage ownership in the underlying property, which allows a correspondence to the value of the property.

The third method, the interest rate method, involves bidders bidding to purchase the tax lien certificates, not the property itself. They do so by bidding down the interest rate; the bidder willing to allow the property owner to redeem the certificate for the lowest interest rate to accrue on the unpaid taxes winds up acquiring the tax lien certificate. If the property owner does not redeem the certificate within a certain time period, usually two to three years, the holder of the certificate can foreclose by commencing a judicial action, obtaining a judgment in the amount required to redeem, and then, if no redemption occurs, obtaining an award vesting title if redemption is not timely made.[18]

Foreclosing the Equity of Redemption of Property Worth More than Taxes

Armed with this background information, the court issued a curt analysis. The court concluded that nothing in New Jersey’s tax lien law purported to speak to the value of the property being determined by the amount paid to acquire the tax lien certificate.[19] The municipality argued unpersuasively that its foreclosure, having been expedited under the portion of the tax lien law that allows the municipality to foreclose in rem when it purchases a tax lien certificate, was entitled to protection.[20] The court disagreed, pointing out that whatever foreclosure method is used does not result in a public auction sale of the property that can serve as a measure of value consistent with BFP. The court also noted that while cities have a compelling interest in collecting real property taxes, the Bankruptcy Code’s policy of benefiting creditors equitably compelled the court to prevent the municipality from realizing a windfall by foreclosing a tax lien certificate in a way that divests an insolvent borrower of its equity in the property.[21]

After dismissing the city’s policy arguments, the court denied the fraudulent transfer summary judgment motion based on the valuation dispute.[22] Based on the same valuation dispute, the court similarly denied the city’s motion for summary judgment on the preference claim. It noted that the tax lien foreclosure, to the extent that it resulted in the city receiving a property worth more than the amount of the tax claims, resulted in the city receiving more than it would have had the property been sold by a chapter 7 trustee and the proceeds paid to the city in satisfaction of its lien.[23]

Because of the dispute over valuation, the court found there to be disputed facts preventing issuance of summary judgment. Underlying the court’s conclusion that the value of the property was legitimately in dispute was a lengthy discourse on reasonably equivalent value. The discourse’s conclusion was that what would be paid to the debtor in an arms’ length sale was a key component of determining reasonably equivalent value.[24] Further, on the record before it, the court concluded that disputed factual issues precluded summary judgment.[25]

A Twist on the Remedy

The remedy that the debtor sought was intriguing. The debtor sought not merely to avoid the judgment of foreclosure vesting title in the city (i.e., a recovery of the property transferred), but rather the value of the alleged fraudulent/preferential transfer.[26] The request was grounded in 11 U.S.C. § 550(a), which permits a party that avoids a transfer to recover “the property transferred, or, if the court so orders, the value of such property.”[27]

The court noted that the reference to recovery of the property itself first in the statute suggests a preference for that as the remedy. In addition, the court expressed a distaste for forcing the city to come up with cash. The court did not rule it out, though, but noted that the city’s willingness to consent to a sale and the debtor’s ability to conceive a plan that benefits creditors would impact the ultimate remedy from the court. However, as the court noted, that decision had to await determination of the avoidance actions on the merits, a decision precluded from being the subject of a summary judgment motion based on the valuation dispute.[28]

The result and analysis in GGI, supra, do not break new ground. Nor is the result surprising given the structure of New Jersey’s tax lien law and the Varquez and Berley decisions, which the court cites frequently. The court suggests that, were a state with a tax lien regime like that before the court in GGI to enact a law declaring that a foreclosure of a tax lien certificate without a sale was deemed to be a transfer of property of a value equal to the amount of the taxes, policy considerations underlying the Bankruptcy Code’s avoidance sections (including 11 U.S.C. §§ 547, 548 and 550) would nevertheless compel a bankruptcy court to override such a determination and assess value based on principles consistent with the “reasonably equivalent value” analysis of the court in GGI, sup