Unlike mortgage foreclosures, which can be immune from attack in bankruptcy court, a tax foreclosure in New Jersey may be set aside as a preference because the process does not entail a public auction related to the value of the property, the Third Circuit held.
Upholding the bankruptcy and district courts, Circuit Judge Jane R. Roth reasoned that BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), was not controlling. In BFP, the Supreme Court ruled that a regularly conducted mortgage foreclosure sale cannot be avoided as a fraudulent transfer under Section 548.
Writing for the high court in BFP, the late Justice Antonin Scalia focused on the words “reasonably equivalent value” in Section 548 in concluding that the fraudulent transfer statute was not focused on achieving fair market value. He was also concerned that applying fraudulent transfer law to mortgage foreclosures would place foreclosures under a federally created cloud.
In her September 12 opinion, Judge Roth emphasized BFP’s focus on fraudulent transfers, while her case dealt with a preference and a different provision in the Bankruptcy Code. She said that the concern with federalism “cannot overcome the plain language” of Section 547.
New Jersey’s Tax Foreclosure Procedure
When an owner has not paid real estate taxes, a municipality in New Jersey sells tax certificates. Under state law, prospective purchasers at a sale of tax certificates do not bid on the value of the property. Rather, the winner is the bidder offering the lowest interest rate. In the case on appeal, the winning bidder offered zero percent interest and a bid that was $13,500 above the unpaid taxes.
After winning the auction, the buyer waited the requisite two years under state law to commence what amounts to a strict foreclosure where there is no sale of the property. The state court entered judgment awarding title to the purchaser. In the intervening two years before foreclosure, the owner could have redeemed the property.
The debtors filed a chapter 13 petition less than 90 days after the foreclosure judgment. They scheduled the property as being worth $335,000 and listed the tax lien creditor as being owed $45,000. There were no mortgages on the property, although there was about $90,000 in other judgment liens.
The debtors sued to set aside the tax lien foreclosure as a preference. They also filed a chapter 13 plan promising to pay all creditors in full.
Upheld in district court, Bankruptcy Judge Christine M. Gravelle ruled that a tax foreclosure sale in New Jersey can be set aside as a preference under Section 547.
The Third Circuit Affirmance
The purchaser fared no better in the Third Circuit. Apart from the purchaser’s nonstatutory arguments, Judge Roth said that the transaction contained all of the elements of a preference under Section 547.
The purchaser made two arguments, “both sounding in principles of federalism,” Judge Roth said. First, the purchaser contended that BFP prohibits setting aside a lawfully conducted tax foreclosure as a preference.
Judge Roth said that the case on appeal differed from BFP in “two critical ways.” She added, “These are not trivial distinctions.”
First, BFP dealt with a fraudulent transfer, not a preference. Second, a mortgage foreclosure is based on the value of the property, even though a forced sale will not realize market value.
Moreover, the relationship to value of the property is “nonexistent” in a tax foreclosure, Judge Roth said. She rejected the idea that there must be “a clear and manifest intent of Congress” before the Bankruptcy Code can “displace an area traditionally regulated by the states.”
Judge Roth distinguished decisions where the Fifth, Ninth and Tenth Circuits immunized tax foreclosure from preference attack. State laws in those cases, she said, called for public auctions.
Judge Roth also rejected the purchaser’s argument based on the Tax Injunction Act, 28 U.S.C. § 1341, which precludes federal courts from enjoining the collection of taxes under state law so long as there is a remedy in state court. She said that the “specific edict” of Section 547 “overrides” the general provisions of the Tax Injunction Act.
To read ABI’s reports on the bankruptcy and district court opinions, click here and here. For ABI’s report on the Ninth Circuit opinion that Judge Roth declined to follow, click here.
Observation
Judge Roth’s opinion strikes the writer as standing for the proposition that vague notions of federalism cannot overcome the Supremacy and Bankruptcy Clauses of the Constitution.
Unlike mortgage foreclosures, which can be immune from attack in bankruptcy court, a tax foreclosure in New Jersey may be set aside as a preference because the process does not entail a public auction related to the value of the property, the Third Circuit held.
Upholding the bankruptcy and district courts, Circuit Judge Jane R. Roth reasoned that BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), was not controlling. In BFP, the Supreme Court ruled that a regularly conducted mortgage foreclosure sale cannot be avoided as a fraudulent transfer under Section 548.
Writing for the high court in BFP, the late Justice Antonin Scalia focused on the words “reasonably equivalent value” in Section 548 in concluding that the fraudulent transfer statute was not focused on achieving fair market value. He was also concerned that applying fraudulent transfer law to mortgage foreclosures would place foreclosures under a federally created cloud.
In her September 12 opinion, Judge Roth emphasized BFP’s focus on fraudulent transfers, while her case dealt with a preference and a different provision in the Bankruptcy Code. She said that the concern with federalism “cannot overcome the plain language” of Section 547.