Secured creditors routinely foreclose upon and sell personal property under Article 9 of the Uniform Commercial Code (UCC), mindful of the requirement that they must do so in a “commercially reasonable” manner. UCC §§9-607 and 9-610. The usual penalty for failing to be commercially reasonable is that any deficiency judgment is reduced, or perhaps the secured creditor might be liable for whatever damages could be shown, but that is usually a remote possibility. See UCC §9-625. However, a recent decision from Delaware, In re American Business Financial Services Inc., 2007 WL 528859 (Bankr. D. Del. 2007), should serve as a reminder that the penalty may be worse: The secured party sale could be avoided as a fraudulent transfer, thus potentially destroying the secured creditor’s recovery altogether.
Early in my career, this was one of the big debates: whether or not a properly conducted foreclosure sale could constitute a fraudulent transfer under either the Bankruptcy Code or state law. Everyone knows that the price obtained at a fire sale will be lower than a price obtained on the open market, but how low is too low? When can the foreclosure sale be an avoidable transfer? In 1994, the U.S. Supreme Court answered the question this way: “We deem, as the law has always deemed, that a fair and proper price, or a ‘reasonably equivalent value,’ for foreclosed property, is the price in fact received at the foreclosure sale, so long as all the requirements of the state’s foreclosure law have been complied with.” BFP v. Resolution Trust Corp., 511 U.S. 531, 545 (1994).
In so doing, the Court recognized that “[f]raudulent transfer law and foreclosure law enjoyed over 400 years of peaceful coexistence in Anglo-American jurisprudence until the Fifth Circuit’s unprecedented 1980 decision in Durrett v. Washington Nat. Ins. Co., 621 F.2d 201 (1980)],” in which the Fifth Circuit had applied the “grossly inadequate price” badge of fraud to set aside a foreclosure sale. Id. at 542. However, the Supreme Court’s analysis was not based solely upon the “over 400 years of peaceful coexistence,” but instead was based in part upon the need for certainty with respect to ownership of real estate. Id. at p. 544-545. Thus, the Court left open the question of whether a properly conducted foreclosure sale of personal property, as opposed to real property, could be avoidable as a fraudulent transfer.
While the question was left open, it was not raised very often following the Court’s decision in BFP. As a result, many people (including me) stopped worrying about the fraudulent conveyance implications of secured party sales. As noted above, the recent decision in American Business Financial Services should be a wake-up call, reminding everyone that they should be worried about it.
The collateral at issue in that case requires some explanation. American Business Financial Services (the debtor) was a financial services organization that originated and serviced mortgage loans. 2007 WL 528859 at *1. It raised capital by selling pools of the loans to special-purpose entities, which in turn sold the pools to trusts that were funded by the sale of notes or trust certificates to investors. Id. Thus, the debtor obtained cash and interests in the trust that generated cash flows (the “I/O Strips”). Id. After the debtor sought bankruptcy relief, Greenwich Capital Financial Products provided a senior, secured, super-priority credit facility (DIP loan) with liens on all assets, including the I/O Strips. Id. Shortly thereafter, the debtor announced an inability to reorganize, and the Court approved a sale of certain assets to Ocwen Loan Servicing. Id. Greenwich declared a default on the DIP loan, the case converted to chapter 7, and a trustee was appointed. Id.
Greenwich then entered into a consent agreement with the trustee, whereby the trustee agreed to sell certain of Greenwich’s collateral in exchange for a portion of the proceeds, and the trustee agreed to give Greenwich a release. Id. The consent agreement was approved by the Court, and so the contemplated sale occurred. Id. Thereafter, Greenwich foreclosed on the I/O Strips and sold them at public auction under Article 9; Ocwen was the successful bidder. Id. at *2. The trustee then filed suit against Greenwich, Ocwen and others, asserting various claims including fraudulent transfers, breach of fiduciary duty and common law fraud. Id. In essence, the trustee claimed that Greenwich failed to disclose its lower appraisal of the I/O Strips in order to obtain fees for the DIP loan, that it conspired with Ocwen to convert the debtor’s property, and that there was a concealed relationship among Greenwich, Ocwen and others. Id. at *4.
On Greenwich’s motion to dismiss, the Court first concluded that the release given by the trustee to Greenwich could not have been intended to release it from future claims based on facts other than those in existence at the time. Id. at *3. The Court then concluded that under New York law, Greenwich became a fiduciary because of its obligation to dispose of the collateral in a commercial reasonable manner. Id. at *6. The trustee’s allegation that Greenwich breached that duty by failing to protect, preserve and maximize the value of the collateral was therefore sufficient to avoid dismissal. Id.
The trustee’s fraudulent-transfer claim sought to avoid payment of all of the fees and default interest to Greenwich, as well as the foreclosure sale of the I/O Strips. Id. at *8. The Court agreed with Greenwich that the DIP loan order constituted a defense with respect to the fees and interest paid, particularly the express provisions indicating that none of the transfers under the loan documents were void or avoidable. Id. However, the Court agreed that the trustee could seek to avoid those transfers related to Greenwich’s disposition of collateral pursuant to the UCC because of the duty to dispose of the collateral in a commercially reasonable manner, which the DIP loan order could not and did not alter. Id. Moreover, the question of whether “reasonably equivalent” value was exchanged for the sale of the collateral could not be determined on a motion to dismiss, because it requires analysis of a “totality of the circumstances test in determining whether reasonably equivalent value was given.” Id. at *9.
What is striking about the decision is the recitation of facts: The I/O Strips were sold at public auction. One has to wonder: How could a public auction ever be avoided as a fraudulent transfer? Almost by definition, “public auction” suggests legitimacy. Yet, that is in fact the question that the BFP Court left open. Unfortunately, the American Business Court does not (nor could it, on a motion to dismiss) analyze the facts underlying the auction. Given the trustee’s allegations in that case, it is possible that the real issue for the Court was the relationship among the parties, and in particular, the buyer with the too-cute name; “Ocwen,” of course, is just “Newco” backwards.
In fact, most of the cases since BFP suggest that a commercial reasonable foreclosure sale to unrelated parties is unlikely to constitute a fraudulent transfer. Rather, the question seems to arise in circumstances where there may be actual fraud, collusion or similar conduct designed to give the value of assets to insiders. Nonetheless, the possibility that a secured party sale might be a fraudulent transfer should be kept in mind whenever a sale is being structured.