Avoiding Tax Sales in Bankruptcy: Not All Foreclosures Are Created Equal

When asked whether a foreclosure sale can be avoided in bankruptcy, the first answer that comes to many practitioners’ minds is “no” because of the Supreme Court’s opinion in BFP v. Resolution Trust Corp.[1] The correct answer, though, is a much more nuanced “it depends.” The Third Circuit’s Sept. 12, 2019, precedential opinion in Hackler v. Arianna Holdings Company LLC[2] is an excellent reminder why.

The facts in Hackler are relatively straightforward. The Hacklers failed to pay taxes on a parcel they owned in New Jersey, which resulted in a tax lien. The township in which the property was located subsequently conducted a public auction of the tax lien. The lien sold at auction and was assigned to Arianna Holding Company LLC. The Hacklers failed to redeem the tax lien, which resulted in a foreclosure judgment vesting title to the property in Arianna.

Two months later, the Hacklers simultaneously filed a voluntarily petition for relief under chapter 13 and an adversary proceeding to avoid the transfer of the property as preferential and/or fraudulent. On summary judgment, the Hacklers argued that the foreclosure occurred within the preference period and permitted Arianna to receive more than it otherwise would have in a chapter 7 had the transfer not taken place. Arianna, in its counter-motion for summary judgment, asserted that the tax foreclosure sale was properly conducted under state law and, as a result, was immune from avoidance under the Supreme Court’s opinion in BFP.

The bankruptcy court ultimately entered summary judgment in favor of the Hacklers on the preference cause of action without rendering a decision on the fraudulent transfer cause of action. The district court affirmed, which brought the case to the Third Circuit. On appeal, the panel was faced with a question of first impression: whether a New Jersey tax foreclosure could be avoided as a preferential transfer.[3]

BFP v. Resolution Trust Corp.: Foreclosure Sales Conducted in Accordance with State Law Cannot Be Avoided as Fraudulent Transfers

Arianna’s primary argument rested upon the Supreme Court’s opinion in BFP. In that case, the Supreme Court was faced with the question of whether a debtor receives “reasonably equivalent value” for purposes of § 548 of the Bankruptcy Code when its property is sold to satisfy a mortgage in a foreclosure sale. The Supreme Court ruled that a debtor does receive reasonably equivalent value, even if the foreclosure sale value is significantly less than the fair market value, so long as the sale is noncollusive and is conducted in accordance with state law.

In the time since BFP, some courts have applied BFP broadly, while others have made an effort to limit its effects.[4] For example, courts have drawn distinctions between mortgage foreclosures, which typically involve a public sale, and strict foreclosures, such as property tax foreclosures, which might not have.[5] Few courts, however, have addressed the treatment of tax foreclosures as preferences under § 547 of the Bankruptcy Code.

New Jersey Tax Foreclosures vs. Mortgage Foreclosures

The various courts in Hackler v. Arianna Holdings Company LLC identified two critical differences between Hackler and the Supreme Court’s decision in BFP. First, the Hackler courts noted that BFP involved fraudulent transfers and not preferential transfers. Unlike § 548, § 547 contains no requirement that a party receive reasonably equivalent value. Thus, the primary rationale and policy considerations of BFP are not necessarily implicated. Second, tax foreclosures in New Jersey are much different than mortgage foreclosures. When foreclosing a mortgage, an arms’ length sale process results in parties bidding for the property, after which it is sold to the highest bidder. In a New Jersey tax foreclosure, however, parties bid only for the government’s lien rights, the value of which may have no correlation to the actual value of the property.

Indeed, even if conducted in accordance with state law, a tax foreclosure can result in the purchaser paying significantly less for a tax certificate than the fair market value of the property. The result of such a sale is that the purchaser of a tax certificate could gain title to the property upon the owner’s failure to redeem without having gone through a noncollusive public auction process and without having realized the property’s full value.

Because of these differences, the Third Circuit was not willing to apply BFP to protect a tax foreclosure from preference liability, even if conducted in accordance with state law.

In re Veltre: A Properly Conducted Foreclosure Sale Isn’t a Preference?

At first blush, the result in Hackler may seem at odds with other Third Circuit case law. In In re Veltre,[6] the Third Circuit found that under Pennsylvania law, a properly conducted judicial foreclosure can never constitute a preference. Pennsylvania law presumes that the price received at a duly advertised public sale is the highest and best obtainable. Citing to BFP, the Third Circuit indicated that such state law would be determinative of value in the bankruptcy preference context. Thus, as a matter of law, the creditor could not have received more than it would have in a liquidation under chapter 7.

Veltre is distinguishable, however, for one of the same reasons that the Third Circuit found BFP to be distinguishable: Mortgage foreclosures and tax foreclosures are not the same. A New Jersey tax foreclosure isn’t a “duly advertised public sale” of the property, it is only a sale of the tax lien rights.[7]

Further, not all states hold that a public foreclosure sale obtains the highest best price for a property as a matter of law. See, e.g., Olentangy Local Sch. Bd. of Edn. v. Delaware Cty. Bd. of Revision, 141 Ohio St. 3d 243 (2014) (holding that pursuant to Ohio statute, sale price at auction is not presumptive evidence of value of property for tax purposes).

Conclusion

Whether a foreclosure sale was conducted in accordance with state law is just one piece of the puzzle in determining whether the sale might be avoidable in bankruptcy. Practitioners must be ready to scrutinize the type of foreclosure, whether a noncollusive public auction occurred and what presumptions state law creates as to the value obtained upon the sale. While cases like Hackler provide some clarity, the many factors at play when tax foreclosures meet bankruptcy will continue to cause confusion. And without further guidance from the courts, avoidance litigation over tax liens will be unavoidable.