Four Circuits Now Permit Fraudulent Transfer Attacks on Real Estate Tax Foreclosures

The Second Circuit joined three other courts of appeals in holding that real estate tax foreclosures can be attacked as fraudulent transfers despite BFP v. Resolution Trust, 511 U.S. 531 (1994), where the Supreme Court ruled that mortgage foreclosures are immune from fraudulent transfer attack.

The Circuit Split

Regarding tax foreclosures, the Second, Third, Sixth and Seventh Circuits now hold that they can be attacked as fraudulent transfers. To read ABI’s reports on the prior opinions, click here, here and here.

The Fifth, Ninth and Tenth Circuits hold to the contrary, having extended BFP from immunizing mortgage foreclosures to protecting tax foreclosures. The most recent of those decisions came from the Ninth Circuit. See Tracht Gut, LLC v. Los Angeles County Treasurer, 836 F.3d 1146 (9th Cir. 2016). To read ABI’s report on Tracht Gut, click here.

The New York Tax Foreclosure

The debtors owned a modest home that may have been worth no more than $30,000. It had no mortgage.

The husband lost his job, and the couple were unable to pay real estate taxes for a time. With some $1,300 in taxes unpaid, the county gave notice under New York real estate law. Later, the county filed a tax foreclosure action and moved for summary judgment.

The state court granted summary judgment and awarded title and possession of the home to the county.

In his June 27 opinion, Circuit Judge Barrington D. Parker explained that New York law employs so-called strict foreclosure for tax delinquencies.

In foreclosure by sale, Judge Parker said there is a sale, with the proceeds used to satisfy the secured debt and with any surplus paid to the debtor.

In strict foreclosure, by contrast, Judge Parker said that a creditor like the county has the court set a deadline for the payment of taxes. If the deadline passes without payment, he said that “the court enters an order transferring title and possession of the property to the creditor.”

In New York’s version of strict tax foreclosure, there is no sale, Judge Parker said. Rather, the transfer is effected by court order, and the county may then sell the property. In the subsequent sale, the county retains all proceeds and does not account to the owner for any surplus in excess of the outstanding taxes.

In the case before the Second Circuit, the couple had opposed summary judgment but lost. After the judgment for title and possession but before the sale, the couple filed a chapter 13 petition. Their plan called for paying the tax arrears in full with 12% interest.

After the chapter 13 filing, the county sold the home to a third party for $22,000. As Judge Parker said, “the County pocket[ed] the difference between the tax debt and the sales proceeds and is not accountable to other creditors for what it does with the proceeds.” In other words, the couple had no liability for the $1,300 in taxes but lost more than $20,000 in equity.

The county stipulated that the debtors could remain in occupancy of the home pending appeal.

Proceedings Below

Soon after filing, the debtors mounted an adversary proceeding under Section 548(a)(1)(B)(i), alleging that the tax foreclosure was avoidable as a constructive fraudulent transfer because the debtors had not received “reasonably equivalent value” for the transfer.

Initially, the bankruptcy court dismissed the complaint on authority of BFP, where the Supreme Court held that a regularly conducted mortgage foreclosure is immune from attack as a fraudulent transfer.

On the first appeal, the district court reversed and remanded for the bankruptcy court to determine whether the debtors had received reasonably equivalent value. Because the $22,000 sale only extinguished $1,300 in taxes, the bankruptcy court decided on remand that the debtors could avoid the transfer for lack of reasonably equivalent value.

The district court affirmed on the second appeal, prompting the county to appeal to the circuit. The debtors were represented by Legal Assistance of Western New York Inc.

The Second Circuit Opinion

Without citing any of the circuit authority on both sides of the issue, Judge Parker affirmed, holding that BFP’s presumption of reasonably equivalent value does not apply to a strict real estate tax foreclosure.

On the merits, Judge Parker first held that the debtor had standing to appeal. He rejected the county’s contention that their federal homestead exemption left them without standing.

Judge Parker said that the debtors had standing because they remained liable for the taxes, which they paid in their plan.

On the merits of the fraudulent transfer, the county relied on BFP. Yet Judge Parker said that BFP did not apply “for a host of reasons.”

“Critical” to the holding of the Supreme Court, Judge Parker said, was “the existence of an auction or sale which would permit some degree of market forces to set the value of the property even in distressed circumstances.” He also quoted BFP for saying that the holding only applied to regularly conducted real estate foreclosures. The Supreme Court specifically said that other considerations may apply to tax foreclosures. BFP, supra, 511 U.S. at 537 n.3.

Comparing strict tax foreclosure with mortgage foreclosure, Judge Parker said that “the strict foreclosure procedures under [New York law] offer far fewer debtor protections than the mortgage foreclosure procedures at issue in BFP.”

The debtors had lost all of their interest in the property even before the county’s tax sale. “The auction was conducted solely for the benefit of the County and the amount of the proceeds bears no relation to the amount of the tax debt that led to the foreclosure,” Judge Parker said.

“Moreover,” Judge Parker said, the county kept all of the proceeds and was not accountable to other creditors, the estate or the debtors. “In addition,” he said, the county’s argument “would produce results that are fundamentally at odds with the goals of bankruptcy law.”

Judge Parker affirmed the judgment of the district court.