The bankruptcy court has discretion to avoid a constructively fraudulent transfer of exempt property even if the result makes the debtor solvent and able to pay her creditors in full, the Second Circuit held in a September 29 opinion.
The New York-based appeals court issued its September 29 opinion against the backdrop of the Supreme Court’s holding in Tyler v. Hennepin County, 143 S. Ct. 1369 (Sup. Ct. May 25, 2023), where the Court held that a real estate tax foreclosure can violate the Takings Clause of the Fifth Amendment when the municipality takes title but doesn’t give the owner the difference between the unpaid taxes and the value of the property. To read ABI’s report, click here.
On the split of circuits that led to Tyler, the Second Circuit was among those to have held 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. See County of Ontario, New York v. Gunsalus, 37 F.4th 859 (2d Cir. June 27, 2022), cert. denied, 143 S. Ct. 447 (2022). To read ABI’s report on Gunsalus, click here.
The Annuity and the Tax Foreclosure
Owning a 49-acre farm and residence, the debtor didn’t pay $22,000 in real estate taxes in 2015. The county filed an in rem real estate tax foreclosure proceeding. On the debtor’s default, the county obtained a judgment of foreclosure transferring the property to the county in 2017.
The county sold the property for $91,000 but refrained from transferring title to the buyer because the debtor had been appealing the default judgment in state court. However, the county kept some $69,000 in surplus funds after paying the $22,000 in taxes.
Just shy of two years after the tax foreclosure, the debtor filed a chapter 13 petition in March 2019. The debtor scheduled the foreclosed property among her property as being exempt and worth $186,000.
The debtor also scheduled ownership of an annuity of unknown value that she also claimed to be exempt. The debtor served the petition and schedules on the county.
The county did not object to the claim of exemption for the annuity. In the meantime, the debtor had sued the county to recover the home and farm as a constructively fraudulent transfer.
In the fraudulent transfer adversary proceeding, the county filed a motion in limine to admit evidence about the value of the annuity. Bankruptcy Judge Paul R. Warren of Rochester, N.Y., denied the motion in limine. He reasoned that the value of the annuity was irrelevant because it was not estate property to be considered in deciding whether the debtor was insolvent at the time of the tax foreclosure.
Later, Judge Warren ruled in favor of the debtor, avoiding the tax foreclosure. The district court affirmed. See DuVall v. County of Ontario, 21- 6236, 2021 BL 430732, 2021 US Dist. Lexis 216970, 2021 WL 5199639 (W.D.N.Y. Nov. 09, 2021). To read ABI’s report, click here.
The county appealed to the Second Circuit.
The Definition of Insolvency
On appeal, the county contended it was error to have excluded evidence about the value of the annuity. The county believed that the annuity was worth enough to make the debtor solvent and therefore bar her fraudulent transfer under Section 548(a)(1)(B), because the debtor could not prove insolvency as required by Section 548(a)(1)(B)(ii)(I).
In his opinion for the Court of Appeals, Circuit Judge Raymond Lohier noted that neither the county nor anyone else had objected to the exemption of the annuity. “[I]f an interested party fails to object within the time allowed, a claimed exemption will exclude the subject property from the estate” under Section 522(l) and Rule 4003(b), Judge Lohier said.
Judge Lohier agreed with the bankruptcy court’s holding that the annuity was exempt due to the lack of a timely objection to the exemption.
Next, Judge Lohier alluded to the definition of “insolvent” contained in Section 101(32)(A), which says that a debtor is insolvent if the debtor’s “debts [are] greater than all of such entity’s property, at a fair valuation, exclusive of . . . (ii) property that may be exempted from property of the estate under section 522 of this title.”
Applying the definition, Judge Lohier said that the “plain text of the Code thus contemplates that insolvency is determined based on the debts and properties of and exemptions from the bankruptcy estate.” Given the lack of an objection to the exemption, he found no error in denial of the county’s motion in limine to exclude the value of the annuity from the determination of insolvency.
Excluding the annuity in the solvency determination, the bankruptcy court did not err in ruling that the debtor had shown the elements of a constructively fraudulent transfer, because the debtor was insolvent and had received less than reasonably equivalent value for the transfer.
The Proper Remedy
The county argued that the proper remedy wasn’t avoiding the transfer. Instead, the county contended on appeal that the bankruptcy court should have awarded damages limited to the amount of the creditors’ claims or the amount of the exemption.
To avoid what it called an “undeserved windfall” to the debtor, the county believed that the remedy should have been limited to rectifying the harm to creditors.
First, Judge Lohier said that “the County’s proposal to limit [the debtor’s] damages to the amount of creditor claims lacks support in the text of Section 522(h).” Likewise, he found “[n]othing in [Sections 522(h), 552(i)(1) or 550(a)] of the Bankruptcy Code . . . to limit the award of damages to the amount of creditor claims.”
Finally, Judge Lohier addressed the county’s contention that the bankruptcy court should have limited the remedy to the amount of the claimed exemption. On that score, he recounted how the parties agreed that the bankruptcy court had discretion between the two remedies.
Even if avoidance would be a windfall for the debtor, Judge Lohier noted how the Second Circuit in Gunsalus had “been critical of windfalls to creditors and debtors alike.” Moreover, he said that allowing the county to retain the $69,000 would be a “defense . . . now unavailable in light of” Tyler.
Judge Lohier affirmed the judgment of the district court and upheld the avoidance of the transfer.
The bankruptcy court has discretion to avoid a constructively fraudulent transfer of exempt property even if the result makes the debtor solvent and able to pay her creditors in full, the Second Circuit held in a September 29 opinion.
The New York-based appeals court issued its September 29 opinion against the backdrop of the Supreme Court’s holding in Tyler v. Hennepin County, 143 S. Ct. 1369 (Sup. Ct. May 25, 2023), where the Court held that a real estate tax foreclosure can violate the Takings Clause of the Fifth Amendment when the municipality takes title but doesn’t give the owner the difference between the unpaid taxes and the value of the property. To read ABI’s report, click here.
On the split of circuits that led to Tyler, the Second Circuit was among those to have held 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.