Can A Property Tax Foreclosure Sale Be Avoided As A Fraudulent Transfer? (Duval v. County of Ontario)

What’s the reasonably equivalent value? (Photo by Marilyn Swanson)

By: Donald L Swanson

Can the foreclosure of a property tax lien on real estate be avoided as a fraudulent transfer under § 584 of the Bankruptcy Code?

That’s the issue before the District Court, on a bankruptcy appeal, in Duvall v. County of Ontario, New York, Case No. 21-cv-06236 in U.S. District Court, WDNY (issued 11/9/2021).

Courts have gone both ways on the issue. 

The Difficulty

Here’s why the issue is difficult to resolve.  The U.S. Supreme Court addressed the same issue in a mortgage foreclosure context and ruled (in BFP v. Resolution Trust, 511 U.S. 531 (1994)):

  • a mortgage foreclosure that’s properly conducted under state law is presumed to achieve “reasonably equivalent value” for the property; and
  • such a result is necessary to respect a state’s authority to carry out its foreclosure laws and regulations. 

Comparing Foreclosure Proceedings

In comparing the BFP result and rationale to the tax foreclosure proceedings:

  • some courts find that BFP does not apply because, (i) mortgage foreclosure laws tend to ensure that reasonably equivalent value, under forced-sale circumstances, is achieved, but (ii) such protections are absent from corresponding tax foreclosure schemes; and
  • other courts extend BFP to tax foreclosures, regardless of the presence or absence of such protections, because BFP ignored substantive value considerations and focused instead on whether the forced sale is non-collusive and in compliance with state law.

Rejecting BFP

In Duval, the Bankruptcy and District Courts reject the County’s attempt to extend BFP to property tax foreclosures, observing that the Supreme Court’s rationale in BFP is preceded by, and hinges upon, a discussion of protections afforded to homeowners in mortgage foreclosure that avoid the “draconian consequences” of outdated strict foreclosure schemes.  Such protections include:

  • notice to defaulting borrowers;
  • significant time allowances before the commencement of foreclosure proceedings;
  • public notice of the sale; and
  • strict adherence to set bidding rules and auction procedures.

Moreover, the Supreme Court explicitly limits its BFP holding to “mortgage foreclosures of real estate,” specifying that “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.” 

Duval Circumstances

In Duval:

  • the County took title to real property prior to any sale, and debtor thereby lost all equity in it;
  • no bidding rules or procedures, even if followed, could possibly have inured to the benefit of the debtor or any creditor other than the County, let alone ensure that the debtor receive reasonably equivalent value; and
  • Unlike BFP’s mortgage foreclose, the amount Duval owed for property taxes ($22,434.40) bears no rational relationship to the value (>$91,000) of the real property being foreclosed, resulting in a substantial windfall to the County at the expense of all other creditors.

Duval Ruling

Accordingly, the District Court in Duval declares:

  • Ultimately, state interests must be balanced against the Bankruptcy Code’s strong policy favoring equal treatment of creditors; 
  • The broader purposes of the Bankruptcy Code and its fraudulent transfer provisions are to ensure both a fair distribution of the debtor’s assets among creditors and a fresh start for the debtor;
  • Such purposes are better served where the debtor is permitted to retain exempt equity, while repaying the County and other creditors. 

And the District Court concludes:

  • BFP‘s holding does not shield the County from debtor’s fraudulent conveyance claim, in light of the competing interests and the particular forced sale scheme presented here.

The ruling was appealed to the Second Circuit Court of Appeals, but the appeal has been dismissed.

Conclusion

The Duval opinion seems well-founded, particularly in light of the details of the tax foreclosure scheme involved.

It will be interesting to see how this issue plays out . . . and whether this issue will make its way, some day, to the U.S. Supreme Court, given the split of authority involved.

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