A recent decision from the United States Court of Appeals for the Third Circuit will likely rekindle the discussion of whether a transfer of property resulting from a tax sale or foreclosure sale may be avoided in bankruptcy. The court held that a Chapter 13 debtor may avoid a transfer of the debtor’s property to a tax sale purchaser made during the 90 day period before bankruptcy as a preferential transfer. The property, which was valued at $335,000, was transferred to the holder of a $45,000 tax lien, who had moved to foreclose the debtor’s right of redemption under New Jersey law.
Generally, under Section 547(b) of the Bankruptcy Code, a transfer of a debtor’s property to a non-insider creditor within 90 days before the debtor’s bankruptcy filing may be avoided as a preference if the transfer was (i) made on account of an antecedent debt, (ii) while the debtor was insolvent, and (iii) the effect of the transfer was to give the creditor more than the creditor would have received, before any transfer, in a Chapter 7 case pending at that time. The Third Circuit held that the tax lienholder received an avoidable preference because the tax lienholder received property worth $345,000 to satisfy a $45,000 debt, which was substantially more than what the creditor would have received in a Chapter 7 bankruptcy case.
The tax lienholder argued that the preference claim was barred under a 1994 Supreme Court case, BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), which held that a transfer of property from a properly conducted foreclosure sale could not be avoided as a fraudulent transfer under Section 548 of the Bankruptcy Code. The Third Circuit disagreed, observing that BFP addressed a different issue, namely, whether property sold at a properly conducted foreclosure sale could be avoided as a fraudulent transfer. Whereas the Supreme Court in BFP focused on the “reasonably equivalent value” element of the claim, in a preference action, a trustee (or Chapter 13 debtor) need only show that a creditor received more on its claim than would have been the case in a Chapter 7 case. The Third Circuit also noted that the Supreme Court limited its decision in BFP to only cover foreclosures of real property and that “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.”
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Practice Pointer: Before this decision, lower courts were divided on the issue of whether a transfer of property resulting from a tax or foreclosure sale could be avoided as a preference. Courts that refused to allow the claim did so on the authority of BFP. Although the Third Circuit’s decision dealt with a transfer of property arising from foreclosure of a tax lien, where such sales rarely result in a purchase approximating much more that the tax due, lenders should evaluate their bidding strategy at a foreclosure sale because a credit bid of an amount that is less than the actual debt could expose the lender to a preference claim. However, as a practical matter, because most bankruptcy filings occur before a foreclosure sale takes place, we do not expect that there will be a flood of preference claims against lenders or even tax sale lienholders if the Third Circuit’s decision is followed in Maryland and other jurisdictions.