Reasonably Equivalent Value, Forced Sales, And the Application of §§ 547 and 548 of the Bankruptcy Code



By John C. Murray**

© 2011





A transfer is deemed to be constructively fraudulent under § 548(a)(1)(B) of the Bankruptcy Code, and may be avoided by the trustee or debtor-in-possession (“DIP”) if, within two years prior to the filing of the bankruptcy petition, the transferor receives “less than reasonably equivalent value” in a transaction and the transaction meets any one of the following requirements: (1) the transferor was insolvent at the time of the transfer or was rendered insolvent as the result of the transfer; (2) the transferor was undercapitalized at the time of the transfer or became undercapitalized as the result of the transfer; or (3) the transferor was unable or rendered unable by the transfer to pay its debts as they became due. These tests are sometimes referred to as, respectively, the “insolvency test,” the “capitalization test,” and the “cash flow test.” This article will examine the factors that courts consider in determining “reasonably equivalent value” in the context of real-property foreclosures and related enforcement actions, and whether such a determination applies at all in connection with preferential transfers under § 547 of the Bankruptcy Code. 


Application of § 548 to Forced Sales


“Reasonably equivalent value” is not defined or explained in the Bankruptcy Code, but has been determined by both federal and state courts on a case-by-case factual basis. Factors considered by the courts include: the good faith of the parties; (2) the difference between the amount paid and the fair market value; (3) the percentage of the fair market value paid, and (4) whether the transaction was arm’s length. See Paul L. Hammann and John C. Murray, Creditors’ Rights Risk: A Title Insurer’s Perspective, 38 j. marshall l. rev. 223, 246-52 (2004). The U.S. Supreme Court specifically addressed the issue of reasonably equivalent value in the context of a mortgage foreclosure sale in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994) (“BFP”). In BFP, the Court held that reasonably equivalent value, in the case of a mortgage foreclosure, is the price received at a regularly conducted, non-collusive foreclosure sale of the property as long as all the requirements of the state’s foreclosure laws have been complied with.

In the case of forced sales (such as foreclosures), however, such factors may not be appropriate or determinative. The Supreme Court was careful to note in BFP that its ruling applied only to judicial and non-judicial real-estate mortgage foreclosures and that “[t]he considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.” BFP , supra 511 U.S. at 537 n. 3. Thus, the Supreme Court's holding in BFP would not necessarily apply to certain other real estate transactions, such as deeds in lieu of foreclosure (where reasonably equivalent value for conveyance of the property must be separately established, most likely by a current appraisal), “strict” foreclosures that are permitted in certain states, and tax foreclosure sales . Also, the BFP rationale may not apply to actions to set aside a foreclosure as a preferential transfer under § 547 of the Bankruptcy Code.

Bankruptcy courts, however, generally have applied the Supreme Court’s holding in BFP to certain forced-sale situations, such as judicial tax sales and “strict” foreclosure sales, in those situations where it has been demonstrated to the court’s satisfaction that the procedural and substantive rights of the debtor have been protected. Also, with respect to the issue of whether the BFP rationale applies to § 547 of the Bankruptcy Code, the majority of bankruptcy cases decided since the BFP decision has held that a secured creditor that acquires real estate by virtue of being the high bidder at a regularly conducted, non-collusive foreclosure sale has not received an avoidable preference under § 547 simply because the property was worth more than the debt. 


Application of BFP to “Strict” Foreclosures


With respect to strict foreclosure statutes (which currently exist only in Connecticut and Vermont), the courts generally have held that the Supreme Court’s ruling in BFP does not presumptively apply where there are insufficient due-process safeguards and no public sale is held.  See, e.g., Federal National Mortgage Ass’n v. Fitzgerald (In re Fitzgerald), 237 B.R. 252 (Bankr. D. Conn. 1999) (“Fitzgerald I”), which held that because Connecticut’s strict foreclosure procedure does not provide for a public sale, the BFP decision, which applies only to a properly conducted, non-collusive foreclosure sale, did not automatically control as to whether the property had been transferred for reasonably equivalent value. Accordingly, the court agreed to conduct further factual proceedings to ascertain the value of the property and the lender’s claim. See also Chorches v. Fleet Mortgage Corp. (In re Fitzgerald), 255 B.R. 807, 810 (Bankr. D. Conn. 2000) (“Fitzgerald II”) (reaffirming court’s rationale in Fitzgerald I, and finding that Connecticut made a legislative decision “not to accord a conclusive presumption of ‘reasonably equivalent value’ to strict foreclosures under state fraudulent transfer law”); Sensenich v. Molleur (In re Chase), 2005 WL 189711 (Bankr. D. Vt. Jan. 27, 2005), at *6 (holding that Vermont’s strict foreclosure process, which “does not include a discretionary redemption period, court oversight of the debt-value ratio, and the mortgagee’s right to move for a sale even if the mortgage does not contain a sale provision -- is not entitled to a presumption of reasonably equivalent value and requires a case-by-case analysis of the fraudulent conveyance allegations”).

But other courts have held that reasonably equivalent value has been established under § 548 of the Bankruptcy Code in connection with strict foreclosures, in compliance with BFP. See In re Talbot, 254 B.R. 63, 69-71 (Bankr. D. Conn. 2000) (holding that strict foreclosure judgment entered in accordance with Connecticut law conclusively established reasonably equivalent value); Chase Manhattan Mortgage Corp. v. St. Pierre (In re St. Pierre),  295 B.R. 692, 698 (Bankr. D. Conn. 2003) (rejecting ,mortgagees’ argument that BFP does not apply to strict foreclosures, and stating that, “[t]here are no allegations that the debtors were denied their procedural rights or that there were irregularities in the foreclosure process”). Cf. In re Pantani, 377 B.R. 28 (Bankr. D. Conn. 2007) (agreeing with court’s decision in Fitzgerald II, supra, but finding that in this case reasonably equivalent value existed despite strict foreclosure because debtor failed to demonstrate any equity in the property).


Application of BFP to Tax Sales


Several bankruptcy courts have applied the BFP holding to other forced-sale situations, such as judicial tax sales, and have upheld such sales upon a finding that the rights of the debtor had been protected. These courts have upheld state tax sales under the BFP rationale so long as the procedures were sufficiently similar to those provided in a mortgage foreclosure sale under state law, concerning notice to the owner-borrower and true competitive bidding.

See, e.g., Washington v. County of King William, (In re Washington), 232 B.R. B.R. 340, 344 (Bankr. E.D. Va. 1999) (finding delinquent tax sale valid because sale was held in strict accordance with state statutory requirements, which gave delinquent taxpayer “more than adequate protection,” including notice and opportunity to cure); In re Samaniego, 224 B.R. 154, 158 (Bankr. E.D. Wash. 1998) (holding that tax foreclosure sale was valid because debtor’s rights had been adequately protected); Russel-Polk v. Bradley,(In re Russel-Polk), 200 B.R. 218, 220-222 (Bankr. E.D. Mo. 1996) (comparing statutory procedure for tax foreclosure sales with that applied to mortgage foreclosure sales and ruling that debtor was provided with same protections, most notably competitive bidding and a two-year redemption period; and finding that same rule should apply even where tax sale price was far below property’s fair market value, which was still “reasonably equivalent value” for purposes of § 548); T.F. Stone v. Harper (In re T.F. Stone Co.), 72 F.3d 466, 471 (5th Cir. 1995)  (“That [the county’s] sale to the [tax purchaser] was a tax sale rather than a mortgage foreclosure sale does not change the fact that it was a forced sale”); Golden v. Mercer County Tax Claim Bureau (In re Golden), 190 B.R. 52, 58 (Bankr. W.D. Pa. 1995) (finding that BFP applied to “regularly conducted tax sales”); Hollar v. Myers, (In re Hollar), 184 B.R. 243, 252 (Bankr. M.D. N.C. 1995) (noting similarities of procedural safeguards in tax sale, including requirement under state statute for public notice and public auction); Lord v. Neumann, (In re Lord), 179 B.R. 429, 432-35 (Bankr. E.D. Pa. 1995) (noting requirement for competitive bidding under specific Pennsylvania bidding procedures); McGrath v. Simon, (In re McGrath), 170 B.R. 78, 82 (Bankr. D.N.J. 1994) (noting requirement for public notice of tax sale and procedures to encourage competitive bidding); Comis v. Bromka (In re Comis), 181 B. R. 145, 150 (Bankr. N.D.N.Y. 1994) (“The Bankruptcy Court is without authority to void a tax foreclosure sale conducted in accordance with state law”).  

However, other courts have ruled that a tax sale, although conducted in accordance with state law, was invalid and constituted a fraudulent transfer. For example, in Sherman v. Rose (In re Sherman), 223 B.R 555 (B.A.P. 10th Cir. 1998), the court held that unlike mortgage foreclosure sales, the principle of “fair market value” must be applied to tax-sale cases to determine whether the transfer was for reasonably equivalent value.  The applicable Wyoming statute provided for the property to be sold to a person selected in a random lottery for the amount of the outstanding taxes, and did not permit a public sale with competitive bidding. According to the court, “there is a significant difference between the circumstances of this case and those surrounding [other bankruptcy court decisions] that have upheld the applicability of the BFP decision to tax sales.” Id. at 559. The court further held that, as a matter of equity, the BFP case did not apply to this particular tax because the $450 paid for the debtor’s real estate at the tax sale was not reasonably equivalent value for property worth between $10,000 and $50,000. Similarly, in Wentworth v. Town of Acton (In re Wentworth), 221 B.R. 316, 319-20 (Bankr. D. Conn. 1998), the court held that a non-judicial tax forfeiture sale of a tax lien under the applicable state statute without judicial oversight, competitive bidding, public notice, or public sale, with a 1 to 13 ratio between the tax lien amount and the property’s value, was not for reasonably equivalent value. The court stated that “[u]nlike a forced sale, whether a mortgage sale such as in BFP, or a tax foreclosure sale . . .  Maine’s forfeiture sale procedure eliminates rather than redefines the market. While the forced sale price may be legitimate evidence of the property’s value the amount of a tax lien is no evidence whatsoever of the property’s value (citation omitted).”

See also 40235 Wash. St. Corp. v. Lusardi, 177 F. Supp. 2d 1090, 1098 (S.D. Cal. 2001) (stating that “other considerations” prevented the court from extending BFP to a tax foreclosure sale), aff'd on other grounds, 329 F.3d 1076 (9th Cir. 2003); Kojima v. Grandote Intern., LLC (In re Grandote Country Club Company, Ltd.), 252 F.3d 1146, 1152 (10th Cir. 2001) (stating that “the decisive factor in determining whether a transfer pursuant to a tax sale constitutes ‘reasonably equivalent value’ is a state’s procedure for tax sales, in particular, statutes requiring that tax sales take place publicly under a competitive bidding procedure”); Harris v. Penesi (In re Harris), 2003 WL 25795591 (Bankr. N.D.N.Y., March 11, 2003), at *5 (“the court is not inclined to extend BFP to strict tax foreclosure proceedings where property is transferred with little judicial oversight and without competitive bidding and a public sale).

At least one court has held that BFP does not apply with respect to forfeiture of real-estate land contracts under state law. (When a vendor elects this remedy in accordance with applicable state law, the vendor declares the contract terminated and retains the vendee’s prior payments as liquidated damages.)  See Dunbar v. Johnson (In re Grady), 202 B.R. 120, 125 (Bankr. N.D. Iowa 1996) (holding that BFP did not apply to forfeiture of real estate contract under state law because “where no sale occurs, the only barometer to determine value is the amount of any debt remaining on the sale contract. This amount has no relationship to market forces . . . [and] could be minuscule and bear no relationship to reasonably equivalent value;” court also noted that  “cancellation of debt of $15,830 in exchange for the transfer of property worth $40,000 does not constitute reasonably equivalent value under § 548(a)(2)”). But seeVermillion v. Scarbrough, 176 B.R. 563, 569-570 (Bankr. D. Or. 1994) (holding that land sale contract forfeiture proceeding complied with BFP requirements for reasonably equivalent value where proceeding was regularly conducted pursuant to state law and vendee did not allege unconscionability on part of vendor); McCanna v. Burke, 197 B.R. 333, 337-338 (D.N.M.1996) (finding that notwithstanding BFP, “strong public policy” favors enforcement of land sale contracts, and stating that “[a]bsent circumstances that result in an inequitable forfeiture, the courts will enforce a real estate [land] contract”).


BFP and State Fraudulent-Conveyance and Fraudulent-Transfer Statutes


Section 548 of the Bankruptcy Code not only applies to transfers made by the debtor within two years before the commencement of the bankruptcy case, but also incorporates state fraudulent conveyance statutes. Both state laws and the Bankruptcy Code contain provisions that make transfers under certain circumstances void as to creditors of the transferor (the seller in the case of a sale transaction; the borrower in the case of a loan transaction). A transfer would violate these laws and may be voided by the trustee or DIP if it is either intentionally fraudulent or constructively fraudulent as to the transferor’s creditors. The Uniform Fraudulent Transfer Act (“UFTA”) has been enacted in forty states and the District of Columbia. (Four states have retained the Uniform Fraudulent Conveyance Act (“UFCA”): Maryland, New York, Tennessee, and Wyoming.) The UFTA was adopted in order to address changes in bankruptcy law (especially in the area of fraudulent transfers) and debtor-creditor relations in general.

Fraudulent conveyance challenges may occur under the UFCA or the UFTA, because § 544(b) of the Code gives the DIP or the trustee the status of a creditor as of the date of the bankruptcy petition, i.e., § 544(b)(1) incorporates state law into the bankruptcy process and enables the trustee to exercise the rights of creditors under state fraudulent transfer law. The UFCA and UFTA are available to the bankruptcy trustee or the DIP under the foregoing “strong arm” provision of § 544(b), which enables the trustee or DIP to void any transfer of an interest of the debtor in property that is avoidable under applicable state law. The policy of § 548, as well as the UFCA and the UFTA, is to preserve assets of the estate for the benefit of creditors. Under § 548(a)(1) of the Bankruptcy Code, the trustee or DIP can “reach back” two years before the filing of the bankruptcy petition, and seek to avoid as fraudulent any transfer made or obligation incurred by the debtor within that period of time.  However, state fraudulent transfer and conveyance statutes do not require that the transfer be made within two years before the filing of the bankruptcy petition, because the action is independent of bankruptcy.  If the trustee or DIP elects to proceed under state fraudulent transfer or conveyance laws, state statutes of limitation control.

The UFTA contains its own statute of limitations.  The UFTA extinguishes any claim not brought within four years after the transfer was made or the obligation was incurred, unless the fraud was intentional and was not discovered until a later time, in which event the limitations period is extended for an additional year after such discovery. See UFTA section 9(a). Under § 4(a)(2) of the UFTA, a transfer made or obligation incurred “without receiving a reasonably equivalent value in exchange” may be fraudulent as to present and, under two of the three alternative financial tests, future creditors. (The UFCA, in its counterpart constructive-fraud provision, uses the language “without fair consideration” and also considers both present and future creditors.) The UFTA and the UFCA also require that an additional element be present: either under capitalization of the transferor or the incurrence of debts by the transferor beyond its ability to pay.

 At least one court -- considering the similarities in both purpose and language of § 548 and the fraudulent conveyance provisions of the UFTA -- has applied the same “reasonably equivalent value” analysis under both laws to a tax foreclosure sale. See In re Grandote Country Club Co., supra, 252 F.3d at 1152 (noting that transfer of real property was for reasonably equivalent value, and not fraudulent under Colorado UFTA, where defendant acquired property through regularly conducted tax sale under Colorado law subject to competitive bidding procedure). See generally Marie T. Riley, Making Sense of Successor Liability, 31 hofstra l. rev. 745, 763 (2003), n. 85 (“[a]lthough courts interpreting the UFTA (including bankruptcy courts applying UFTA via 11 U.S.C. 544(b)) may consider BFP as persuasive, they are not bound by the holding even in cases involving real property foreclosure sales”).


Application of BFP to Preferential Transfers
Under § 547 of the Bankruptcy Code


Subject to certain affirmative defenses, a transfer to a creditor is deemed a preference and may be set aside by the debtor or the bankruptcy trustee pursuant to § 547(b) of the Bankruptcy Code if the transfer was: (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt; (3) made while the debtor (transferor) was insolvent; (4) made within ninety days of the date a bankruptcy petition is filed or within one year of that date if the transfer was to an insider; and (5) enabled the creditor to receive more than the creditor would receive under a Chapter 7 liquidation proceeding.

The concept of a preferential transfer is a federal bankruptcy law creation. Although the Bankruptcy Code prohibits certain types of preferential transfers, there is generally no counterpart to this avoidance power under state law (including the UFTA and the UFCA). Such preferences generally are not prohibited by state law (although some states do provide a basis to challenge transfers to “insiders”).

Several bankruptcy decisions have dealt with the issue of whether the BFP holding applies to preferential transfers under § 547 of the Bankruptcy Code. Following the Supreme Court’s decision in BFP, the majority of courts has held that a secured creditor that acquires real estate by virtue of being the high bidder at a regularly conducted, non-collusive foreclosure sale has not received an avoidable preference under § 547 even though the property was worth more than the debt.

For example, inNewman v. FIBSA Forwarding, Inc. (In re FIBSA Forwarding, Inc.), 230 B.R. 334 (Bankr. S.D. Tex. 1999), aff'd, 244 B.R. 94 (S.D.Tex.1999), the bankruptcy court held that the Supreme Court’s ruling in BFP -- finding that a regularly conducted, non-collusive foreclosure sale was not a fraudulent transfer under § 548 of the Bankruptcy Code -- should be applied to nullify a challenge to a real estate foreclosure sale on the basis that it constituted a preferential transfer under § 547. The court reached this conclusion even though it acknowledged that the secured creditor had resold the property within a matter of weeks after the foreclosure sale for a substantially greater sum than it had bid to obtain the property. The court also acknowledged that “[a] reasonable businessman or businesswoman would no doubt conclude that the Bank received more in this foreclosure than it would have received in a chapter 7 liquidation.” Id. at 338. But the court nonetheless agreed with the holding of the Supreme Court in BFP that “real property titles were an important element of state law that could not be impinged by federal bankruptcy law without clear textual guidance.” Id. at 340.

Several other courts also have extended BFP’s rationale to § 547. See, e.g., In re Pulcini, 261 B.R. 836 (Bankr. W.D. Pa. 2001),  where the court stated that:

Although BFP dealt with § 548(a), not § 547(b), we believe that the rationale of BFP applies to the present matter with equal force. It compels the conclusion that a pre-petition transfer of a debtor’s interest in real property to a lien creditor who purchases the property at a regularly conducted, non-collusive sheriff’s sale and who then sells the property to a third party for an amount greater than the amount of its lien is not avoidable in accordance with § 547(b) as a preference. In particular, the lien creditor does not “receive more” for purposes of § 547(b)(5) than it would receive in a chapter 7 liquidation. [Emphasis in text].

                                                                                                Id. at 844.

Cases such as In re Pulcini and In re FIBSA Forwarding, Inc., supra, suggest that a Chapter 7 bankruptcy liquidation would produce the same proceeds as a foreclosure sale, and they note that the Supreme Court’s state federalism concerns in BFP regarding state property laws apply equally to § 547 of the Bankruptcy Code.  See also Cottrell v. United States (In re Cottrell), 213 B.R. 33, 43 (Bankr. M.D. Ala. 1997) (affirming bankruptcy court decision that found BFP rationale equally applicable to both § 547 and § 548); Glaser v. Chelec, Inc. (In re Glaser), 2002 WL 32375007 (Bankr. E.D. Va., Oct. 25, 2002), at *11 (“[M]ost courts have held that a secured creditor which acquires real estate by virtue of being the high bidder at a regularly conducted, non-collusive foreclosure sale has not received an avoidable preference simply because the property was worth more than the debt”). In a pre-BFP decision, Ehring v. Western Community Moneycenter (In re Ehring), 900 F.2d 184 (C.A.9, 1990), the court stated that:

A preference exists only when the creditor has received more under the foreclosure than it would have under Chapter 7 liquidation. There is nothing in the statute that prohibits the creditor from purchasing the property in a liquidation sale – just as at foreclosure. In fact, section 547(b)(5) likely presumes a liquidation sale similar to the foreclosure sale forced by the mortgagee. [Citation omitted]. We conclude therefore that a creditor who purchases at a regularly conducted foreclosure sale has not received more than it would have under a Chapter 7 liquidation sale.

Id. at 188-89. The court stated further that:

            If the creditor received “more” it is only because the creditor elected to purchase the property at the foreclosure sale rather than simply accepting the receipts of a sale to a third party. Had the third party outbid the creditor, there could be no preference because the price paid would not have been transferred for an antecedent debt. Since section 547 does not reach a third-party purchaser, it is difficult to see why the existence of a preference should turn on the status of the purchaser as a creditor. If the sale was defective or the purchaser otherwise took unfair advantage of the debtor, the transfer may be voided under section 548, regardless of whether the purchaser was the creditor or a third party. We see no reason to construe section 547 to permit avoidance of an otherwise properly conducted sale based solely on the creditor being the highest bidder.

                                                                                                 Id. at 188.

But other courts have held that BFP does not apply with respect to preference actions under § 547 with respect to foreclosure sales. See, e.g., Rambo v. Chase Manhattan Mtg. Corp. (In re Rambo), 297 B.R. 418, 432 (Bankr. E.D. Pa. 2003) (“Under fraudulent conveyance law, the state prescribed foreclosure sale determines how the property has to be sold. In the preference contest [sic], it is the federal bankruptcy-prescribed sale by a Chapter 7 trustee that is determinative”); Norwest Bank Minn., N.A. v. Andrews, 262 B.R. 299, 306 (Bankr. M.D. Pa. 2001) (rejecting BFP as binding precedent for determining whether foreclosure sale can be avoided as preference under § 547(b)). Cf. JP Morgan Chase Bank v. Rocco (In re Rocco), 319 B.R. 411 (Bankr. W.D. Pa. 2005) (distinguishing Norwest Bank Minn., supra, on basis that record in this case did not support finding that lender’s claim was “substantially less” than fair market value of debtor’s residence); In re Robinson, 2002 WL 31685731, 1 (Bankr. E.D. Pa, Nov. 7, 2002), at *1 (noting that “[t]he case law is divided on whether § 547 can be utilized to avoid a sheriff’s sale”); In re Park North Partners Ltd., 80 B.R. 551, 554-55 (N.D.Ga.1987) (in pre-BFP decision, court held that fully secured creditor received preference when it purchased collateral at foreclosure sale for less than its fair market value, with amount of preference being difference between collateral’s fair market value and secured debt). See generally Craig H. Averch & Blake L. Berryman, Mortgage Foreclosure as a Preference: Does BFP Protect the Lender? 7 j. bankr. l. & Prac. 281, 288-89 (1998) (arguing that BFP does not apply to preferences because it merely holds that the operative legal standard under 548, “reasonably equivalent value,” is ambiguous).


The Villarreal Decision


In a recent Texas bankruptcy court decision, Villarreal v. Showalter (In re Villarreal), 413 B.R. 633 (S.D. Tex., 2009), the bankruptcy court held, in a Chapter 13 adversary proceeding brought by the debtors against the bankruptcy trustee, that BFP did not preclude the court from voiding a pre-bankruptcy sale of the debtor’s property as a preferential transfer under § 547 of the Bankruptcy Code. The court found that even though the foreclosure was conducted in accordance with state law, it enabled the lender to receive significantly more than it would have received in a Chapter 7 liquidation. With respect to the actual value of the property, the court noted that the lender’s appraiser had appraised the property at more than $4 million shortly after the foreclosure sale and that the lender, as the creditor-bidder, received at least $3,250,000 (the total debts against the property were less than $750,000) to satisfy the remainder of its $70,000 claim. The court concluded that in a hypothetical Chapter 7 liquidation the lender would have been paid approximately $100,000. The court noted that “[a]fter the Supreme Court’s decision in BFP, courts split in their application of § 547(b)(5) of the [Bankruptcy] Code.” Id. at 638. Although acknowledging that other courts assumed that the BFP analysis applied to § 547(b)(5), the court rejected this reasoning based on the plain language of § 547(b)(5). The court stated that:

The language of § 547 does not allow this Court to compare values at the moment of the foreclosure. Rather, § 547(b)(5) avoids transfers that enable a creditor to receive “more” than the creditor would have received under a hypothetical chapter 7 liquidation. 11 U.S.C. § 547(b)(5). Accordingly, § 547 mandates the comparison of values at different points in time by requiring the Court to compare the actual value received by the creditor at the moment of foreclosure with the amount that the creditor would have received if “the transfer had not been made.11 U.S.C. § 547(b)(5). Sections 547(b)(5)(A) and (C) require the consideration of a hypothetical transfer not at a foreclosure sale but “to the extent provided by the provisions of this title.” Accordingly, the Court must determine how distributions in this case would have been made in a hypothetical chapter 7 liquidation. [Emphasis in text.]

                                                                                                Id. at 639.

            The court stated further that:

This result -- a different economic result than would occur under § 548 -- arises because a chapter 7 liquidation does not have the same constraints as a foreclosure sale. A chapter 7 liquidation affords the trustee the time to orchestrate an orderly sale that produces a greater value than would be received at a foreclosure sale.


The court in In re Villarreal reasoned that there is no language in § 547 with respect to resolving policy issues such as the meaning of “reasonably equivalent value” contained in § 548 (which language does not appear in § 547). The court concluded that a Chapter 7 trustee (as opposed to a Chapter 11 trustee) “has the time and incentive to promote a competitive auction or of to find a buyer willing to pay a fair market value.” Id. at 641.  See generally Allison E. Graves, Creditors Beware: Foreclosure Sale Avoided As Preferential Transfer Under § 547(b) of the Bankruptcy Code When Sale Resulted in Creditor Receiving More Than it Would Have in a Chapter 7 Liquidation, ABA Section of Real Property, Trust & Estate Law, eReport (December, 2009) (discussing and analyzing In re Villarreal and BFP decisions with respect to preferential transfers under § 547 of Bankruptcy Code). 

The court also concluded that it was not bound by stare decisis to follow the decision in In re FIBSA Forwarding, Inc., supra, stating that “FIBSA is a decision reached by United States Bankruptcy Judge Steen and affirmed by United States District Judge Ellison of this District. This Court concludes that -- although such an opinion deserves great deference -- it is not binding on this Court.” In re Villarreal, supra, 413 B.R. at 640. Most bankruptcy judges state that they are bound only by decisions handed down by the U.S. Supreme Court and their respective Circuit Court of Appeals.  Cases from other circuit courts, district courts outside their district, the District Court for the district in which they sit, or even other bankruptcy judges within their district, may support an argument but generally are not binding on bankruptcy judges. But see In re DePugh, 409 B.R. 125, 131 (Bankr. S.D. Tex. 2009) (stating that district court decisions are binding precedent for bankruptcy courts within same district); In re, Inc., 283 B.R. 209, 218 (Bankr. N.D. Tex. 2002) (decisions from district court on appeal are binding precedent for bankruptcy courts in this district); John C. Murray, The Lender’s Guide to Single-Asset Real Estate Bankruptcies, 31 real prop. prob. & tr. j. 393, 411 (1996)].

Note, however, that a preference challenge, such as decided by the court in In re Villarreal, supra, only applies if the secured creditor bids in its debt, and not if the “windfall” instead goes to a third party who successfully bids for the property at the foreclosure sale. This is so because a preference must be a transfer to a creditor on account of an antecedent debt under § 547(b)(2) of the Bankruptcy Code. A third-party purchaser could only be subject to a challenge based on being a recipient of a fraudulent transfer under § 548 of the Bankruptcy Code – which is what the court in BFP ruled out. An interesting implication is that the lender may decide to purchase the property at the foreclosure sale through a subsidiary or affiliate that bids up to the amount of the debt – particularly since it is a common practice for lenders to place their real estate in real-estate subsidiaries or affiliates, or new special purpose entities. The cash might indirectly flow to the lender, but since it is only the amount of the secured debt, it is not a preference. The purchase by the subsidiary or affiliate is protected by the BFP decision (but a trustee may argue that this a subterfuge based on form over substance, and there may be regulatory issues if the subsidiary or affiliate, rather than the creditor, books the income).[1]

On August 24, 2009, at 2009 WL 2601298, the bankruptcy court granted the debtor’s motion to certify an appeal to the Fifth Circuit Court of Appeals, concluding that:

Because the Court’s judgment reaches a decision on a bankruptcy issue not previously decided by this Circuit or by the Supreme Court, this Court certifies this matter for a direct appeal to the United States Court of Appeals for the Fifth Circuit.

Id. at *2.

            The author is unaware, as of the date of this article, of any further action taken by the Fifth Circuit Court of Appeals with respect to this case.


Concerns of Title Insurers


It will be interesting to see if other bankruptcy courts follow the court’s reasoning in In re Villarreal. As a result of: 1) the court’s ruling in that case (as well as other cases holding that BFP does not apply to preferential transfers under § 547); 2) the continued downturn in the real-estate markets; 3) significant increases in personal and business bankruptcy filings, and; 4) other reasons related to the nature of and challenges associated with underwriting creditors’ rights risk arising out of the insured transaction, title insurers generally are no longer willing to delete the creditors’ rights exclusion or issue the ALTA Form 21 or 21-06 Creditors’ Rights Endorsement. The ALTA Form 21 or 21-06 Creditors’ Rights Endorsement (which, when it was available, and subject to significant underwriting due diligence that ultimately proved to be beyond the core competency of title insurance underwriters generally) insured against loss because of the occurrence, on or before the date of the policy, of a fraudulent transfer or preference under federal bankruptcy law or state insolvency or creditors’ rights laws.[2] In light of the foregoing, it would be prudent for a purchaser or lender to increase the scope and thoroughness of its own due diligence prior to purchasing a property or making a mortgage loan. Also, a mortgage lender would be well advised to obtain a current appraisal from an independent reputable appraiser at or near the time of the foreclosure sale to support the lender’s position -- assuming that such is the case -- that it did not receive more than it would have as the result of a Chapter 7 liquidation.

It is important to note that the basic title insurance forms still cover fraudulent and preferential transfer risk that may exist in the past chain of title, i.e.  arising from transfers in the title chain prior to the present transaction being insured.  Therefore, title insurance underwriters will be alert to these issues, particularly where title is derived from a foreclosure or deed-in-lieu or other transfer as to which the applicable statute of limitations has not yet run, and are likely to impose underwriting requirements as part of their underwriting due diligence in order to determine whether title can safely be insured free of exception for the risk of a challenge of this nature arising out of a prior transfer. 




The U.S. Supreme Court, in the BFP case, declined to apply § 548 of the Bankruptcy Code to void a pre-bankruptcy petition foreclosure sale, holding that “a fair and proper price, or a ‘reasonably equivalent value,’ is the price in fact received at the foreclosure sale, so long as all the requirements of the State’s foreclosure law have been complied with.” BFP v. Resolution Trust Corp. supra, 511 U.S. at 545. But uncertainty remains as to whether the BFP rationale applies to non-judicial “strict” foreclosures in states that permit such proceedings. There is also uncertainty as to whether the holding applies to tax foreclosure sales, tax forfeitures, and certain other non-judicial sales, or (as evidenced by the recent Villarreal case, supra) with respect to preferential transfers under § 547 of the Bankruptcy Code.

These types of issues so far have been (and are likely to continue to be) decided on a case-by-case basis based on the facts of the particular case and applicable state law. The burden in such situations will be on the creditor to clearly establish that all substantive requirements and procedural safeguards were strictly complied with to render the sale sufficiently analogous to the foreclosure-sale context of the BFP decision. With respect to a voluntary recovery of the real property security by the lender pursuant to a deed in lieu of foreclosure where there is no auction or arms-length sale, it appears clear that the lender will not be entitled to the “safe harbor” of BFP. In this situation the lender would be well advised, before agreeing to accept a deed from the borrower, to obtain an independent appraisal establishing that that the value of the property is less than the outstanding indebtedness. There is also uncertainty as to whether the BFP decision applies to foreclosure sales that could be deemed preferential transfers in violation of § 547 of the Bankruptcy Code, which section does not contain the language “reasonably equivalent value.” Such “loose ends” in connection with the application of BFP to certain factual situations other than conventional real-estate foreclosure sales create problems for lenders (and title insurers) because, as noted above, they are addressed by the bankruptcy courts on a case-by-case basis, and the decisions are often conflicting. One of the reasons given by the Supreme Court for its holding in BFP was that the states have an essential interest in the security of their real estate titles and that the Supreme Court would not impute into the phrase “reasonably equivalent value” a Congressional intent to displace that interest. But this worthwhile result unfortunately does not necessarily (or universally) apply to other forced-sale situations, to deeds in lieu of foreclosure, or to preference claims under § 547 of the Bankruptcy Code. Practitioners would be well advised to be cautious when seeking to invoke BFP in these situations and should closely monitor existing and developing case law in this area to determine if a particular factual situation falls within the Supreme Court’s holding in BFP


* Nothing contained in this Article is to be considered as the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. This Article is intended for educational and informational purposes only. The views and opinions expressed in this Article are solely those of the Author, and do not necessarily reflect the views, opinions, or policies of the Author’s employer, First American Title Insurance Company.
** John C. Murray is Vice President and Special Counsel for the First American Title Insurance Company, National Commercial Services, in Chicago.
[1]  See generally Prof. Dan Schechter, Oversecured Creditor Who Submits Successful Credit Bid at Foreclosure Sale Receives Preferential Transfer When Value of Property Exceeds Amount of Bid (In re Villarreal (Bankr. S.D. Tex.)),  2009 comm. fin. news 74, 74 (2009) (concluding that borrowers seeking to void foreclosures will be much more likely to file bankruptcy petitions within 90 days after foreclosure proceeding in order to take advantage of cases such as In re Villarreal, and stating that “The Supreme Court in BFP was trying to put a stop to the strategic use of bankruptcy as a means of overturning foreclosure sales. Instead of attacking foreclosures as fraudulent transfers, bankrupt debtors will now attack them as preferences.”)
[2]  The applicable regulatory agencies or Departments of Insurance in several states have withdrawn approval of the Creditors’ Rights Endorsement and it is likely that other states are considering similar actions. (Note: ALTA and CLTA decertified the Creditors’ Rights Endorsement in February 2010. Creditors’ rights coverage pertaining to the insured transaction itself has never been permitted as a regulatory matter by the title insurance regulators in Florida, New York, Texas or New Mexico.  At various points during 2010, the states of New Jersey, Pennsylvania, Delaware, Ohio and Oregon  decertified/withdrew the ALTA Form 21/21-06 or any other form of endorsement affording creditors’ rights coverage.)


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