Bankruptcy & Finance

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Gordon Rees Scully Mansukhani, LLP

Megan Adeyemo

Executive Editor, Bankruptcy & Finance
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Robinson and Cole

Michael Enright

Contributing Editor, Bankruptcy & Finance
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MONTH-IN-BRIEF (Jun 2022)

County’s Tax Lien Foreclosure Avoidable as a Fraudulent Transfer

By Michael Enright

The Supreme Court broadly protected mortgage foreclosure sales conducted in accordance with applicable state law from avoidance as constructive fraudulent transfers (based on receipt of less than reasonably equivalent value from the sale) in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994). Ever since then, owners whose properties have been foreclosed have litigated over the scope of BFP’s protection in subsequently filed bankruptcy cases. Recently, the Court of Appeals for the Second Circuit grappled with such an issue in Gunsalus v. County of Ontario, New York, No. 20-3865-bk (2d Cir. June 27, 2022). There, a couple that owned a house in Ontario County free and clear of any mortgage failed to timely pay real estate taxes on the property, subjecting the property to a tax lien in the amount of $1,290. The County provided all required notices and then filed an in rem tax foreclosure action under New York’s Real Property Tax Law. The owners contested the foreclosure action, but lost, and the state court entered a final judgment granting title to the County. After acquiring title, the County scheduled an auction of the property and sold it for $22,000. Although the unpaid tax bill had only been $1,290, New York law permitted the County to pocket the difference, which it did. The owners then filed a chapter 13 case and a plan that provided for payment in full of the tax debt plus 12% interest. They filed an adversary proceeding to avoid the tax foreclosure as a constructively fraudulent transfer. The Bankruptcy Court dismissed the fraudulent transfer action in reliance on BFP, holding that it entitled the County to a presumption that the foreclosure provided reasonably equivalent value. The District Court reversed, and the matter went up to the Court of Appeals. The Court of Appeals affirmed the District Court, holding for the couple who owned the house, noting language in BFP that limited the scope of its holding to mortgage foreclosures because the considerations bearing on other types of foreclosures, such as tax liens, may be different. The Court of Appeals focused on the strict foreclosure that gave title to the home to the County in exchange for satisfaction of the $1,290 tax lien and not the County’s subsequent sale to a third-party purchaser for $22,000, which was conducted solely for the benefit of the County and yielded a surplus for which the County was not accountable to other creditors. As the court noted, “[s]uffice it to say that under no reasonable calculus do these procedures convey to the debtor value that is substantially comparable to the worth of the transferred property.” The County’s position would provide a windfall to the County at the expense of the estate, the other creditors, and the debtors and “would produce results that are fundamentally at odds with the goals of bankruptcy law.” The court’s ruling will no doubt provide comfort to similarly situated debtors. However, the scope of the presumption of BFP remains subject to uncertainty given the wide variety of tax lien foreclosure processes across fifty different states, and the details of the different methods may create distinctions that will continue to plague the lower courts faced with assertions of constructive fraud in pre-bankruptcy foreclosure proceedings concerning the debtor’s real property.

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