Preference actions have been vexing creditors for as long as the Bankruptcy Code has been around. Indeed, a creditor who receives a pre-petition transfer in violation of the preference statute may have to give the transferred asset back to the debtor—even if the creditor did nothing wrong. See 11 U.S.C. § 547(b).
More often than not, the “transfers” at issue in preference actions involve pre-petition payments to vendors. In In re Hackler and Stelzle-Hackler, 938 F.3d 473 (3rd Cir. 2019), however, the Third Circuit had the occasion to analyze a more unique situation where the “transfer” at issue was caused by a tax lien foreclosure. The Third Circuit held that the tax sale violated the preference statute and, therefore, could be avoided.
Facts
The Hackler family (Hacklers) owned real property in New Jersey. In 2013, they failed to pay taxes and the township sold the resulting tax lien at public auction. Like many jurisdictions, the auction calls for bids only on the interest rate to accrue on the unpaid taxes; in other words, the auction does not call for bids that correspond to the actual value of the property.
In 2016, the tax lien certificate holder (the “Buyer”) filed for foreclosure. When the Hacklers did not redeem, a final judgment vested title to the property to the Buyer (i.e., the “Transfer”). At the time, the Buyer was only owed approximately $45,000 in past due taxes, other liens totaled only about $89,000, and the property’s value was approximately $335,000. Less than ninety 90 days later, the Hacklers filed for bankruptcy and immediately filed a preference action to avoid the Transfer.
The Arguments
The Hacklers argued that the foreclosure sale met all the requirements for a preference under 11 U.S.C. § 547(b) and, therefore, the sale could be avoided. Indeed, the sale was (1) for the benefit of the Buyer/creditor, (2) on account of a pre-existing debt, (3) made while the debtors were insolvent, (4) made within 90 days of the petition, and (5) allowed the Buyer/creditor to receive more than it would be entitled to receive under a chapter 7 liquidation (i.e., $45,000). The Third Circuit agreed that the sale satisfied all of the elements of the preference statute and its “reading of it end[ed] there.” 938 F.3d at 478.
The Buyer primarily argued that a lawfully-conducted state tax foreclosure cannot constitute a voidable preference under BFP v. Resolution Trust Corp, 511 U.S. 531 (1994). BFP v. Resolution Trust Corp. held that a non-collusive and regularly conducted foreclosure sale by a secured creditor could not constitute a fraudulent transfer because the sale price automatically satisfies the “reasonably equivalent value” prong of 11 U.S.C. § 548. This ruling respected state law and the states’ interest in protecting the stability of real estate titles. Indeed, the Supreme Court reasoned that if it allowed the Bankruptcy Code to undermine validly conducted mortgage foreclosure sales, then “[t]he title of every piece of realty purchased at foreclosure would be under a federally created cloud.” 511 U.S. at 544. BFP seemed to warn against creating such a disruption to state procedures through an interpretation of the Bankruptcy Code.
The Buyer glommed onto this warning and argued that BFP stood for the proposition that absent a clear statement from Congress showing an intent to displace state-regulated foreclosure sales, the Bankruptcy Code should not be construed to displace state law. In other words, federalism principles should lead to an outcome where tax sales under state law should not be set aside under federal bankruptcy law.
Showing little concern for the impact of its ruling on federalism principles, the Third Circuit distinguished BFP in two ways. First, BFP considered a fraudulent transfer under § 548 whereas the Transfer implicated preference concerns under § 547. Thus, the issues were materially different. Indeed, BFP turned on the interpretation of the phrase “reasonably equivalent value”—which does not appear in the preference statute. Second, the mortgage foreclosure process analyzed under BFP involved a public auction tied to actual value of the property itself. By contrast, the tax sale did not. Thus, the Hacklers’ property was never subjected to a real auction based on the value of the property. The Hackler court relied on these distinctions to distinguish BFP and other cases.
Some may view the Hackler court’s reliance on the presence of public auctions as a seemingly odd distinction. Indeed, whether property is sold for fair value is not an element of a preference claim under § 547. Rather, the only valuation at issue in a preference is whether the creditor received more from the transfer than it would have received in a chapter 7 liquidation. Nevertheless, the Third Circuit seemed to believe that whether or not a public auction occurred was a material factor in whether a sale could be avoided.
The Third Circuit also expressed little concern over federalism principles. For example, in addressing the BFP concerns directly, the Third Circuit concluded that “while a debtor’s filing for bankruptcy may impose a cloud on the title of her foreclosed property, we believe such a result to be mandated by the Code.” 938 F.3d at 480. Thus, the Third Circuit was not persuaded that tax sales under state law should be entitled to any special exception from the preference statute. It, therefore, affirmed the avoidance of the Transfer.
Impact of In re Hackler
Hackler itself acknowledges that its outcome places a cloud over the title to property that is purchased by a creditor at a tax or mortgage foreclosure sale for less than fair market value. A concern with this result is that after any such sale, the former owner could file for bankruptcy within 90 days of the sale, file a preference action and undo the transfer. Since Hackler addressed a foreclosure process that did not allow competitive bidding and distinguished that case from those involving competitive bidding, such preference actions may be more likely in situations involving foreclosure proceedings that do not contain an element of competitive bidding—such as with many tax sales. Nevertheless, the disruption that these types of actions could cause on otherwise final sales under state law could be immense.
The Hackler reasoning, however, is not universally accepted. For example, some courts within the Ninth Circuit hold that foreclosure sales may not be avoided as preferences. In In re Ehring, 900 F.2d 184 (9th Cir. 1990), the creditor held a mortgage against the debtor’s property, purchased it at a foreclosure sale and resold the property for a profit of approximately $110,000—all within the 90-day preference period. The Ninth Circuit held that the transfer was not a preference because it did not enable the foreclosing creditor to receive more than it would have in a chapter 7 liquidation. The Ninth Circuit reasoned that if the creditor received more, it was because it elected to credit bid at the sale and was not outbid by a third party. Had a third party outbid the creditor, there would not have been a preference because the creditor would have been paid only the amount it was owed, and the preference statute does not reach third-party purchasers. Thus, “it is difficult to see why the existence of a preference should turn on the status of the purchaser as a creditor.” 900 F.2d at 188. The Ninth Circuit “saw no reason to construe section 547 to permit avoidance of an otherwise properly conducted foreclosure sale based solely on being the highest bidder” and concluded that “a creditor who purchases at a regularly conducted foreclosure sale has not received more that it would have under a chapter 7 liquidation sale.” Id. at 189.
In In re Tracht Gut, LLC, 836 F.3d 1146, 1149 (9th Cir. 2016), the Ninth Circuit held that a tax foreclosure sale could not be set aside as a fraudulent conveyance because California’s tax sales had the same procedural safeguards as California’s mortgage foreclosure sale at issue in BFP. Although Tracht Gut was not a preference case, it suggested that the rationale of the Third Circuit in Hackler may have some validity in cases where there is not an opportunity for competitive bidding at a foreclosure sale because BFP noted “forced sales (to satisfy tax liens, for example) may be different,” id. at 1152 (quoting BFP, 511 U.S. at 537, n. 3), and distinguished a New Jersey bankruptcy decision refusing to apply BFP to tax foreclosures. Id. at 1154 (discussing Berkey Assocs. v. Eckert (In re Berley Assocs.), 492 B.R. 433, 440-41 (Bankr. D. N.J. 2013)).
One bankruptcy court within the Ninth Circuit has expressly rejected the bankruptcy court’s decision in Hackler—i.e., the decision affirmed by the Third Circuit. See In re Hull, 591 B.R. 25 (Bankr. D. Or. 2018) (rejecting In re Hackler, 571 B.R. 662 (Bankr. D. N.J. 2017)). The property at issue in Hull was worth between $60,000 and $80,000 and subject to property taxes of just $4,915.78. The county obtained a September 25, 2015 foreclosure judgment which constitutes a certificate of sale to the county. That judgment was entered on the court’s registry on September 28, 2015, and subject to a two-year right of redemption. State law provided that if the property was not timely redeemed, it would be deeded to the county on the day following the expiration of the redemption period. The debtors failed to redeem the property and it was deeded to the county on September 27, 2017. The debtors filed for bankruptcy on October 27, 2017 and sought to have the transfer avoided as a preference. The Hull court ruled that the September 25, 2015 judgment constituted a transfer which occurred outside of the 90-day preference period and the expiration of the redemption right was not a transfer. Id. at 28-29. The Hull Court also held the conclusion that the transfer occurred when the judgment was entered rather than the date the deed was recorded was consistent with 11 U.S.C. 547(e)(2) because the transfer was perfected when the judgment was entered into the court’s registry on September 28, 2015. Id. at 31. The Hull Court distinguished Hackler on the primary basis that Oregon law was different than New Jersey law. Id. at 30-31. Hull did not consider the lack of competitive bidding when it held the tax foreclosure was not a preference.
Conclusion
Hackler, BFP, Ehring, Tracht Gut, and Hull all relied on wildly different factors to reach their conclusions. This disparate approach demonstrates that there is not even agreement amongst the courts on what the relevant test is—or should be—for determining whether non-consensual transfers of these types can, or should, be avoided. Courts that are persuaded by Hackler will likely introduce a relatively new issue in future preference litigation involving mortgage and tax foreclosures: i.e., whether the sale was subject to competitive bidding. This may be viewed by some as somewhat odd, because the presence or absence of competitive bidding is not contemplated by the preference statute. Instead, the test under § 547(b)(5) is whether the transfer enabled the creditor to receive more than it would in a Chapter 7 liquidation. Going forward, it will be interesting to see whether other courts: (i) will consider the presence or absence of competitive bidding in future preference cases; or (ii) federalism issues convince other judges to conclude that federal law should not disrupt valid foreclosures under state law.
