As stated in Doug Waldorf’s post below, the concept of property valuation in regards to a deficiency judgment is well established within the Eleventh Circuit. The fair market value of the property is established at the foreclosure sale. When foreclosure and bankruptcy cross paths, however, other considerations come into play, and it is important that lenders understand their rights in such situations.

Take for example a scenario in which a lender sells a foreclosed piece of property, and immediately after the property is sold, the debtor files for bankruptcy. A debtor may shortly thereafter file an adversary proceeding under §§ 547 or 548 of the Bankruptcy Code, alleging a fraudulent or preferential transfer, in an attempt to set aside the foreclosure sale.

These two code sections ensure that a creditor receives no more, nor a debtor any less than it deserves as a result of such transfers. Under § 548, a constructive fraudulent transfer occurs when the debtor receives less than a reasonably equivalent value in exchange for such transfer. In 1994 the Supreme Court clarified that the “fair and proper price for foreclosed property, 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.” Thus, in an otherwise valid foreclosure sale, the price received by the creditor will always have “equivalent value” under § 548.

Until very recently, courts have treated transfers under § 547 similarly, although the preferential transfer valuation test is different than the fraudulent transfer “equivalent value” test in § 548. Specifically, § 547(b)(5) allows a transfer to be voided as preferential if it enables a creditor to receive more than it would have under a “hypothetical” Chapter 7 liquidation.

What happens, however, when a creditor with a claim of $70,000 purchases a property appraised at $4 million (by the creditor’s own appraiser) for $70,000 at a pre-petition foreclosure sale? The creditor argued that the Supreme Court had definitively settled the issue, the price paid at the foreclosure sale was the “equivalent value” of the property, and the bankruptcy court did not have the right to set aside the sale. The debtor, however, argued that the transfer enabled the creditor to receive a windfall, and far more than it would have received on its claim under a Chapter 7 liquidation.

The court for the Southern District of Texas (and a year later in a similar case, the Northern District of Texas) agreed with the debtor, finding that a Chapter 7 trustee would “secure more than the foreclosing creditor will on his own [and, therefore], the policies of the Code are furthered if a secured creditor can be prevented from reclaiming property and earning a windfall at the expense of the estate.”

Although most jurisdictions have rejected similar arguments in the past, choosing instead to extend the Supreme Court’s § 548 valuation test to similar § 547 transfers, these recent hypertextual interpretations of § 547 may open the door for debtors to challenge alleged “windfalls” that a secured creditor may receive by foreclosing on property and purchasing it at a prepetition foreclosure sale. Such a shift in policy has the potential to significantly affect a lender’s right to enforce the foreclosure sale of a property on which the creditor foreclosed prior to the debtor filing for bankruptcy relief.