The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D.CA, Ret.), analyzing a recent decision of interest:
A bankruptcy court in the Eastern District of Michigan (the Court) ruled that a state court judgment for foreclosure of tax claims and the subsequent sale of the debtor’s residence were not fraudulent transfers under Bankruptcy Code § 548. West v State of Michigan (In re West), 2022 WL 1309939 (Bankr. E.D. Mich. May 2, 2022).
To view the opinion, click here.
Debtor Joseph West purchased a home in Owosso, Michigan (the Owosso property) in Shiawassee County (the County) in 2016 for $130,000. He did not pay property taxes due on the Owosso property between 2018 and 2020. The State of Michigan (the State), as the Foreclosing Governmental Unit for the County, sought and received a judgment of foreclosure in February 2021. The debtor did not appeal the judgment nor did he redeem the property as allowed by statute.
In July 2021, the debtor filed a chapter 13 case. In his schedules he exempted equity in the Owosso property and disclosed two tax liens for a total of $13,000, arising from unpaid taxes in 2018-2020. His chapter 13 plan proposed to pay the County the unpaid taxes over the plan term and further provided that “the Shiawassee County Treasurer shall set aside the Judgment of Foreclosure…and title to the property shall re-vest in the Debtor.” (Emphasis added by the Court.) In August 2021 the Owosso property was sold at a public auction for $160,000. In December 2021 the debtor filed an adversary complaint against the buyers at auction, the County, and the State to set aside the tax foreclosure sale as a fraudulent transfer under § 548.
The State filed a motion to dismiss, arguing that (1) the Rooker-Feldman doctrine precluded the Court from reviewing or setting aside the state court judgment of foreclosure and (2) the State’s actions were consistent with state tax foreclosure laws and therefore a fraudulent transfer claim was precluded. The Court concluded that the Rooker-Feldman doctrine did not deprive it of jurisdiction because the relief sought by the debtor was not a review of the merits of the foreclosure judgment but rather whether that judgment could be set aside under federal bankruptcy law. However, the Court found that the debtor failed to state a § 548 claim and granted the motion to dismiss.
The debtor asserted that the value the State received from the auction of the Owosso property far exceeded the amount owed for back taxes and therefore it had not given reasonably equivalent value for the transferred property. In dismissing that claim the Court looked first to the Supreme Court’s seminal ruling on § 548 in a foreclosure context, BFP v Resolution Trust Corp., 511 U.S. 531 (1994), where it held the if a state’s foreclosure law had been complied with, the price received at a mortgage foreclosure sale conclusively established reasonably equivalent value. However, the Court recognized that case law had often drawn a distinction between a mortgage foreclosure sale and a tax lien sale. That distinction was in play here, but also in play was that Michigan had recently amended its foreclosure law because of a Sixth Circuit opinion, Lowry v Southfield Neighborhood Revitalization Initiative, 2021 WL 6112972 (6th Cir. 2021. The Sixth Circuit had ruled that a right of first refusal under the earlier Michigan foreclosure law, which allowed the State or County to purchase a tax-foreclosed property for an amount equal to the unpaid taxes before it was offered to the public, prevented such sale from automatically being reasonably equivalent value under the BFP precedent because the exercise of the right of first refusal did not market-test the value.
In the face of that ruling—and one by the Michigan Supreme Court that the State’s retention of foreclosures sale proceeds over and above the taxes constituted an unconstitutional taking—the Michigan legislature amended its statute, eliminating the right of first refusal and also creating a procedure to allow the foreclosed property owner to recover surplus proceeds. Those amendments allowed the holding of BFP to apply to future Michigan tax sales, such as of the Owosso property, because a public auction was held to establish reasonably equivalent value and the debtor could follow the established procedure to receive any surplus funds. Since the state laws no longer created a taking and the sale price was established by auction, no fraudulent transfer claim could stand.
This decision is consistent with others which have found that some tax lien sales may not be set aside as fraudulent transfers. However, that conclusion has not been universally reached when analyzing a tax foreclosure sale because state tax foreclosure statutes differ and will control the outcome of any § 548 action. If those procedures allow closed bidding, either by the government or through some government-controlled sale procedure, such that the property may be purchased for only the amount of the tax default, then the principles of BFP are usually found to be inapplicable because there was no public auction to set the price paid. On the other hand, if the sale is by way of public auction, then the indicia for receiving a fair market value for a tax foreclosed property will apply and the courts generally will find the price to be the reasonably equivalent value. Any debtor’s counsel who is seeking to set aside a prepetition tax sale must become familiar with his or her state’s procedures to determine whether a public auction controlled the price or whether the payment of only the defaulted taxes had been sufficient for the sale.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D.CA, Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.