The following is a case update written by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), analyzing a recent decision of interest:
After a thorough review of competing case law on the issue, a bankruptcy court in Massachusetts denied a City’s request to apply the reasoning of BFP v Resolution Trust Corporation, 511 U.S. 531 (1994) (holding that the price received at a mortgage foreclosure auction satisfied the requirement for reasonably equivalent value to avoid a fraudulent transfer action) to the Massachusetts property tax strict foreclosure scheme which results in a tax taking, rather than an auction. In doing so, the court concluded that by not excepting tax sales from section 548 of the Bankruptcy Code, Congress displayed a policy choice that reasonably equivalent value must be obtained for a transfer of a debtor’s property for the benefit of the unsecured creditors and a state’s interest in assuring citizens pay their taxes did not trump that policy. Yourelo Your Full-Service Relocation Corp. v City of Revere (In re Yourelo Your Full-Service Relocation Corp.), 2020 WL 6927549 (Bankr. D. Mass 11/23/20). To view the opinion, click here.
Debtor Yourelo Your Full-Service Relocation Corp. (Debtor) owned real property (the Property) in the City of Revere, Massachusetts (City). In June 2017 the City assessed real estate taxes and related costs against the Property in the sum of $120,564.19. In October 2019 the City obtained a judgment from the Massachusetts Land Court and recorded the judgment with the Registry of Deeds. This recording foreclosed the Debtor’s equity of redemption and transferred absolute title to the Property to the City (the Transfer). Soon thereafter the Debtor filed a chapter 11 petition in the bankruptcy court and brought an adversary proceeding against the City, asserting that the transfer was a constructive fraudulent transfer. The complaint alleged that the City had appraised the value of the Property at $684,100.00 and that the fair value of the Property was substantially greater than the amount of the foreclosed tax obligations.
The City filed a motion to dismiss the complaint, asserting that as a matter of law the Transfer could not be a fraudulent transfer because it had conducted a strict foreclosure of a tax lien in compliance with applicable state law, despite the fact that the value of the property significantly exceeded the amount of the tax debt. It argued that the bankruptcy court should adopt the reasoning of the Supreme Court in BFP (as described above) to insulate the City from potential exposure to the avoidance action. It pointed out that a “tax taking” followed by strict foreclosure is the prevailing method used to collect unpaid property taxes in Massachusetts. The Debtor distinguished the facts of BFP from the current circumstance because Massachusetts’s strict foreclosure proceeding did not test the value of the Property via an auction or other due process procedure and, unlike a surplus bid in a mortgage foreclosure, the surplus goes to the City rather than the property owner.
The bankruptcy court denied the motion to dismiss and allowed the claim under section 548 for a constructive fraudulent transfer to proceed.
The court recognized that the issue before it – whether a property subject to a prepetition tax sale could be recovered by a bankruptcy estate as a fraudulent transfer – had been widely litigated around the country, with differing results. In allowing the fraudulent transfer action to proceed, it joined the majority of the courts, particularly when the state procedure did not result in a public auction. It compared the due process protections accorded to the property owner in the mortgage foreclosure setting such as happened in BFP to the procedures followed under Massachusetts law. Unlike a mortgage foreclosure which culminates after notice in a public auction, the Massachusetts tax taking required only a showing of default by the property owner after ample notice to cure and then the issuance of a judgment in favor of the City based on that default. Once the City recorded the judgment, the Debtor’s interest in the Property was severed and the full value of the Property belonged to the City, creating a windfall in the present case. The court found this difference in the due process rights established by the procedure to make the reasoning of BFP inapplicable.
In reviewing the plethora of cases which came down on both sides of the issue, the court noted that if the tax foreclosure process culminated in an auction, the facts more closely resembled those in BFP and some courts found for the taxing agency, particularly if any surplus inured to the debtor. Plus, a small minority of the cases ruled that so long as the state-mandated foreclosure procedure was strictly followed, the policies supporting the state’s interest in collecting its taxes outweighed those protected by the bankruptcy statute. The Massachusetts court rejected that minority view and ruled that the procedural due process protections afforded the taxpayer by the Massachusetts strict foreclosure statute do not immunize the City from the fraudulent conveyance claim. The lack of competitive bidding and exposure to market forces to obtain fair value for the Property made the presumption of “reasonably equivalent value” found in BFP inapposite here.
I have followed this issue at the bankruptcy court level closely (few appellate courts have addressed it; the cases seem to settle before appellate review) and agree with the majority view adopted by the Massachusetts court because it balances the ultimate need of the public agency to enforce its tax collection rights while at the same time preserving excess equity established by the property’s fair value for the creditors of the estate. The Supreme Court’s determination that “fair value” was received in BFP turned on the public exposure to the market and competitive bidding for the property at the auction sale, protections which are glaringly absent in the strict tax taking followed here. That the City followed the state mandated procedure precisely is insufficient due process to justify the “taking” of excess equity from the debtor and therefore its creditors in a bankruptcy.
This case can be very useful to the practitioner who faces this issue, from either side of the bar. The review of the reported cases is extensive, with a thorough collection of cases on both sides of the conflict. Included in that review is an analysis of the different outcomes depending on just how much due process is allotted under any particular state’s procedures and how that has affected the ultimate determination of some courts. In addition to the collected cases, the court also cites to a recent law review article – Bartell, Tax Foreclosures as Fraudulent Transfers – Are Auctions Really Necessary, 93 AM BANKR. L.J. 681 (Winter 2019) – which might be worth a read before preparing a brief on this issue.
These materials were authored by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.) a member of the ad hoc group, with editorial contributions by Monique D. Jewett-Brewster, a shareholder-elect with Hopkins & Carley, ALC, a member of the ad hoc group and a past Chair of the CLA Business Law Section. 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.