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February 17, 2022

In Rem Tax Lien Foreclosure Sales Under Attack

It is well known that real property taxes are liens on taxed property and that a taxing municipality or authority (taxing authorities) has the power to enforce its lien against the  property. Enforcement is often effected by an in rem foreclosure action against the property, with the property being considered responsible for payment. Although procedures for enforcement of tax liens can vary substantially from one jurisdiction to the next (sometimes within the same state or county), the process and goal are generally the same—judicial or nonjudicial foreclosure of the lien followed by either selling the property at public auction or transferring the title to the taxing authority, which then either sells the property or permits it to be redeemed by the owner.

Notwithstanding the procedure used, taxing authorities desire the outcome of their in rem foreclosure proceedings to be predictable, both to obtain payment of the past-due taxes and, equally important, to maintain the integrity of the foreclosure process so as not to discourage potential purchasers from participating in future sales.

In recent years, a number of bankruptcy courts, federal district courts, and circuit courts of appeal have determined that tax sales can be challenged as fraudulent transfers under section 548 of the United States Bankruptcy Code as not having realized “reasonably equivalent value” as measured by the apparent fair market value of the property at the time of the sale. Those decisions have introduced doubt about the sustainability of the titles obtained by purchasers of tax lien foreclosed property and, consequently, the ability of taxing entities to assure potential purchasers of foreclosed properties that their titles will be secure.

Presently, the Fifth, Ninth, and Tenth Circuits hold that tax lien foreclosure sales under state law cannot be challenged as fraudulent transfers. That position is based on the United States Supreme Court’s decision in BFP v. Resolution Trust, 511 U.S. 531 (1994), which involved a California state court mortgage foreclosure sale. In that case, the court essentially eliminated the possibility of a bankruptcy debtor or trustee successfully challenging a mortgage foreclosure sale conducted under state foreclosure law as a fraudulent transfer under section 548 if the foreclosure action satisfied all requirements of the law. It held that the sale price obtained for the mortgaged property at the foreclosure sale was, by definition, “reasonably equivalent value” for the property. Significantly, however, the Supreme Court emphasized that its ruling applied only to “mortgage foreclosure of real estate,” specifically stating that “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.”

Contrary to the three aforesaid circuits, the Third, Sixth, and Seventh Circuits have held that state law tax lien foreclosure sales can be challenged as fraudulent transfers under section 548. In December 2021, the Sixth Circuit Court of Appeals, ruling on a bankruptcy debtor’s challenge to a tax lien foreclosure sale under Michigan law, reversed the decision of the federal district court that had affirmed a bankruptcy court decision that dismissed the debtor’s section 548 fraudulent transfer complaint on the basis that the BFP decision extended to tax lien foreclosure actions in Michigan. The Sixth Circuit held that the BFP decision did not apply to the facts of the debtor’s case. It found that, unlike the procedural protections provided by California law to the mortgagor in that case, Michigan’s tax lien foreclosure law permitted the taxing authority to purchase the liened property without public auction for a minimum bid that had no relation to the value of the property—in that case, only about 10 percent of the property’s alleged fair market value. Further, the taxing authority was entitled to retain any surplus money that might result from its later disposition of the property. Nevertheless, notwithstanding those findings, the Sixth Circuit remanded the case to the district court because the record on appeal was factually insufficient with respect to other aspects of the debtor’s section 548 claim.

Perhaps more significant for property owners and taxing authorities within the jurisdiction of the Second Circuit (New York, Connecticut, and Vermont), on November 9, 2021, District Judge David G. Larimer of the Western District of New York issued an opinion in DuVall v. County of Ontario affirming a bankruptcy court’s grant of a Chapter 13 debtor’s petition to avoid under section 548 transfer of the debtor’s real property in an in rem tax lien foreclosure proceeding conducted pursuant to New York’s Real Property Tax Law (RPTL). Judge Larimer found that the RPTL’s in rem foreclosure procedure “lacks the modern legal protections that tend to ensure the receipt of a more reasonably equivalent value under forced-sale circumstances, such as those cited in justification of the BFP holding.” He also quoted from a 2018 decision of the same district (Hampton v. County of Ontario) that had reached a similar conclusion, finding that the BFP holding “does not deprive an in rem tax foreclosure debtor of standing to bring an avoidance proceeding, where the legal protections cited by the Supreme Court as the underpinning for BFP, which tend to ensure the debtor’s receipt of a more reasonably equivalent value under forced-sale circumstances, are absent from the applicable state law foreclosure scheme.”

Judge Larimer noted that the bankruptcy court’s final decisions in Hampton v. County of Ontario and another matter presenting “identical questions of law” had been consolidated for an appeal to the Second Circuit on December 16, 2021. Presumably, the decision of that appeal will place the Second Circuit in one of the two existing camps with respect to the voidability of an in rem tax lien foreclosure sale as a fraudulent transfer. Its decision could have a significant impact on the manner in which taxing authorities within its jurisdiction conduct future tax lien foreclosure proceedings.

Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area will publish an additional alert after the Second Circuit issues its decision of that appeal.

Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts on an ongoing basis to keep clients and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Frank Heller, partner, at fheller@barclaydamon.com; Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practice Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com, respectively; or Bob Wonneberger, partner, at rwonneberger@barclaydamon.com

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