California Tax Sale in Compliance with State Law Requirements Cannot be Voided as a Fraudulent Transfer in a Bankruptcy Proceeding
The Ninth Circuit has recently held that tax sales of real property in compliance with the requirements of California law could not be voided as fraudulent transfers in a bankruptcy case under a claim that the price obtained at the sale was not a reasonable equivalent value. See In re Tracht Gut, LLC, 2016 WL 4698300 (9th Cir., September 8, 2016). The decision extended the rule set forth in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), where the Supreme Court held that the price received at a mortgage foreclosure sale satisfies the Bankruptcy Code’s requirement of “reasonable equivalent value,” as long as the mortgagee complied with the relevant foreclosure laws of the state in question, which, coincidentally, was also California. Because the California tax sales have the same procedural safeguards as the California mortgage foreclosure sale, the Ninth Circuit concluded that the price obtained at the tax sale was also, as a matter of law, “reasonable value” for purposes of the fraudulent transfer section of the Bankruptcy Code. Consequently, the tax sale could not be voided.
In BFP, the Supreme Court recognized that the price obtained in a foreclosure sale is generally lower than the fair market value. The Supreme Court, however, rejected the relevancy of market value in the context of a forced sale. As the Court explained, because state law allows the forced sales of real estate, property sold at foreclosure is worth less than property sold at leisure and pursuant to normal marketing techniques. As a result, the lower price obtained at a foreclosure sale is a direct consequence of the forced nature of the sale, rather than a badge of fraud under the law of fraudulent transfers. Given that there was no indication that the state law dealing with foreclosure should be preempted, the Supreme Court assumed its validity and the effect of such laws on property prices, refusing to allow debtors in bankruptcy to void such sales on account that the price obtained was below market value.
What are the procedural safeguards that must be followed to come under the ruling of BFP? “Foreclosure laws typically require notice to the defaulting borrower, a substantial lead time before the commencement of foreclosure proceedings publication of a notice of sale, and strict adherence to prescribed bidding rules and auction procedures.” BFP, 511 U.S. at 542. Since the California tax sale laws include the same type of safeguards found in the foreclosure laws at issue in BFP, the Ninth Circuit found that the rationale and policy considerations behind BFP were just as relevant in the context of a California tax sale.
In contrast, where state laws do not provide safeguards similar to those discussed above, some bankruptcy courts have refused to extend the holding of BFP beyond real estate foreclosure sales. See, e.g., Berley Assocs. v. Eckert, 492 B.R. 433 (Bankr. D.N.J. 2013) (holding that BFP does not apply to prepetition tax sales in New Jersey because such sales do not require competitive bidding or advertising); In re Herkimer Forest Prod. Corp., 2005 WL 6237559 (Bankr. N.D.N.Y. 2005) (holding the BFP does not apply to prepetition tax sales, noting the absence of public sale and competitive bidding safeguards).
In short, as long as the tax sale has the appropriate safeguards (especially notices and the opportunity for competitive bidding) the BFP holding should control and the sale will not be able to be voided as a fraudulent transfer in a bankruptcy proceeding.