When Can a Preference Action Brought under Federal Law Reverse a State Law Tax Foreclosure Sale?

Recently, the Third Circuit, in In re Hackler and Stelzle-Hackler, 938 F.3d 473 (3d Cir. 2019), analyzed whether a “transfer” caused by a tax lien foreclosure sale violated the Bankruptcy Code’s preference statute such that it could be avoided. The Third Circuit in Hackler determined that such a sale could be avoided. Some other courts disagree.

Arguments

• Debtor: The Hacklers argued that the foreclosure sale met all the requirements for a preference.
• Creditor: The creditor, the buyer of the property at the tax foreclosure sale, argued that a lawfully conducted state tax foreclosure cannot constitute a voidable preference under BFP v. Resolution Trust Corp, 511 U.S. 531 (1994).

Decision

The Third Circuit agreed with the debtor that the sale satisfied all of the elements of the preference statute and its “reading of it end[ed] there.” In re Hackler, 938 F.3d at 478. The Third Circuit summarily disregarded the creditor’s federalism arguments and then distinguished BFP in two ways:

1. BFP considered a fraudulent transfer under 11 U.S.C. § 548, whereas the tax foreclosure was challenged as a preference under 11 U.S.C. § 547. Thus, the statutes were different. For example, BFP turned on the interpretation of the phrase “reasonably equivalent value”—which does not appear in the preference statute. By contrast, the preference statute is concerned solely with whether the transfer allowed the recipient to receive more than it would recover in a Chapter 7 liquidation.
2. The mortgage foreclosure process analyzed under BFP involved a public auction tied to the actual value of the property itself. By contrast, the tax sale did not. The debtors’ property was never subjected to a real auction based on the value of the property

The court’s reliance on the presence of public auctions is a seemingly odd distinction, given that whether property is sold for fair value is not an element of a preference claim under 11 U.S.C. § 547. The only valuation at issue in a preference is whether the creditor received more from the transfer than it would have received in a Chapter 7 liquidation. The Third Circuit was also not persuaded that tax sales under state law should be entitled to any special exception from the preference statute. It therefore affirmed the avoidance of the transfer.

Consequences

Hackler itself acknowledges that its outcome places a nationwide bankruptcy cloud over the title to property that is purchased by a creditor at a tax or mortgage foreclosure sale for less than fair market value.

The Hackler reasoning, however, is not universally accepted, especially in the Ninth Circuit:

• In In re Ehring, 900 F.2d 184 (9th Cir. 1990), the Ninth Circuit held that the transfer was not a preference because it did not enable the foreclosing creditor to receive more than it would have in a Chapter 7 liquidation.
• In In re Tracht Gut, LLC, 836 F.3d 1146, 1149 (9th Cir. 2016), the Ninth Circuit held that a tax foreclosure sale could not be set aside as a fraudulent conveyance because California’s tax sales had the same procedural safeguards as California’s mortgage foreclosure sale at issue in BFP.
• The District of Oregon, in In re Hull, 591 B.R. 25 (Bankr. D. Or. 2018) (rejecting In re Hackler, 571 B.R. 662 (Bankr. D.N.J. 2017)), ruled that the September 25, 2015, judgment constituted a transfer that occurred outside the 90-day preference period and that the expiration of the redemption right was not a transfer. The Hull court distinguished Hackler on the primary basis that Oregon law was different than New Jersey law. (Id. at 30–31). Hull did not consider the lack of competitive bidding when it held that the tax foreclosure was not a preference.

Hackler, BFP, Ehring, Tracht Gut, and Hull relied on different factors to reach their conclusions. Two issues to pay close attention to in future cases are (1) whether other courts will consider the presence or absence of competitive bidding in future preference cases and (2) whether federalism concerns persuade other judges to conclude that federal law should not disrupt valid foreclosures under state law.