Tax foreclosure sales of real estate can be fraudulent transfers

In Gunsalus v. County of Ontario, 37 F. 4th 859 (2d Cir, 6/27/22) the Second Circuit recently held that a
deed issued pursuant to a New York real estate tax lien foreclosure can be attacked and set aside by a
Chapter 13 debtor as a fraudulent transfer when “reasonably equivalent value” is not received for the property. Although the foreclosure proceeding was conducted in accordance with the requirements of NY Real Property Tax Law §§1120, et. seq., commonly referred to as “Article 11”, the Second Circuit held that provided no immunity from fraudulent transfer attack.

The debtors owned a home of modest value in Ontario County that had no mortgage. The County held a tax lien for unpaid property taxes in the amount of $1,290.00 and commenced an “Article 11” tax foreclosure action in Ontario County Supreme Court, ultimately resulting in the entering of “a final judgment of foreclosure awarding the County possession of, and title to, the home”. The County thereafter scheduled an auction of the property and sold it to a third party for $22,000.00. After crediting $1,290.00 toward the tax lien the County pocketed the difference of $20,710.00, resulting in the debtor forfeiting all of their accumulated equity to the County. All of this was done in full compliance with Article 11 procedures!

Article 11 employs “strict foreclosure” for tax delinquencies. If property taxes are not paid within a certain time period after they are due (the Lien Date”) the County compiles a “List of Delinquent Taxes” and files it in the County Clerk’s Office. If the property taxes remain unpaid for another statutory period the County prepares, files and serves a Petition of Foreclosure in Supreme Court of the County. The last day to exercise the statutory right of redemption is two years after the lien date, unless extended by the taxing authority. If the property is not redeemed the Court enters an Order awarding the taxing authority possession of, and title to, the property. There is no foreclosure sale, so market forces play no role in seƫng the value of the property. In addition, neither the homeowner nor any other creditors have any claim to the surplus funds generated beyond the amount needed to satisfy the tax debt. In Gunsalus this resulted in a $20,710.00 windfall to the County.

The Second Circuit contrasted the “strict foreclosure” procedure with the “foreclosure by sale” procedures that govern mortgage foreclosures in most states, including New York, where mortgage foreclosures are governed by NY Real Property Actions and Proceedings Law Article 13. The Court noted that mortgage foreclosure proceedings in New York and other states ensure “that (1) foreclosures would occur by sale, (2) the proceeds of the sale would be used to satisfy the debt, and (3) any surplus over the debt would be refunded to the debtor”. The Court went on to note that “foreclosures by sale…emerged to avoid the draconian consequences of strict foreclosure”.

Bankruptcy Code section 548(a)(1)(B)(i) states a transfer is fraudulent and can be avoided if the debtor “received less than a reasonably equivalent value in exchange for such transfer”. Reasonably equivalent value is not defined in 11 USC § 548, but in BFP v. Resolution Trust Corp. 511 US 531, 548 (1994) the Supreme Court indicated the determination of whether a transfer is for reasonably equivalent value is determined by “whether the debtor has received value that is substantially comparable to the worth of the transferred property” (BFP, at pg. 548) In Gunsalus the County relied heavily upon the BFP opinion, which held that a mortgage foreclosure proceeding conducted in compliance with a state’s foreclosure laws is conclusively presumed to have provided reasonably equivalent value sufficient to satisfy the requirements of 11 USC § 548(a)(1)(B)(i). “Critical to that conclusion was the existence of an auction or sale which would permit some degree of market forces to set the value of the property”.

The BFP opinion makes it clear, however, that it “covers only mortgage foreclosures of real estate. The considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different” (BFP at p. 537, n.3). The Second Circuit found that admonition to be dispositive, noting that New York’s Article 11 strict foreclosure procedures offer far fewer debtor protections than the mortgage foreclosure procedures at issue in BFP, and set aside the transfer of the debtor’s home as .fraudulent