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Setting Aside a Tax Sale through Bankruptcy

by | Jan 7, 2022 | Bankruptcy, Debt, Tax

By: Dean A. Langdon

It has long been the rule in bankruptcy cases that the price received for real property at a foreclosure sale was “reasonably equivalent value” and the transfer could not be set aside as a fraudulent transfer under 11 U.S.C. § 548. BFP v. Resolution Trust Corp., 511 U.S. 531 (1994). Does this holding also apply to real property sales conducted to pay delinquent real property tax bills? Probably not (at least in Michigan) under a recent Sixth Circuit Court of Appeals ruling.

In Lowry v. Southfield Neighborhood Revitalization Initiative (In re Lowry), Case No 20-1717 (6th Cir. 12/27/21) the Court of Appeals reversed the district court’s affirmance of a bankruptcy court decision dismissing Lowry’s complaint to set aside a Michigan tax foreclosure and remanded for further proceedings. The bankruptcy court’s ruling was based on the holding in BFP as well as the Rooker-Feldman doctrine. The district court affirmed solely on the basis of the Rooker-Feldman doctrine, deeming Lowry’s efforts an attempt to review a state court judgment.  Lowry appealed and prevailed, although the opinion is unpublished.

Lowry failed to pay the property taxes on his home in Southfield, Michigan for 2011 through 2015, although he entered into payment arrangements with the Oakland County Treasurer beginning in 2013. Lowry continued to struggle, however, and entered into payment plans for the 2014, 2015 and 2016 property taxes. At the time, Michigan law gave the state a right of first refusal to purchase property for the minimum bid needed to pay the outstanding tax bills, and that right “trickled down” to the city where the property was located if the state did not exercise its rights.[1] In June 2016 the Oakland County Treasurer filed suit to collect the unpaid taxes and a judgment of foreclosure was entered in February 2017, providing that Lowry had until March 31, 2017 to pay the taxes, or title would vest with the Treasurer. Although Lowry entered into yet another payment plan, the property vested with the Treasurer, which sold it to the City of Southfield for the amount of the unpaid taxes ($14,496.50). The City then sold the property to the Southfield Neighborhood Revitalization Initiative (“SNRI”) for $1. Lowry claimed the property was worth $152,000 at the time.

After some unsuccessful state court efforts, Lowry ultimately filed a Chapter 13 bankruptcy in late 2018 and in 2019 filed two adversary complaints against the Treasurer and SNRI, alleging the tax foreclosure process denied him due process and that the transfer could be avoided under 11 U.S.C. § 548 as a transfer for less than reasonably equivalent value. The bankruptcy court dismissed the adversaries, holding that Lowry was attempting to relitigate the state court foreclosure proceedings in violation of the Rooker-Feldman doctrine, and that the rule of BFP should be extended to tax foreclosures in Michigan, precluding the use of Section 548 to set aside the transfer.

The Court of Appeals reversed on the Rooker-Feldman issue holding that Lowry was not trying to attack the state court judgment, but to set aside the resultant transfer of his real property under Section 548. The Court stated: “We can assume that the state court reached a proper foreclosure judgment, and then independently decide whether the foreclosure could be avoided as a fraudulent transfer under § 548.” The Court recognized that the Supreme Court has limited the Rooker-Feldman doctrine to situations where the alleged source of injury is the state court judgment itself. Just like a foreclosure judgment is different from a foreclosure sale, here the judgment granting the foreclosure to the Treasurer was a different event than the actual transfer of the property once the taxes were paid.

Turning to the application of the BFP decision, the Court noted that the BFP ruling itself was limited to mortgage foreclosures and realized that the considerations under other forced sales may be different. The Court noted the factual differences between a public auction and the Michigan tax foreclosure process, which did not provide for an auction, but granted the state/city the right to purchase the property for the amount of outstanding taxes without any auction process. The Michigan property was not concerned with the value of the real property, only the amount of the outstanding tax bills, which distinguished the situation from that in the BFP case.

While this decision could be helpful to debtors’ counsel looking for arguments to set aside a forced sale (other than a mortgage foreclosure), careful analysis of applicable state law and sale procedures will be necessary.  For example, in Kentucky while delinquent tax bills are sold for the amount of tax (and interest and penalties) owed, the purchaser does not acquire the underlying property. In fact, the owner of a delinquent tax bill must initiate a judicial foreclosure action and have the property offered for sale at public auction to recover the delinquent taxes. This exposes the real property to the market in way much more aligned with the process in the BFP case than in Lowry. It is important to recognize the potential for a forced sale to be set aside as a fraudulent transfer under Section 548 and to dig deeper if you think your client’s situation may be distinguishable from that in the BFP case.

[1] Michigan law also permitted the state or city to keep any surplus proceeds when a property was subsequently sold, which the Michigan Supreme Court found to be a violation of the Michigan Constitution’s “takings clause” in 2020. Rafaeli, LLC v. Oakland Cty., 952 N.W.2d 434 (Mich. 2020).

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