In re Berley Associates Ltd., No. 12-32032; U.S. Bankruptcy Court (DNJ); opinion by Kaplan, U.S.B.J.; filed May 16, 2013. DDS No. 42-6-xxxx [19 pp.]

Debtor Berley Associates Ltd. owned a vacant lot in Morristown. When it failed to pay real estate taxes on the property in 1999, the township conducted a public tax sale. The successful bidder obtained a tax-sale certificate and accompanying lien on the property that was then assigned to defendant Geza Eckert.

Eckert filed a state court complaint to foreclose on the tax-sale certificate. When Berley failed to redeem the certificate, a final judgment was entered in the foreclosure action, enabling Eckert to obtain title to the property.

The next day, Berley filed a voluntary Chapter 11 bankruptcy petition and listed the property with a fair market value of $500,000 in its schedules of assets and liabilities. It then filed this adversary proceeding seeking to have the court void the final judgment that conveyed title to Eckert as (i) a fraudulent transfer pursuant to 11 U.S.C. § 548(a) and/or (ii) a preferential transfer pursuant to 11 U.S.C. § 547(b), based on the alleged sizable difference between the property’s fair market value and the indebtedness owed to Eckert.

In arguing that compliance with the substantive and procedural requirements for the foreclosure of his tax lien bars subsequent avoidance efforts by the debtor, Eckert primarily relies on BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), which held that, at least with respect to mortgage foreclosures, transfer of title for a value significantly less than the property’s fair market value is not a fraudulent conveyance so long as the transfer complies with state law. He argues that the same reasoning applies to transfers of title as a result of tax-sale foreclosures, citing In re McGrath, 170 B.R. 78 (D.N.J. 1994), and In re 2435 Plainfield Avenue Inc., 72 F.Supp.2d 482 (D.N.J. 1999), aff’d 213 F.3d 629 (3d Cir. 2000).

McGrath held that tax-sale certificate foreclosures and mortgage foreclosures were sufficiently similar that the rationale of BFP should apply equally to tax foreclosures. In Plainfield, the district court determined that the bankruptcy court had erred when it found that a cause of action existed under the Fraudulent Conveyance Act, concluding that the FCA had been repealed and superseded by the Uniform Fraudulent Transfer Act. which, as modified by the Tax Sale Law, prevents a court from setting aside a tax foreclosure judgment as a fraudulent conveyance.

Eckert also disputes the debtor’s contention that the transfer of title is a voidable preference under 11 U.S.C. § 547(b).

Both parties moved for summary judgment.

Held: The transfer of title to defendant in a prepetition tax sale and foreclosure context, where there was no competitive bidding, may constitute a fraudulent conveyance under 11 U.S.C. § 548(a)(1)(B), and is not barred by BFP v. Resolution Trust Corp., 511 U.S. 531 (1994). Likewise, the transfer at issue may constitute an avoidable preference under 11 U.S.C. § 547(b) if the fair market value of the property is more than the redemption amount owed at the time of foreclosure.

A transfer of property is deemed constructively fraudulent under 11 U.S.C. § 548(a)(1)(B) if, within two years prior to its bankruptcy petition, the transferor receives "less than reasonably equivalent value" in a transaction and the transferor was insolvent, undercapitalized or could not pay its debts as they became due at the time of the transfer.

The court says the mechanics and procedures in mortgage and real estate tax foreclosures are distinctly different, leading to paramount substantive differences. Significantly, in the former, competitive bidding for the underlying property is encouraged through advertising and public auction. As a result, a value for the property may be inferred. With tax sales, public bidding occurs at the inception of the process, within months after the delinquency, and is limited to the rate of interest on the unpaid taxes (which has little connection to the value of the property). Similarly, the fixed redemption amount at the time of foreclosure is calculated from the accrued taxes and interest thereon, not the value of the property.

The court says equity or "fairness" of the price is of paramount consideration in determining whether to set aside a tax sale. It rejects Eckert’s argument that reasonably equivalent value was received by the debtor simply because he complied with the state tax-sale foreclosure statutes. It says that a judgment of foreclosure, based solely on delinquent taxes in a nonsale foreclosure proceeding, does not necessarily provide a property owner "reasonably equivalent value" for real estate without a public sale offering.

The court says the absence of competitive bidding and appropriate advertising is a significant bar to adjudicating "reasonably equivalent value" in a tax-sale foreclosure scenario. Courts in other jurisdictions have taken a similar approach.

Therefore, the court finds that BFP, McGrath and Plainfield do not bar recovery by the debtor under 11 U.S.C. § 548(a)(1)(B), in that the price received at the tax-sale certificate foreclosure does not necessarily reflect a reasonably equivalent value for the underlying property. It says its judgment is buttressed by the fact that a tax-sale certificate foreclosure is a "strict foreclosure" that does not result in a public sale, but merely a straight transfer of title.

The court says there is insufficient evidence at this time to conclude that the debtor received reasonably equivalent value from Eckert. It notes that by requiring the parties to establish equivalent value, it is neither nullifying nor undercutting the New Jersey tax sale law. Nor is it persuaded that avoidance of the transfer will chill the sale of tax-sale certificates by clouding title to acquired properties since it has discretion to fashion a monetary award should the debtor prove successful on its claims.

The court also rules that the transfer of title in the property to Eckert at the tax-foreclosure sale may be deemed a preferential transfer under § 547 if it is determined that the property’s fair market value is more than the redemption amount owed to Eckert at the time of the foreclosure. Absent competitive bidding or another method of establishing reasonable value, it cannot determine on this record the value of the property. Thus, there remains a genuine dispute as to the value of the property, which precludes the grant of summary judgment at this juncture.

For debtor/plaintiff Berley Associates Ltd. — Morris S. Bauer (Norris, McLaughlin & Marcus). For defendant Eckert — Keith A. Bonchi (Goldenberg, Mackler, Sayegh, Mintz, Pfeffer, Bonchi & Gill).