Daily Development for Monday, August 29, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

BANKRUPTCY; FRAUDULENT CONVEYANCE; STRICT FORECLOSURE: A strict foreclosure will be analyzed like a deed in lieu of foreclosure to determine whether reasonably equivalent value has been received by the debtor in exchange for the cancellation of the debt, and a court will review all the facts an circumstances in determining whether such value existed. 

Sensenich et al. v. Molleur (In re Chase), 2005 WL 1880784 (8/2/05)

The Bankruptcy Court had previously determined as a matter of law that compliance with the Vermont strict foreclosure process does not create a presumption of "reasonably equivalent value" and that a transfer effectuated under the strict foreclosure process may be avoided in the absence of "reasonably equivalent value"  Sensenich, et al. v. Molleur (In re Chase), 2005 WL 189711, January 27, 2005).   In that case, the Bankruptcy Court determined that the property had a value of $151,200 on the transfer date, while the outstanding debt was $110,927.64 (In re Chase, 2005 WL 280436,  February 3, 2005).

In the most recent skirmish in the dispute, the Bankruptcy Court ruled finally that the debtor did not receive "reasonably equivalent value" when the property was transferred to the lender through strict foreclosure and that transfer therefore constituted a fraudulent conveyance.  The decision hies back to case law that once was at the forefront of every real estate lawyer’s thinking, but has now passed into dusty memory.

In 1994 (yes, 1994) the Supreme Court decided in B.F.P. v. Resolution Trust Corp., 511 U.S. 531, that the price obtained at a regularly conducted foreclosure sale complying with state law was conclusively presumed to provide “reasonably equivalent value” for bankruptcy law purposes.  This decision appeared to put to rest a seething dispute in the lower courts on the question, which had generally been referred to as “the Durrett issue, name for the case that seemed to be at the center of the dispute, Durrett v. Washington Nat. Ins. Co., 621 F.2d 201 (1980). (Can these cases possibly be so long ago?)  Durrett had held that fraudulent conveyance analysis did apply to foreclosure sales, and touched off a storm of application and interpretation.  What emerged as the “Durrett benchmark” rule was that “reasonably equivalent value” meant 70% of the fair market value as determined by the court.  But other courts demurred, concluding that courts should look at all the facts and circumstance

s.  Foremost in this group was In re Bundles, 856 F.2d 825 (7th Cir. 1988).  Another demurring court found that Durrett was simply wrong when applied to a regularly conducted foreclosure auction and that such auctions ought to be treated as producing a “reasonably equivalent value.”  In re Madrid, 21 B.R. 424 (9th Cir. BAP. 1982), (aff,d on other grounds 725 F.2d 1197 (9th Cir.) 

Ultimately, as noted the Supreme Court apparently put all this controversy to rest, but the Court, in the B.F.P. case noted that it was reaching no conclusion as to circumstances in which a public sale had not been used to sell the property. 

Taking its cue from this exception in B.F.P., the court used  a bifurcated approach to resolve how the Vermont strict foreclosure process fit within the fraudulent conveyance statutes. It noted that Connecticut was the only other state using strict foreclosure, and that bankruptcy courts in that state had split on whether strict foreclosures could be presumed to return reasonably equivalent value.  This court opted to conclude that there was no such presumption, and further rejected the notion that a “benchmark” ratio test ought to be used.  Instead, it embraced the Bundles notion that all facts and circumstances ought to be studied.  Reviewing, therefore, all the facts in this case, th e court concluded that the transfer arising out of the strict judicial foreclosure process was fraudulent.

The Trustee was entitled to either avoid the transfer under 11 USC Section 548, or under Vermont law.  As an alternative to the order avoiding the transfer authorized by federal statute,   the Trustee under Vermont law could obtain a money judgment for the difference between the debt and the value of the property(see 9 VSA Section 2292). That’s what  the Trustee sought here.   The Court held the transfer to be fraudulent and awarded the Trustee a judgment against the Defendant in the amount of $40,272.36.

Comment 1: Of course, what makes the case interesting is that the U.S. Supreme Court had already eliminated the Durrett analysis with respect to most state law foreclosures in the famous case of In re BFP. , where, basically (and not without controversy) the Court ruled that a foreclosure auction carried out in accordance with state law was deemed to return to the debtor “reasonably equivalent value.”  Of course, where there is no auction, there is less reason to conclude that the process provides the necessary safeguards to protect value. 

Comment 2: On the other hand, Vermont practitioners might well be able to demonstrate how the strict foreclosure process, in practice, is hedged about with sufficient procedural limitations that it is rare, if ever, that any forfeiture of value is suffered.  Without looking, the editor suspects that the courts involved in a strict foreclosure have discretion to order a foreclosure by sale where there is in fact danger that excess value will be lost.   Even in a judicial foreclosure process, there is going to be some slippage, and arguably judicial supervision of a strict foreclosure sale provides just about the same level of protection that a debtor might get in a judicially supervised auction, and probably more that the debtor might get in a private power of sale auction.

Comment 3: As the case here applies as well to deeds in lieu of foreclosure, and abandons the 70% rule in favor of a Bundles test, practitioners need to take this case into account in evaluating the deed in lieu option. 

The editor was assisted in preparing this item by comments from Jack Murray of First American Title Insurance Company, Chicago office, but the comments above are the editor’s own.

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