Daily Development for Wednesday, February 4, 2004 by: Patrick A. Randolph, Jr. Elmer F. Pierson Professor of Law UMKC School of Law Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu BANKRUPTCY; AUTOMATIC STAY; TAX FORECLOSURE: Automatic stay voids deed transferred under state tax foreclosure when bankruptcy filed after foreclosure sale but shortly before actual delivery of the deed. Matter of Pierce (Elbar v. Pierce) 2004 U. S. App LEXIS 1316 (5th Cir. 1/29/04) Debtor failed to pay her property taxes and the mortgagee threatened to foreclose. The mortgagee reached an agreement with the debtor to pay the delinquent taxes, but its check was returned because of an inadvertent error in the legal description. The Constable then sold the property at the tax sale to a third party, Elbar for $31,000. Two days later, before the deed had been issued and the sale proceeds were disbursed, the Constable received written notice that the debtor had filed a Chapter 13 bankruptcy petition -- which filing occurred "less than 30 minutes before the tax sale had taken place." The court acknowledged that the parties had no actual or constructive notice of the debtor's bankruptcy. Elbar filed a petition to lift the automatic stay with the bankruptcy court, asking it to validate the tax sale retroactively under sec. 362(d) of the Bankruptcy Code ("Code"), and asking the court to authorize transfer of title to the property. Elbar also argued that it had acquired at least the mortgagee's interest in the property, as the mortgagee was merely a co-defendant in the tax suit and not a debtor in bankruptcy. The Fifth Circuit agreed with the holdings of the bankruptcy court and the district court, which voided the tax sale. The Fifth Circuit acknowledged that on the date of the tax sale neither the Constable nor Elbar had actual or constructive notice of the debtor's bankruptcy filing. The court ruled, however, that sec. 362(a) of the Code automatically stayed the State tax sale, which therefore was "null and void and without legal effect," and could not operate to transfer the mortgagee's interest in the property. According to the court, "Elbar cites no authority that that even remotely supports its novel theory that the highest bidder at an invalid tax sale obtains the mortgagee's security interest in the property, simply because the mortgagee was an in rem co-defendant in the Debtor's tax deficiency judgment." Reporter's Comment 1: The bankruptcy court agreed with Elbar that it had discretion, under sec.362(d) of the Code, to annul the automatic stay retroactively and validate the tax sale. It refused to do so in this case, however, because it concluded that the debtor had filed her bankruptcy petition in good faith and honestly believed that the delinquent taxes had been paid by the mortgagee. The Fifth Circuit affirmed this holding by the bankruptcy court. Reporter's Comment 2: Elbar argued to the bankruptcy court and to the district court -- but for some reason not to the Fifth Circuit, which resulted in a waiver of the argument -- that sec. 549(c) of the Code created "an exception to the automatic stay for good- faith purchasers of a Debtor's real property who lack notice of the Debtor's pending bankruptcy." But the bankruptcy and district courts rejected this assertion, finding that because the bankruptcy court had elected not to exercise its discretion to retroactively annul the automatic stay, the post-petition sale (even though only by less than 30 minutes) was invalid under sec. 362 of the Code. The Fifth Circuit affirmed these holdings. Reporter's Comment 3: This case should give some pause to title insurers, with respect to the finality of tax sales. Would an insurer have been willing to insure the transfer of title to the property as a result of the tax sale? (The case does not mention whether Elbar sought or obtained title insurance for the transaction.) I presume that we would not want to insure the transaction at least until the deed had been delivered and the proceeds disbursed. But how would we know if and when the bankruptcy proceeding was filed, given that the petition was filed by the debtor less than 30 minutes before the tax sale? What if it had been filed less than 30 minutes before delivery of the deed? Reporter's Comment 4: Is this purely an equitable "do the right thing" decision by the Fifth Circuit, which did not want to penalize a debtor who apparently honestly believed that the taxes had been paid when she filed for bankruptcy and was not out to "game" the timing of her petition? The Fifth Circuit does not mention the actual market value of the real property; perhaps the $31,000 paid by Elbar at the tax sale was far below the property's "fair value." Reporter's Comment 5: What if the bankruptcy filing had occurred in another state? As the ALTA has noted, "Because it is a practical impossibility for the title insurance industry to search contemporaneously bankruptcy filings in every bankruptcy court in all 50 states at the time of closing . . . the existence of an undisclosed bankruptcy case places the risk of loss on the lending, leasing and development industries, potentially chilling credit availability." According to the Fifth Circuit Elbar did not raise the issue, on appeal to the court, of whether Sec. 549(c) of the Code creates an exception to Sec. 362, so the court declined to rule on this issue. However, this issue is of serious concern to title insurers, and to other parties to real estate transactions. Editor's Comment: There is a real problem of bankruptcy courts concluding that the interest of resolving problems in the individual bankruptcy estate supercedes the need for regularity and predictability in commercial transactions generally. Sooner or later something awful will happen and Congress will get involved. In this case, however, the equities may favor the bankrupt anyway and the purchaser will get its money back and the taxes will get paid. So it's hard to argue with the outcome. Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. The same is true of all commentary provided by contributors to the DIRT list. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA. 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