Daily Development for Thursday, March 4, 2010
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri
BANKRUPTCY; PREFERENCES; PROPERTY SOLD AT FORECLOSURE PRE-FILING: Unlike in the case of bankruptcy fraudulent conveyances, a regularly conducted foreclosure sale will not be viewed as producing value sufficient to satisfy the preference test of “no more than the trustee could obtain in a Chapter 7 liquidation.” Hence, foreclosure sales with the characteristics of preference scan be avoided in bankruptcy.
In re Villareal, 413 B.R. 633 (Bkrtcy. S.D. Texas, 2009)
This is the case that is said to have awakened the title insurance industry to the dangers of granting the “creditor’s rights” endorsement. It states a concept that law professors knowledgeable about bankruptcy law have been driving into their students ever since In re BFP was first decided by the U.S.. Supreme Court.
Although the Supreme Court in In re BFP emphasized deference to the state law procedures for liquidating property and establishing value, the fact is that the test of “reasonably equivalent value” - which is what the Supreme Court was evaluating, is quite different from the “liquidation value” that appears in the preference statute. The court in the instant case emphasized that a bankruptcy court is not bound by the strictures of an auction sale - it can advertise and negotiate, separate and combine. The price produced for that asset often will exceed the price tha tmight be produced at a foreclosure sale, especially a Texas sale in which there is little notice and a short notice period.
Of course, it didn’t help the petitioner’s case that the appraisal evidence showed that equity in the property sold (at a second mortgage foreclosure) was in excess of $3,250,000, and it sold at the foreclosure sale to the junior creditor for $70,000.
Comment 1: Here are some comments from Jack Murray on the decision (previously published on DIRT:)
“In Newman v. FIBSA Forwarding, Inc. (In re FIBSA Forwarding, Inc.), 230 B.R. 334 (Bankr. S.D. Tex. 1999), aff'd, 244 B.R. 94 (S.D.Tex.1999), the bankruptcy court held that the Supreme Court's ruling in BFP -- finding that a regularly conducted, non-collusive foreclosure sale was not a fraudulent transfer under § 548 of the Bankruptcy Code -- should be applied to nullify a challenge to a real estate foreclosure sale on the basis that it constituted a preferential transfer under § 547. But in In re Villarreal, the bankruptcy court concluded that it was not bound by stare decisis to follow the decision in In re FIBSA Forwarding, Inc., supra, stating that "FIBSA is a decision reached by United States Bankruptcy Judge Steen and affirmed by United States District Judge Ellison of this District. This Court concludes that -- although such an opinion deserves great deference -- it is not binding on this Court." In re Villarreal, supra, 413 B.R. at 640. [Note: Most bankruptcy judges state
that they are bound only by decisions handed down by the U.S. Supreme Court and their respective Circuit Court of Appeals. Cases from other circuit courts, district courts outside their district, the District Court for the district in which they sit, or even other bankruptcy judges within their district, may support an argument but are not binding on bankruptcy judges. See John C. Murray, The Lender's Guide to Single-Asset Real Estate Bankruptcies, 31 REAL PROP. PROB. & TR. J. 393, 411 (1996)].
It will be interesting to see if other bankruptcy courts follow the court's reasoning in In re Villarreal. As a result of the court's ruling in that case (as well as other cases holding that BFP does not apply to preferential transfers under § 547) and the current litigious climate in general, title insurers may no longer be willing to delete the creditors' rights exclusion or issue the ALTA Form 21-06 Creditors' Rights Endorsement (which insures against loss because of the occurrence, on or before the date of the policy, of a fraudulent transfer or preference under federal bankruptcy law or state insolvency or creditors' rights laws) with respect to Loan Policies (assuming the deletion or endorsement is otherwise appropriate and available) that would cover preferential transfers - at least until 91 days have elapsed since the foreclosure sale, with no intervening bankruptcy filing by or against the borrower. (Also, it may be prudent for the lender to obtain a current appraisal fr
om an independent reputable appraiser at or near the time of the foreclosure sale to support the lender's position that it did not receive more than it would have as the result of a Chapter 7 liquidation (if such is the case)).”
Comment 2: It also bears noting (the court did not) that a non-judicial private sale conducted with scant notice may not be the equivalent of a judicial foreclosure as approved in In re BFP. Some other courts, however, have extended the Supreme Court’s reasoning to private sales.
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