Commercial Bankruptcy Advisor

The Third Circuit Determines That New Jersey Tax Foreclosure Is Subject To Bankruptcy Preference Avoidance

Unlike mortgage foreclosures, which are immune from fraudulent conveyance avoidance attack, the Third Circuit recently ruled, in a case of first impression, that a transfer of title pursuant to a New Jersey tax sale foreclosure proceeding may be avoidable as a preference under § 547(b) of the United States Bankruptcy Code.¹ An understanding of the underlying facts of the case is necessary to fully appreciate the rationale of and distinctions made by the Third Circuit.

Husband and wife homeowners failed to pay property tax which resulted in the township’s listing of their New Jersey home for a tax sale. Unlike a mortgage foreclosure, where the highest bid on the property itself wins, a New Jersey tax foreclosure involves a public auction on only the rate of interest of the unpaid taxes. There, the interest rate is bid down and, in the event that the interest rate is bid to zero, bidding continues with offers of premiums above the value of the unpaid tax lien. The successful bidder is awarded a tax sale certificate which the property owner may redeem within two years by paying the certificate holder the accrued taxes, plus interest. If the property owner fails to redeem the certificate, the certificate holder may, after the two-year redemption period, file for a foreclosure judgment that vests title of the property to the tax lien certificate holder.

Here, the homeowners failed to redeem the certificate and, as a consequence, title to the property vested with the certificate holder following the entry of the final judgment of foreclosure. However, two months after the transfer of title, the homeowners filed for bankruptcy, initiated an adversary proceeding seeking to avoid the transfer of the property as a preference, and submitted a Chapter 13 plan proposing to pay the certificate holder’s claim in full. On cross motions for summary judgment, the Bankruptcy Court ruled in favor of the homeowners, voiding the transfer, and directing the return of title to the homeowners. The District Court affirmed and an appeal to the Third Circuit followed.

The Third Circuit found that the transfer to the certificate holder through foreclosure fell squarely within the preference avoidance statute of § 547(b) of the Bankruptcy Code.² The transfer was made to the tax certificate holder, for a debt that arose prepetition, made within 90 days before the petition date when the homeowners are presumed to be insolvent, and that bestowed a property worth $335,000 upon a party that would have received only $45,000 (the redemption amount) in a Chapter 7 proceeding. The Third Circuit found the terms of the statute to be unambiguous and that applying such straightforward terms did not lead to an absurd result.

In urging the Third Circuit to look beyond the plain terms of the statute, the certificate holder advanced two separate arguments for overturning the rulings of the Bankruptcy and District Courts.

Relying on the Supreme Court’s decision in BFP v. Resolution Trust Corp.,³ the certificate holder argued that a lawfully-conducted tax sale cannot constitute a voidable preference under § 547. BFP holds that consideration received from a non-collusive, real estate mortgage sale conducted in compliance with applicable state law satisfies the requirement that a property transfer be made in exchange for “reasonable equivalent value,” thus preventing the avoidance of the transfer as a fraudulent conveyance under § 548 of the Bankruptcy Code. However, the Third Circuit distinguished BFP in two critical ways.

First, the decision in BFP is predicated on the language of § 548 and, in particular, the term “reasonably equivalent value,” which are not analogous to the preference avoidance statute of § 547. Second, the mechanics of a mortgage foreclosure and a New Jersey tax foreclosure sale are markedly dissimilar: the highest bid for the entire property prevails in a mortgage foreclosure where the public bids on the lowest rate of interest on the unpaid taxes in a New Jersey tax sale. Thus, the holding of BFP— that the price reached in a state-law mortgage foreclosure should as a matter of law be considered “reasonably equivalent value” for the property for purposes of the fraudulent conveyance statute of § 548 — bears no relation to the tax sale where there is no connection between the winning bid and the value of the property. Since the term “reasonably equivalent value” is not found within § 547 and given the divergent mechanisms and policy objectives between mortgage foreclosures and tax sales, the Third Circuit declined to extend the lessons of BFP to preference avoidance.

The Third Circuit quickly dispensed with the certificate holder’s second main contention that the Bankruptcy Court’s voiding of the title transfer violated the Tax Injunction Act, which provides that “district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law.” While acknowledging that a state has a compelling interest in enforcing the collection of taxes, the Third Circuit rejected the holder’s argument that the avoidance of the title transfer adversely affected the township’s ability to still collect taxes. The Bankruptcy Code permits the courts to unwind preferential transfers and the specific provisions of the Bankruptcy Code supersede the general prohibitions of the Tax Injunction Act.

This ruling from the Third Circuit provides clarity and hope to New Jersey homeowners who fail to redeem tax sale certificates within the statutory two-year period that bankruptcy may provide a viable option to save their home from forfeiture. Questions remain, however, on the application of the Hackler decision to other states within the Third Circuit where the tax foreclosure process involves bidding on the property itself and is thus more akin to a mortgage foreclosure than the interest rate bidding mechanism of New Jersey tax sale foreclosures.

¹ Hackler v. Arianna Holdings Company, LLC, No. 18-1650, 2019 U.S. App. LEXIS 27514 (3d Cir. Sept. 12, 2019).

² 11 U.S.C. § 547(b) provides for the avoidance of a transfer of an interest of the debtor in property; made to or for the benefit of a creditor; for or on account of an antecedent debt; made within 90 days or one year, in the case of an insider; that results in the creditor receiving a greater distribution than it otherwise would have in a hypothetical chapter 7 distribution.

³ 511 U.S. 531 (1994).