United States: Bankruptcy Case Law in PA Now Differs from NJ on Avoidance of Tax Foreclosure Transfers

Last Updated: May 20 2016
Article by Michael Viscount

Owners of foreclosed properties who are seeking to avoid tax lien sales in bankruptcy now face starkly different fates in Pennsylvania as compared to New Jersey, according to a recent ruling from a bankruptcy judge in Philadelphia.

The reasoning seems to stem from the different procedures followed to complete the tax lien foreclosure process. When the transfer of title is effected by a judicial sale with competitive bidding, the sale is not avoidable, according to a Philadelphia bankruptcy judge's ruling on May 18, 2016. In New Jersey, where the transfer is made without a judicial sale, but by strict foreclosure upon entry of the judgement of foreclosure, the requirement that reasonably equivalent value be given is not satisfied, according to judicial rulings on New Jersey transfers.

It has become vogue for real property owners to seek redress in bankruptcy court when they lose the property through a tax lien foreclosure as a result of a failure to pay real estate taxes. Typically, such a property owner files bankruptcy after the tax foreclosure conveyance and brings suit in bankruptcy court to avoid the sale as a fraudulent conveyance. Alternatively, if the bankruptcy is filed before the expiration of 90 days from the date of the conveyance, some owners seek to avoid the conveyance as a preference.

The success of this approach now depends on which state the property is located in and may even hinge on the state in which the bankruptcy court sits.

When the matter goes to trial in bankruptcy court, the primary issue is whether the grantee as a result of a foreclosed tax lien sale paid reasonably equivalent value. On the face of it, this will never be the case, because, in the typical scenario, the delinquent taxes are only a fraction of the fair market value of the real estate. However, the amount of taxes paid by the grantee is not the end of the inquiry.

In 1994, the U.S. Supreme Court ruled that, in a mortgage foreclosure sale, the reasonably equivalent value requirement is met as long as the foreclosing party followed all of the proper procedures through to the conduct and completion of the judicial sale of the property to satisfy the debt. BFP v. Resolution Trust Corp., 511 U.S. 531 (1994).

Since that time, courts in various states have considered the holding of the BFP case in cases involving tax lien foreclosure. I practice in New Jersey and Pennsylvania and can address holdings by judges in each of those states.

New Jersey Decisions

In New Jersey, the often cited bankruptcy court decisions are In Re McGrath, 170 B.R. 78 (Bankr. D.N.J. 1994), In Re 2433 Plainfield Avenue, Inc., 223 B.R. 440 (Bankr. D.N.J. 1998) (reversed on other grounds) and In re Berley Associates, Ltd., 492 B.R. 433 (Banrk. D.N.J. 2013). (See my January 2014 alert, New Jersey Tax Lien Foreclosures Subject to Claw Back.)

The McGrath case was decided by Judge Stephen A. Stripp in 1994 shortly after the holding in the BFP case, and he concluded that a conveyance pursuant to a tax lien foreclosure was not different from a conveyance pursuant to a mortgage foreclosure action, i.e., if procedurally correct the reasonably equivalent value standard was met and the sale would not be avoided. However, when Judge Stripp looked at the issue again in 1998, he came to the opposite conclusion in 2433 Plainfield Ave.

In 2013, Judge Michael B. Kaplan, who still presides in the New Jersey Bankruptcy Court, concluded that the conveyance could be avoided when evidence indicated that there was no marketing and no competitive bidding in connection with tax lien foreclosures in New Jersey. Judge Kaplan found that New Jersey had a strict foreclosure procedure where the only bidding was at the time of the purchase of the tax lien certificate long before the equity of redemption is foreclosed and that the bidding is on interest rate not on the price for the real estate which is fixed at the amount of the delinquent taxes which are a fraction of the property's actual fair value.

Pennsylvania Law Differs

Now Judge Richard E. Fehling, a Pennsylvania bankruptcy judge, has ruled the opposite way from what we have seen most recently in New Jersey.

In his May 18, 2016 decision in In re Crespo, Judge Fehling followed the Supreme Court's holding in BFP in finding compliance with the procedure and therefore satisfaction of the reasonably equivalent value test sufficient to defeat the claim to avoid the conveyance.

What seems to have been significant in Crespo, although not fully articulated in the opinion of the court, is that under Pennsylvania law the property is subjected to open bidding at a judicial sale. Contrast this to the procedure in New Jersey where the entry of judgement effects the transfer of the property by strict foreclosure upon entry of judgement foreclosing the equity of redemption, and without the need to conduct an actual judicial sale.

The lesson of these various holdings is that avoidance of tax lien conveyances in bankruptcy will depend in large part on the state law procedures followed to effect the transfer. Where there is a judicial sale with open bidding that presents the prospect of competition to purchase title to the property, there is a high likelihood the conveyance will not be avoided. On the other hand, where the procedure is that entry of judgement effects the transfer without a judicial sale, the prospect for avoidance is likely.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Michael Viscount
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