Bankruptcy Aspects of Public Trustee Foreclosures and Deed in Lieu Transfers
| Jurisdiction | United States,Federal |
| Citation | Vol. 14 No. 9 Pg. 1966 |
| Pages | 1966 |
| Publication year | 1985 |
1985, November, Pg. 1966. Bankruptcy Aspects of Public Trustee Foreclosures and Deed in Lieu Transfers
The relative safety of public trustee foreclosures is now undergoing radical changes. These changes are being created by recent decisions of bankruptcy courts in Colorado and throughout the United States which are setting aside or avoiding foreclosure sales as fraudulent transfers under Bankruptcy Reform Act of 1978(fn1) ("Code") § 548 or as preferential transfers under Code § 547.
Accepting a deed in lieu of foreclosure is equally rampant with bankruptcy hazards. Typically, such a deed is challenged in bankruptcy court on the same grounds as a foreclosure sale. The challenge is based upon either the theory that the transfer constitutes a voidable preference under Code § 547 or that the transfer itself was fraudulent under Code §§ 544 and/or 548.
The transfer of property by a deed in lieu of foreclosure is becoming more common in today's real estate practice. However, acceptance of such a deed is risky and should not be done without some attention to the survivability of the transfer in the event of a subsequent bankruptcy.
A "preference" is a term of art which finds its basis in 11 U.S.C. § 547. It is broadly defined as a transfer by which an insolvent debtor favors one creditor over other creditors by making "preferential payments" during the ninety-day period preceding the filing of the bankruptcy petition. Code § 547 requires the trustee to prove the following five elements of a preference action:
1) The transfer of the property of the debtor was made to or for the benefit of a creditor;
2) The transfer was made for or on account of an antecedent debt owed by the debtor before such transfer was made;
3) The transfer was made while the debtor was insolvent;
4) The transfer was made (a) on or within ninety days before the date of the filing of the petition or (b) between ninety days and one year before the date of the filing of the petition, if the creditor receiving the benefit of the transfer was an insider and had reasonable cause to believe the debtor was insolvent at the time of such transfers; and
5) It enabled such creditor to receive more than such creditor would receive if the case were a case under Chapter 7, the transfer had not been made and such creditor received payment of such debt to the extent provided by the provisions of the Bankruptcy Code.(fn2)
If the recipient of the deed can demonstrate that only one of the five requirements set forth above has not been met, the transfer may not be avoided by the trustee. Generally, the last three elements are the critical elements in determining whether a deed in lieu transfer constitutes a voidable preference.
Insolvency: The test for insolvency is simply that of a balance sheet determination of whether the borrower's liabilities exceed its assets at a fair valuation exclusive of fraudulently transferred property and property acquired post-petition which is exempted from property of the estate. It is generally understood that a debtor's inability to pay debts as they become due does not render that debtor insolvent for purposes of a preference action.(fn3)
With respect to transfers occurring on the date of or during the ninety-day period preceding the date of the filing of the petition, the debtor is presumed to be insolvent.(fn4) This presumption may be rebutted by an affirmative showing by the transferee that the debtor was not insolvent, at which time the burden would shift to the trustee to prove insolvency. No presumption exists beyond the ninety-day period. Accordingly, any transfers to insiders falling outside the ninety-day period, but within the one-year period, would require the trustee to prove the existence of insolvency in the first instance.
Transfer Made Within Prepetition Time Limits: The second element is a requirement that the transfer has been made on or within ninety days before the date of the filing of the petition or, in the case of an insider who had reason to believe that the debtor was insolvent at the time of the transfer, anytime during the one-year period before the date of the filing of the petition.(fn5)
Whether and when a transfer is made is determined by reference to Code § 547 (e). A transfer of real property, other than fixtures, but including the interest of a seller or purchaser under a contract for sale of real property, is generally deemed to have been made when the transfer is valid against a bona fide purchaser. Actual notice of insolvency by an insider is not required, only that the insider had knowledge of facts which would put a reasonably intelligent person on notice that the debtor was insolvent.(fn6) In a deed in lieu transaction, bankruptcy trustees are generally able to show that the insider transferee of the deed in lieu had reasonable cause to believe the transferor was insolvent, since to be an "insider" carries with it the implication of...
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