Avoiding the Avoid: Re-securing the Mortgage Lender Post-bfp

• Jurisdiction: United States,Federal
• Citation: Vol. 31 No. 1
• Publication year: 2014

Avoiding the Avoid: Re-securing the Mortgage Lender Post-BFP

Sarah Trevino

AVOIDING THE AVOID: RE-SECURING THE MORTGAGE LENDER POST-BFP

Abstract

The Supreme Court's decision in BFP v. Resolution Trust Corp. was intended to end the debate over what constitutes "reasonably equivalent value" pursuant to 11 U.S.C. § 548(a) with respect to foreclosure sales. In BFP, the Court held that the consideration received at a foreclosure sale is, in itself, reasonably equivalent value and rejected a minimum threshold amount. In its attempt to clarify the law, the Court left open the option for a bankruptcy trustee to avoid a foreclosure sale based on a lack of state law compliance. As shown in this Comment, state foreclosure laws vary drastically, and relying on state law compliance undermines the uniform application of the Bankruptcy Code.

First, this Comment compares the decision in BFP and its predecessors with the legislative intent behind the various fraudulent transfer acts and § 548 of the Bankruptcy Code. Second, this Comment further proposes amending the Bankruptcy Code to require a trustee seeking avoidance of a real estate transfer to show a lack of substantial compliance with state real estate foreclosure laws and to expressly exempt foreclosure sales from § 548's reasonably equivalent value requirement. Finally, this Comment proposes needed definitions in § 101 of the Bankruptcy Code including definitions for "reasonably equivalent value" and "real estate foreclosure sale." This solution would not only codify the decision in BFP, but would also clear up the numerous inconsistencies in the trustee avoidance powers based on the drastically different state foreclosure laws and promote uniform application of the Bankruptcy Code.

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Introduction

The current practice of allowing a trustee to avoid a prepetition foreclosure sale based on lack of state law compliance and the lack of an expressly defined federal standard for "reasonably equivalent value" under the constructive fraud provision of § 548 of the Bankruptcy Code¹ (the "Code") lead to enormous inconsistencies in the avoidance powers of the bankruptcy trustee. These inconsistencies stand in direct contradiction with Congress's intentions in drafting these provisions of the Code. Congress, in its 1984 and 2005 amendments, gave additional protection to creditors and attempted to prevent debtor abuse.² This intended creditor protection, coupled with other Code provisions,³ proves Congress's intent not to hinder a secured creditor's ability to secure its collateral. The United States Supreme Court's decision in BFP v. Resolution Trust Corp. reflects this same intent to give protection to lenders for noncollusive foreclosure sales in determining constructive fraud under § 548.⁴

As the Seventh Circuit Court of Appeals held in Bundles v. Baker (In re Bundles),⁵ Congress's intentional use of a federal standard made clear that it did not believe relying on state foreclosure law to avoid a transfer would protect federal interests.⁶ The later decision in BFP provided a federal standard for determining reasonably equivalent value in foreclosure sales, but left outstanding the frequently occurring and inconsistent practice of avoiding

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foreclosure sales based on state law deficiencies in the sale.⁷ In complying with the Supreme Court's ruling in BFP, Congress should expressly exempt real estate foreclosure sales from avoidance powers in the "constructive fraud" provision of § 548(a)(1)(B).

With the current issues in the national housing market and state foreclosure processes, the Code should not, and as § 541(c) proves, is not required to, defer to state law in determining avoidance powers.⁸ Section 541(c) allows an interest of the debtor to become property of the estate "notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law."⁹ Avoidance based on state law compliance should require "substantial compliance" rather than complete compliance with state law.

This Comment argues that having a federal foreclosure standard and exempting foreclosure sales from "constructively fraudulent" avoidance would resolve the inconsistencies with state law requirements. This solution aligns the bankruptcy trustee's avoidance powers with the intent of Congress, the purpose of the Code, and current case law. Homeowners have state law remedies under wrongful foreclosure statutes to protect their interests.¹⁰ Therefore, mortgagees, as secured creditors, should not be subjected to additional hurdles to secure their collateral under the avoidance powers if the sale is absent actual fraud, as stated in § 548(a)(1)(A), or is otherwise noncollusive.

The beginning of this Comment will map out the current avoidance powers under the Code and the rise of the Uniform Fraudulent Conveyance Act ("UFCA") and Uniform Fraudulent Transfer Act ("UFTA"). It will then discuss the split of authority in determining the meaning of the reasonably equivalent value requirement of § 548(a) before and after the Supreme Court's decision in BFP.

Part II.A of this Comment will propose needed amendments to the Code, including the need for a state law substantial-compliance standard in accordance with the decision in BFP and current case law. Part II.B discusses state inconsistencies and the need for a federal standard. First, it will show that these amendments will prevent avoidance based on the numerous inconsistent

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state laws governing foreclosure sales, including the jurisdictional splits in determining the validity of the Mortgage Electronic Registration System and proof of chain of assignments, while maintaining the freedom to avoid foreclosure sales shown to be collusive. Second, it will address the difficulty of determining what minimum bid is sufficient to "shock the judicial conscience" as stated in BFP¹¹ so as to avoid a foreclosure sale on that basis. Third, it will then layout recent decisions pertaining to state law foreclosure notice and advertisement requirements. Fourth, it will highlight the need to shift to a substantial-compliance safe harbor for avoidance powers in regard to foreclosure sales. Finally, Part II.C of this Comment will address collusive sales and the reasons why foreclosure sales should still be subject to avoidance when actual fraud, or collusion, is present as opposed to constructive fraud.

I. Background

Upon filing a bankruptcy petition, a bankruptcy estate is created pursuant to § 541 consisting of "all legal or equitable interests of the debtor in property."¹² Property that has been subject to a prepetition foreclosure sale is not property of the estate because the debtor no longer has a legal or equitable interest in the property after the sale, and thus no interest at the time of the filing of the petition.¹³ Sections 544 through 549 of the Code allow a trustee to avoid these prepetition and postpetition transfers under various circumstances, including actual fraud, constructive fraud, or a lack of state law compliance.¹⁴

Drafters of the UFTA, the successor to the UFCA, conformed the UFTA to the language in § 548 of the Code.¹⁵ Section 548(a)(1)(A) maps out the avoidance powers based on actual fraud, while § 548(a)(1)(B) allows for avoidance of a sale in which the debtor fails to receive reasonably equivalent value for the property or one that is constructively fraudulent.¹⁶

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Since the Code does not define reasonably equivalent value,¹⁷ courts have used different tests in determining reasonably equivalent value, especially for a forced sale such as a foreclosure sale. These standards have varied drastically throughout the circuits. The Fifth Circuit used a percentage approach,¹⁸ while the Ninth Circuit Bankruptcy Appellate Panel ("BAP") allowed a rebuttable presumption of sufficient price in a foreclosure sale.¹⁹ The Seventh Circuit added a third approach and looked to the totality of the circumstances in determining reasonably equivalent value.²⁰ Finally, in 1994, the Supreme Court addressed the issue of reasonably equivalent value.

In BFP, the Court held that consideration received at a noncollusive foreclosure sale within one year prepetition satisfies the reasonably equivalent value requirement of § 548.²¹ The Court intended to close the door on the reasonably-equivalent-value debate, but it expressly left open the option of avoidance based on lack of state law compliance,²² thus leaving the door open for more costly and unnecessary litigation.

A. Avoidance Powers Under the Code

Under § 541, a debtor's assets, which include "all legal or equitable interests," are placed into the bankruptcy estate upon the filing of a bankruptcy petition.²³ Occasionally, if a debtor has defaulted on his home loan, the lender would have already foreclosed on the debtor's property before the debtor files a bankruptcy petition. Under the avoidance powers in the Code, a trustee may set aside a prepetition foreclosure sale and bring the foreclosed property, or the value of it, back into the estate for distribution to creditors.²⁴

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Sections 544 through 549 of the Code set out the numerous prepetition and postpetition avoidance powers of the trustee.²⁵ Section 544 allows a trustee to avoid a transfer that could have been avoided under applicable law, including state law, by an unsecured creditor or a hypothetical claimant.²⁶ This section of the Code is the root of many inconsistencies in the exercise of the avoidance powers, and those inconsistencies are exacerbated by the drastic variation among state foreclosure and property laws.²⁷ Section 545 of the Code allows a trustee to avoid certain statutory liens.²⁸ Section 547 allows avoidance of prepetition preferential transfers.²⁹ Section 548 sets out the fraudulent transfer avoidance powers.³⁰ Finally, § 549 covers the avoidance of postpetition transfers authorized under § 303(f) or § 542(c).³¹

The purpose of these avoidance powers is to preserve all potential...