Court denies lender’s motion to dismiss Section 547 preference action seeking to avoid valid foreclosure sale

• Reed Smith LLP
• Ann E. Pille
• USA
• ·         December 19 2011
• Whittle Development, Inc. v. Branch Banking & Trust Co. et al. (In re Whittle Development Inc.) 2011 WL 3268398 (Bankr. N.D. Tex., July 27, 2011)      

CASE SNAPSHOT

The lender foreclosed on the borrower’s property after the borrower defaulted on its loan obligations. At the foreclosure sale, the property was sold to a subsidiary of the lender for less than the outstanding loan balance. Within one month following the foreclosure sale, the borrower filed for chapter 11 bankruptcy, and the lender filed a deficiency claim for the difference between the loan balance due and the amount of the credit bid at the foreclosure sale. Despite the fact that the foreclosure sale was operated in accordance with state law, the borrower argued that the value of the property exceeded the pre-foreclosure loan balance, and that the foreclosure sale was avoidable as a preferential transfer. The lender filed a motion to dismiss the preference claim, and the Bankruptcy Court denied the motion.

FACTUAL BACKGROUND

Whittle Development, Inc. was a real estate developer in Dallas, Texas. Whittle and the lender entered into a loan agreement secured by real property. After Whittle defaulted on its obligations, the lender notified Whittle of its intent to foreclose upon the property securing the note. A sale was held in conformity with all relevant state requirements, and the property was sold to a subsidiary of the lender for $1.2 million. Within a month, Whittle filed for bankruptcy, and the lender filed a deficiency claim for the roughly $1 million that remained due and owing following the foreclosure sale.

The debtor argued that there was no deficiency claim, contending that the property was worth $3.3 million. As such, the debtor contended that the lender received more than it would have under a chapter 7 liquidation, rendering the foreclosure avoidable as a preferential transfer under section 547 of the Bankruptcy Code. The debtor filed an adversary action, and the lender filed a motion to dismiss.  

COURT ANALYSIS

Under section 547 of the Bankruptcy Code, a transfer can only be avoided if the creditor received more than it would receive in a chapter 7 case. The lender argued that this requirement could not be met as a matter of law, because the Supreme Court’s decision in BFP v. Resolution Trust Corp. 511 U.S. 531 (1994), held that a non-collusive foreclosure sale conducted in accordance with state law was not avoidable because, as a matter of law, it provided “reasonably equivalent value” for the property transferred. The debtor countered that, if it could prove the property’s fair market value was $3.3 million, the lender did indeed receive more through foreclosure than it would have in a chapter 7 liquidation (i.e., both the property and a $1 million deficiency claim on a $2.2 million debt). Further, the debtor argued that BFP did not control the outcome of this case, because BFP dealt with a constructively fraudulent transfer under section 548, and that section’s requirement of “reasonably equivalent value” is distinguishable from section 547, which requires only that the creditor receive more than it would have under chapter 7 without regard to equivalent value. The debtor’s position was that the amounts bid at a foreclosure are not per se equal to the fair market value of the property. As such, it is possible that a creditor might receive more through a pre-petition foreclosure sale than it might have obtained in hypothetical chapter 7 liquidation. If true, the prong of section 547 at issue would be satisfied, and the transfer would be avoidable.

In declining to dismiss the preference claim, the court held that applying the BFP reasoning to a case involving section 547 was “misplaced.” In BFP, the Supreme Court analyzed what, as a matter of law, was meant by “reasonably equivalent value” under section 548. Section 547, however, does not require that value be reasonably equivalent; it requires only that a creditor receive an amount in excess of a hypothetical recovery. The court concluded that BFP was not controlling, and that the debtor’s complaint was sufficient to state a claim against the lender.  

PRACTICAL CONSIDERATIONS

Mere compliance with state law is insufficient to shield a foreclosure sale, and the benefits received therefrom, from a preference action. Secured lenders that wish to credit bid at a foreclosure sale need to be cognizant that a low-ball offer may subject them to liability if their borrower files for bankruptcy protection within 90 days after the foreclosure sale.

 

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Charles
Charles Wayne Cox – Oregon State Director for the National Homeowners Cooperative
Email: mailto:Charles@BayLiving.com
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