Seventh Circuit holds that a lawfully conducted tax sale was a nonetheless a fraudulent conveyance under § 548(a)(1)(B) of the Bankruptcy Code

The Seventh Circuit has held that an Illinois tax sale, lawfully conducted in accordance with the rules governing such sales, was nonetheless a fraudulent conveyance under § 548(a)(1)(B) of the Bankruptcy Code. In In re Smith, No. 15-1166, (7th Cir. Jan. 2016) the Chapter 13 debtors brought an adversary proceeding to avoid, as constructively fraudulent, a prepetition tax sale transfer of their property. The principal question on appeal was whether compliance with state law for tax sales was sufficient to establish that the sale was for reasonably equivalent value under § 548(a)(1)(B). The tax buyer, and the District Court, relied primarily on BFP v. Resolution Trust Corp., 511 U.S. 531, 114 S.Ct. 1757, (1994), where the Supreme Court held that a mortgage foreclosure sale that complies with state law is deemed for reasonably equivalent value as a matter of law. The Seventh Circuit read BFP’s special rule for forced mortgage foreclosure sales was based on practical concerns about how to harmonize federal bankruptcy law with state mortgage foreclosure law. In finding a foreclosure sale to be for a reasonably equivalent value, the Supreme Court held that for a foreclosed property it is the price in fact received at the foreclosure sale. Unlike mortgage foreclosure sales, Illinois tax sales do not involve competitive bidding where the highest bid wins. Instead, bidders bid how little money they are willing to accept in return for payment of the owner’s delinquent taxes. Competitive bidding is limited to only the penalty interest rate on the lien, not the real estate. The bid amounts bear no relationship to the value of the underlying real estate. Thus, Illinois’s tax sale method is not designed to produce bids that could fairly be called reasonably equivalent value. The Illinois sale method thus differs dramatically from the competitive bidding in BFP, which focused on the context of [a] … sale of real estate, not the delinquent taxes. To the tax buyers argument that applying the general rule of § 548 to tax sales will wreak havoc with Illinois’s system for collecting delinquent property taxes, the Court was unmoved. It concluded that [w]hile applying § 548 may make purchases of Illinois tax liens marginally less attractive as investments, federal law mandates this result. We must enforce the federal bankruptcy remedy for fraudulent transfers where the reasoning of BFP does not apply, based on fundamental differences between the auction systems used in that case and this one.

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