When acquiring property through a property tax sale, there
are risks to the buyer if the property owner becomes a debtor in
bankruptcy. Under the Bankruptcy Code a
transfer might be avoided if the debtor was insolvent (or becomes insolvent due
to the transfer) and received less than reasonably equivalent value for the
property. If that transfer took place
within the look back period (either 2 or 4 years depending on the bankruptcy
filed, Chapter 7, 11 or 13) and the sale price was not “reasonably equivalent
value” for the property, then the transaction might be challenged as a fraudulent
transfer.
The U.S. Supreme Court in 1996 held that in a foreclosure
sale, if state law for the foreclosure process was followed, then the price
obtained as a result of that foreclosure sale constituted reasonably equivalent
value as a matter of law. However, the court noted that there might be
exceptions to the rule in other contexts, such as a forced sale to satisfy tax
liens.
In tax sales where the only reason for the sale was to pay
the delinquent property taxes, if there is a significant disconnect between the
sale price and the value of the property, and if there was no opportunity for
competitive bidding, then it’s an open question whether the sale price will be
considered a fair value. If the sale were
to be timely challenged in a subsequent bankruptcy, the court may well decide
to avoid the sale as a fraudulent transfer.
If that happens, the bankruptcy court could recover the fraudulent
transfer from the initial transferee and even the next transferee who acquired the
property from the initial transferee (unless buyer #2 can assert a successful
defense as a good faith purchaser).
Bottom line. . . when purchasing properties through forfeiture
procedures, such as a property tax sales, that do not include competitive
bidding, buyers need to be aware that their liability doesn’t end with the transfer
deed.
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