By Guest Blogger: Paul B. Porvaznik, Esq.

When you file for bankruptcy, you sign sworn schedules that itemize your assets.  If you fail to fully disclose or update your asset summary, you risk a creditor objecting to your discharge on the basis of fraud.  Another peril of nondisclosure concerns claims that arise after the bankruptcy filing; like future lawsuits.   So, what happens if a claim develops after you file your bankruptcy petition but before you are granted a discharge and you don’t inform the bankruptcy court of this claim?  That’s the question examined in Schoup v. Gore, 2014 IL App (4th) 130911 (4 Dist. 2014), a case that will doubtless serve as a cautionary tale for future bankruptcy petitioners.

 In Schoup the debtor filed in 2010 and obtained a discharge in 2012.  Several months into the case the debtor was injured on private property, giving rise to a premises liability claim.  The debtor didn’t tell the bankruptcy court or trustee of the premises suit until after his bankruptcy case was discharged. Indeed, after obtaining his discharge the debtor filed that claim. The property owners moved for summary judgment on the basis of judicial estoppel, arguing that the plaintiff’s failure to disclose the suit as an asset in his bankruptcy barred the post-discharge action entirely.  The trial court agreed and the plaintiff/debtor appealed.

Ruling: Summary judgment affirmed. Why? Because the judicial estoppel doctrine barred the plaintiff’s premises liability suit.  Judicial estoppel prevents a litigant from taking a position in one case and then, in a later case, taking the opposite position (i.e., you can’t claim that you’re an independent contractor in one case and then in a second case, claim that you’re an employee).  Judicial estoppel’s purpose is to protect the integrity of the court system and to prevent a party from making a mockery of court proceedings by conveniently taking whatever position happens to serve that party at a given moment.  (¶ 9).  The five elements of judicial estoppel: (1) two positions are taken by the same party; (2) the positions must be taken in judicial proceedings; (3) the positions must be taken under oath; (4) the party must have successfully maintained the first position and received a benefit from it; and (5) the two positions must be “totally inconsistent.” (¶ 10).  Illinois courts have consistently held that a debtor who fails to disclose an asset – including an unliquidated lawsuit – can’t later realize a benefit from the concealed asset after discharge.  (¶ 14).

The Court agreed with the trial court that all five elements were met.  First, the plaintiff took two positions: he impliedly represented to the bankruptcy court that he had no pending lawsuits and then filed a personal injury suit in state court after discharge.  The two positions were taken in judicial proceedings (Federal bankruptcy court and Illinois state court) and under oath (the plaintiff signed sworn disclosures in the bankruptcy court and filed a sworn complaint in state court).  The plaintiff also obtained a benefit from concealing the premises liability case as he received a discharge without any creditor knowing about the state court claim.  Finally, plaintiff’s positions were “totally inconsistent”: he omitted his personal injury case from his bankruptcy schedules and then filed a state court personal injury suit after he got his discharge. (¶¶ 17-18).

In conclusion, a party that had absolutely nothing to do with the plaintiff’s prior bankruptcy was able to get a case dismissed because the plaintiff didn’t update his asset schedules to account for an inchoate lawsuit.  The case is a great reminder to always check on-line bankruptcy records to see if a plaintiff suing your client has any prior bankruptcies.  More than once I’ve found that a plaintiff recently received a discharge before filing suit and never disclosed the lawsuit as an asset in the bankruptcy case.  In those situations, the plaintiff, not wanting to deal with a judicial estoppel motion (like the one filed by the defendants in this case), is usually motivated to settle for a reduced amount and in one case, even non-suited the case.  Viewed from the debtor’s lens, I counsel clients to fully disclose all assets – even lawsuits that haven’t materialized on the bankruptcy filing date.  Otherwise, they run the risk of having a creditor challenge the discharge or even having a future lawsuit dismissed; like the plaintiff in this case.

My other observation concerns the “sworn statement” judicial estoppel element.  What if the state court complaint wasn’t verified under oath?  Would that still meet the sworn statement criterion?  It’s unclear from the text of the opinion.  If the complaint wasn’t verified, I think I’d argue that the plaintiff didn’t take two sworn contradictory positions.

Paul Porvaznik Photo

About the Author: Paul B. Porvaznik, Esq. is a business litigation attorney practicing in Chicago at the firm of Molzahn, Rocco, Reed & Rouse, LLC, a full-service litigation firm.  He has practiced for 17 years primarily in the areas of general civil litigation, mechanics liens, landlord-tenant law, collections, post-judgment enforcement and general business disputes.

Home for Sale

On November 1, 2012 Freddie Mac and Freddie Mae changed the prevailing short-sale guidelines that featured examples of eligible hardships that permit homeowners to sell their homes even if current on their mortgages. Ultimately that new guidelines enabled lenders and servicers to quickly and easily qualify borrowers. Let’s take a look at the main changes:

Eligibility Requirements

  • Mortgage must be owned by Fannie Mae or Freddie Mac
  • Borrower must show hardship
  • Death of borrower or co-borrower
  • Unemployment
  • Divorce
  • Long term disability
  • Employment transfer/relocation over 50 miles away
  • Increased housing expenses
  • Disaster
  • Business failure

New Guidelines

  • Offer a streamlined short-sale program for the borrowers most in need.
  • Enable servicers to quickly and easily qualify borrowers that are current.
  • Fannie Mae and Freddie mac will waive the right to pursue deficiency judgments in exchange for financial contribution if a borrower has sufficient income or assets to make cash contributions or sign promissory notes.
  • Special treatment for military personnel with Permanent Change of Station orders will be given.
  • Provides servicers and borrowers clarity on processing a short-sale when foreclosure sale is pending.
  • Fannie Mae and Freddie Mac will offer up to $6,000 to second lien holders to help expedite a short-sale.

Not sure if a short-sale is right for your situation? Call us or send an e-mail to mhedayat[at]mha-law.com to learn more.

seal_of_the_supreme_court

In June 2013 the US Supreme Court published an opinion arising from a dispute over the estate of Pierce Marshall – better known as the husband of Anna Nichole Smith. That case, Stern vs. Marshall, gave rise to a surprising decision; namely, that Bankruptcy Courts could not rule on the State-law aspects of a dispute even if they were before the Bankruptcy Court as part of the larger dispute. The operative distinction would henceforth come down to whether or not a dispute qualified as a “core proceeding” (i.e. whether it was the kind of question over which the Bankruptcy Court had jurisdiction).

Since the Stern decision was released in 2011, results across the country have often been inconsistent as Bankruptcy Lawyers and Judges attempt to apply this new set of distinctions and decide whether cases should be heard or referred back to the State Courts. In many cases, Bankruptcy Courts defaulted back to State Courts without much discussion.

In an update and clarification to its Stern vs. Marshall Opinion, the Supreme Court recently decided Executive Benefits vs. Ch. 7 Trustee for Bellingham Ins. Agency(Jun. 09). The opinion answered a number of questions that had arisen in the wake of Stern. In particular, the Supreme Court clarified how Bankruptcy Courts should proceed when faced with “core” claims that were now designated as “non-core” under the Stern standard. These claims fall into the so-called “statutory gap” in the Bankruptcy Code.

In its Opinion the Supreme Court observed that 28 U.S.C. §157(c) does in fact permit “Stern” type claims to proceed before the Bankruptcy Court as non-core claims. How? The Supreme Court explained it this way:

With the “core” category no longer available for the Stern claim at issue, we look to section 157(c)(1) to determine whether the claim may be adjudicated as a non-core claim – specifically, whether it is “not a core proceeding” but is “otherwise related to a case under title 11.

In short the Supreme Court determined that, when faced with a Stern claim, the Bankruptcy Court must now decide whether it satisfies the standards of 28 U.S.C. §157(c)(1). If it doesn’t, the Bankruptcy Court could not hear the claim and had to send it back to State Court. If it did however, the the Bankruptcy Court was to “hear the proceeding and submit proposed findings of fact and conclusions of law to the district court for de novo review and entry of judgment.”

Discharging Taxes in Bankruptcy

In response to questions we get over and over, here is our totally unofficial Guide to Discharging Taxes in Bankruptcy. We’ve gathered many of the tried-and-true rules on the topic but beware! The rules and decisions are constantly evolving, so take this guide with a grain of salt and always consult a competent Bankruptcy Attorney before making any decisions. Okay, enough disclaimers. Here it is:

Chapter 7 Liquidation

In a Chapter 7 liquidation Bankruptcy – whether an individual or a business entity – taxes can be discharged as long as:

(1) They relate to a return due 3+ years before a filing;
(2) That tax return was filed 2+ years before the filing;
(3) They weren’t assessed within 240 days before filing;
(4) That return was not fraudulent or frivolous; and
(5) Taxpayer/debtor not found guilty of evading tax laws.

Note: Even if the tax debt in question does not qualify under these criteria, penalties may still be discharged in Chapter 7 if the events that gave rise to the penalties occurred 3+ years before the filing date.

In such a situation the whole claim, including penalties and interest, would be listed on Schedule E and bifurcated into the non-dischargeable and dischargable portions.  The non-dischargeable portion would be listed in the “Amount Entitled to Priority” column of Schedule E, while the dischargable balance would be identified as “non-priority” and listed in the “Amount Not Entitled to Priority” column. The non-priority penalties do not get listed again on Schedule F.

Chapter 13 Reorganization

Taxes that do not qualify for discharge in Chapter 7 can stll be paid over 3 to 5 years in Chapter 13

(1) Interest stops accruing the moment the Chapter 13 bankruptcy is filed so payments are interest-free.
(2) Most tax penalties are treated as non-priority, unsecured debt and typically discharged or 10-15 cents on the dollar or less.
(3) In such case, tax penalties area still bifurcated from the priority tax claim and listed as “non-priority, unsecured” claims.

Note: If a tax lien has been recorded against the debtor’s real or personal property prior to the bankruptcy filing date, then the tax claim should be listed on Schedule D as secured – not on Schedule E as unsecured priority. That lien will be eliminated if there is no equity in the underlying property, or reduced to the present equity value of the debtor’s interest in that property as of the filing date of the case.

Want to know more about tax discharge strategies in Bankruptcy? Contact M. Hedayat & Associates, P.C. for your confidential consultation.

In re MS Valley Livestock

As a rule, debtors ask the Bankruptcy Court to protect them. In return for its iron-clad protection the Bankruptcy Court demands that all rules be obeyed and debtors refrain from hiding or giving away assets that could be used to satisfy creditors.

To ensure that nothing slips through the cracks Bankruptcy law empowers the case Trustee to claw back anything paid or given away by a debtor within 90 days of filing. In essence, Bankruptcy law treats all such transfers as attempts to shed assets. So payments in that period automatically constitute preferential transfers (“preferences”). Preferences can be sucked back into the Bankruptcy Estate by the Trustee; so unsuspecting vendors can be ambushed and forced to give back money they actually earned!

Finally, to make things even more confusing there are exceptions to the preference rule such as payments in the ordinary course of business, a contemporaneous exchange for value, and receiving new value for the payment.

In re Mississippi Value Livestock

In re Mississippi Valley Livestock, decided recently by the 7th Circuit Court of Appeals, involved payments made by the debtor within 90 days of an involuntary bankruptcy filing. But since the debtor had not planned on filing, it would be hard to say that it was purposely trying to get rid of property or playing hide-and-seek with assets. So this was not exactly the kind of case the law was meant to prevent. No, this was one of those cases that pushed the Bankruptcy law to its limits.

The Facts

Mississippi Valley Livestock (“Debtor) was in the business of buying and selling cattle for slaughter. J&R Farms (“J&R”) hired the Debtor to sell its cattle and remit the proceeds – essentially a consignment arrangement. The two entities enjoyed a long, prosperous commercial relationship until the Debtor started to fall behind in payments: first to J&R, then to all its other creditors.

While J&R was prepared to wait for things to turn around, a group of creditors got together and petitioned the Debtor into involuntary bankruptcy; but not before it paid around $900,000 to J&R. The Trustee in the Debtor’s case objected that the constituted a “transfer” of “property of the estate” on account of an existing (i.e. “antecedent”) debt: the dictionary definition of a preference.

Finally, no exception applied because this was not an “ordinary” payment – it represented an extraordinary payment to a particular creditor while the other creditors were poised to get nothing at all. The upshot, said the Trustee, was that the Debtor had chosen to pay J&R with money that should have been used to pay all creditors pro rata.

The Issues

The first issue in the case was whether or not the money paid by the Debtor was really its property, and therefore property of the Bankruptcy Estate. If this was the Debtor’s money, then paying it all to J&R – even though it was owed – was a derogation of the pro rata payment obligation of the Trustee: a Bankruptcy no-no.

But J&R argued that the Debtor was really just giving it back its own property (or at least the proceeds from the sale of that property). So if the sold cattle had never belonged to the Debtor, the proceeds from the sale of those cattle didn’t belong to the Debtor either.  And when the Debtor paid J&R, it was just returning what it didn’t own: certainly, that did not constitute a preference, right?

As usual however, there was a fly in the ointment. The Debtor had placed the proceeds from the sale of J&R’s cattle into the same account it used for other monies. The result was comingling of funds, making them indistinguishable when paid out.

So the second issue in the case was whether the Debtor paying J&R back with the proceeds from the cattle sale (J&R’s own money) or with its operating funds and savings (which should have gone to the Trustee and been distributed to other creditors)?

Bankruptcy Court and District Court Agree: The Proceeds Were Not the Debtor’s Property

 The Bankruptcy Court and District Court agreed with J&R that the Debtor was merely holding the proceeds of the cattle sale as a bailee and did not have a legal or equitable interest in them.  This was especially true because property interests in Bankruptcy are created and defined by State law – not Bankruptcy law. In its evaluation of the case, the 7th circuit does a very thorough analysis of the law on this subject, focusing on the distinction between bailor/bailee relationships and conditional sales in Illinois.  The Court concludes that a bailor/bailee relationship existed here.

Time For A Constructive Trust

While that conclusion could have been the end of the story, in this case it was not. Had the Debtor returned the consigned cattle, there would be no dispute. But here the proceeds were returned to J&R, not the cattle.  The Court concluded that a link had to be found between those cattle and the money returned, or the Debtor would be back in preference territory.

The method used to create that link was the constructive trust – an equitable device in Illinois law that is used when one party has money to which it is not entitled. A constructive trust prevents unjust enrichment of that party. Here, if a constructive trust were construed then the funds in question would never have been part of the Debtor’s Bankruptcy Estate.

Of course a constructive trust actually circumvents the Bankruptcy Code since it prioritizes some creditors over others (which is why it is used so sparingly in Bankruptcy Court). Here however, it was the perfect vehicle because it permitted the Debtors payments to J&R to be characterized as a kind of restitution claim.  The Court noted that in order for a restitution claim to lie, the funds had to be traced to the creditor’s specific interest; which is just what happened here.

But since the funds in this case were comingled, there were insufficient findings at the Trial Court level to support the necessary tracing. As a result the case was remanded for further findings.

The Upshot

The moral of the story here is 2-fold:

First, comingling proceeds or fungible items of personal property is a danger to all parties – Debtors, Creditors, and everyone involved.

Second, even where the parties maintain solid practices, proceeds should be remitted in the ordinary course of business and not permitted to pile up.

Got a thorny issue yourself? Give us a call and find out how we can help you!

Chapter 13 Bankruptcy

[T]here are known knowns… known unknowns … and unknown unknowns… things we do not know we don’t know.—US Secretary of Defense Donald Rumsfeld

When it comes to Bankruptcy, many Debtors don’t know what they don’t know about real estate taxes. Confused? So were the District Courts until the 7th Circuit Court of Appeals addressed the issue in the case of In re LaMont, Opinion 13-1187 (January 7, 2014).

The 7th Circuit began its analysis in LaMont by acknowledging the 2 kinds of real estate taxes with which Debtors must deal:

(a) Sold; and (b) Unsold.

The 2 are treated differently under State law and receive distinct treatment in a Plan of Reorganization as well:

Unsold taxes can be paid through the Plan in the same way that a Debtor would pay arrears to a secured creditor like a mortgage company. The rationale for such treatment is that the taxing body – the County – is presumed to have a secured lien in the subject property for its taxes. Moreover, those axes cannot be sold once a Bankruptcy Petition is filed. Such taxes generally get paid directly to the County Treasurer via the Plan.

Sold taxes are trickier. They can be paid through the Plan like unsolid taxes, but only so long as the “redemption period” has not expired. Even if the redemption period expires during the Plan, sold taxes can still be paid over the rest of the Plan period. And while that is taking place, the Automatic Stay will remain in effect to prevent Tax Buyers from redeeming the sold taxes or forcing a sale of the underlying property (the typical State law remedy).

In LaMont the issue was sold taxes. The LaMont Debtors owed real property in Minooka, Illinois on which the Village had levied a special assessment that they hadn’t paid. The Court noted that in this context a special assessment was deemed a property tax. Thus, the unpaid assessments were disposed of at a tax sale. Shortly afterwards the Debtors filed Chapter 13 and their Plan provided for payment of the assessment directly to the Village. However, the Plan did not identify. nor did notice go out to, the tax buyer. Nonetheless, the Plan was confirmed and the Debtors made payments to the Trustee who distributed them to the creditors including the Village.

But was the tax buyer bound by the terms of the confirmed Plan even though he had not been notified? In answering the questions the Court conducted a thorough analysis of the Illinois property tax system including tax sales and redemption periods – treating the sold special assessments the way they would sold property taxes.

The upshot of the analysis was that for the entirety of the redemption period – usually 2 to 2 ½ years, – a property owner could redeem his or her sold taxes by paying the County Clerk the past due amount, plus penalties and interest. Between 3 and 6 months before the expiration of the redemption period, a tax buyer had to file a Petition for Tax Deed with the Circuit Court, then take the resulting Order to the County Clerk to secure a Tax Deed, which then had to be recorded within a year. If those steps were not followed the tax buyer would lose his interest in the subject property. That is time enough for the property owners to act, but here the time period was tolled because of the Bankruptcy. Still, the Debtors neither identified the proper party to pay nor made adjustments to their Plan of Reorganization.

The LaMont the tax buyer filed his Petition for Tax Deed with the Circuit Court 3 years after the Debtors filed Bankruptcy and the Circuit Court denied it. The tax buyer then filed a Lift Stay Motion in the Bankruptcy Court, which denied the Motion because he was ostensibly being taken care of in the Plan. The tax buyer appealed, arguing that the Stay should not apply since he was not given notice of the case. But the District Court affirmed the Bankruptcy Court.

The tax buyer had also argued that his interest was in the real property, so it was not an interest against the Debtors. In other words he argued that his interest automatically divested the Debtors of their interest in the property after the redemption period expired. In response the 7th Circuit first examined whether or not the tax buyer had a claim, concluding that he did even though there wasn’t a traditional creditor-debtor relationship present. Nonetheless, the Court found that the tax buyer did not have an executory interest in the property itself: he merely had a tax lien on the property.

In reaching its decision the LaMont Court reviewed Illinois case law in concluding that, while there were differences, precedent favored the treatment of sold taxes as a lien. Since the tax buyer’s claim was deemed to be a lien, it could be modified under Section 1322(b)(2) of the Bankruptcy Code and the Debtors could force him to take payments even past the redemption date as long as the Plan was in effect.

In short, sold taxes can be addressed in a Plan of Reorganization but notice should be given to the payee or the Debtors risk paying into their Plan for 5 years only to end up with no credit towards their sold property taxes – and in the end stand to lose their home. Sad but true.

Who Should You Trust?

When Fiduciaries Go Bad

Section 523(a)(4) of the Bankruptcy Code, 11 USC 523(a)(4) makes debts arising from “fraud or defalcation while acting in a fiduciary capacity” nondischargeable.  You know what that means, right? If you answered “Yes,” then you’ve overcome a gulf that several Federal Courts of Appeal could not.

In fact it was not until the decision in Bullock v. Bankchampaign (October term 2012 decided May 13, 2013 slip opinion 11-1518) that the Supreme Court addressed that Circuit split and determined once and for all that “defalcation” requires a showing that the actor had the requisite state of mind or scienter. In short, to have a debt excepted from discharge based on breach of a fiduciary duty, a Debtor must have known that what they were doing was wrong, or must have acted with a gross neglect of whether that was true.

So why did the Supreme Court rule on this relatively abstruse point? It turns out that the Courts of Appeal couldn’t even agree on whether there was a scienter component to defalcation, much less what defalcation should mean. The Supreme Court had to clarify the issue for good.

The Court started its analysis by looking at an old case that discussed requirements for the fraud exception to discharge.  In Neal v. Clark, 95 U.S. 704 (1878) the Court declared that Bankruptcy fraud must be “positive fraud, fraud in fact, involving moral turpitude or intentional wrong” rather than merely implied fraud or fraud in law. The key to Bankruptcy fraud, it seemed, was intentional action and moral turpitude. Certainly moral terpitude seemed a necessity for fraud to exempt a debt from discharge. After all, what good would Bankruptcy be if it did not absolve most all forms of debt? It seemed logical to draw the line at bad actions by bad actors.

Using this logic the Supreme Court concluded that intentional acts, bad faith, and moral turpitude, were prerequisites for a finding of nondischargeability due to a breach of fiduciary duty; while the necessary state of mind could only be shown by demonstrating acts that were intentional or had been taken with reckless disregard as to their propriety.

The Model Penal Code was pressed into service to support the idea that only actual knowledge of wrongdoing or “conscious disregard” of “a substantial and unjustifiable risk” could demonstrate the necessary state of mind to support this discharge exception. Whether the conduct also violated a fiduciary duty was another question. What was certain however, was that the “risk” must have been so obvious “that its disregard would involve gross deviation from the standard a law-abiding person would observe.” (citing Model Penal Code).

Likewise, the Court emphasized that exceptions to discharge “should be confined to those plainly expressed.” Kawaauhau v. Geiger, 523 U. S. 57, 62 (1998). In this case, the Trustee wasn’t a professional: simply a son in charge of his father’s trust. The Court noted this and observed that when there was no apparent fault or intent there was no policy reason for excepting the debt from discharge.

The takeaway here is that the discharge exception in Sec. 523(a)(4) of the Code requires a showing of intent or reckless disregard. It is also important to note the distinction between professional and nonprofessional trustees.

Questions? Concerns? Contact M. Hedayat & Associates, PC for a confidential consultation.

This piece from the Wall Street Journal’s Real Time Economics site answers the question with charts galore! The short answer comes in 3 parts:

1) For working people, 2013 was more of the same slow, jobless recovery;
2) For high net-worth individuals and corporations it was a bonanza; and;
3) The housing sector underwent a slow, painful, and uneven half-recovery.

Check it out here.

WSJ Real Time Economics 2013 Graph

Homeless Couple (In re Smith)(Tax Deeds)

Q: If a debtor files Bankruptcy after taxes are sold, the redemption period has expired, and the property is sold to a disinterested third party, can Bankruptcy still help them recover that property?

A: Kind of. The debtor is out of luck unless the redemption period expired within the 2 years prior to the filing. Then things get a lot more interesting. And that is exactly what happened in the Chapter 13 case of In re Smith.

Inheriting Property, Losing it to a Tax Sale

The Smiths inherited property in 2004 as to which 2001 real estate taxes had already been sold. Although they had until April 2005 to redeem the sold taxes by paying the tax amount plus statutory interest, they failed to do so. As a result the tax buyer was able to obtain a tax deed on April 15, 2005.

Filing Chapter 13 and an Adversary Complaint

Nearly 2 years later, on April 13, 2007, the Smiths filed a Chapter 13 case and Adversary Complaint to avoid the sale of their property pursuant to 11 USC 548. Their Adversary case was appealed all the way to the 7th Circuit.

When Was the Property Transferred?

The initial issue before the 7th Circuit was when the tax sale legally took place – that is, when it was “perfected.” Was it once the redemption period expired? Once the tax deed was issued? The Court determined the sale was perfected when the tax deed was issued.

With the date of perfection fixed, the next question was whether the issuance of a tax deed constituted the kind of transfer that can be undone via Bankruptcy – a Fraudulent or Preferential transfer. Certainly 11 U.S. 548(a)(1)(B) permits the Bankruptcy Trustee to avoid the transfer of an interest of the debtor in property of the Estate made within 2 years before the filing of the petition; but only if the debtor received less than reasonably equivalent value in exchange and was either insolvent when the transfer was made or became insolvent as a result.

Was Reasonably Equivalent Value Given?

The Court quickly determined that the Smiths were insolvent when the property was taken by the tax buyer. But had they received “reasonably equivalent value”? The winning bid at a Sheriff’s Sale is presumed to be a “fair and proper price” or “reasonably equivalent value,” so was this situation (a tax sale) like that one (a foreclosure?). The Court said “No.” So when the tax buyers attempted to rely on BFP v. Resolution Trust Corp., 511 U.S. 531, 114 S. Ct. 1757, 128 L. Ed. 2d 556 (1994) and claimed that the Smiths received “reasonably equivalent value,” the 7th Circuit distinguished that case. After all, it pertained to foreclosure sales and had already been distinguished in the context of tax sales. (See Williams v. City of Milwaukee (In re Williams), 473 B.R. 307, 320 (Bankr. E.D. Wis. 2012), aff’d in part, City of Milwaukee v. Gillespie, 487 B.R. 916 (E.D. Wis. 2013)).

Instead, the Court noted that the Illinois tax sale process does not provide for competitive bidding – unlike a Sheriff’s Sale. The only purpose for a tax sale is to deliver funds to the taxing body. There is essentially no relationship between the sale price and property value. State law allows for the tax buyer to potentially receive a windfall: but Bankruptcy law does not.

Using that standard, tax sales (virtually) always fail to satisfy 11 U.S.C. 548 and, as a result, will always constitute fraudulent transfers. Here, based on testimony, the Smiths’ property had an appraised value of nearly 20x the amount paid at the tax sale. Even the 3rd-party purchaser to whom the tax buyer sold the property only paid about half the appraised value. Regardless of the amount paid for the property, however, the key was that its value was greater than the Debtors’ homestead exemption ($15,000).

If The Transfer Was Invalid, Now What?

So if the issuance of a tax deed in this context constituted a “fraudulent transfer” that was invalid under Sec. 548 of the Bankruptcy Code, what was the proper remedy? Sec. 550(a)(1) of the Code allows for recovery from the initial transferee (the tax buyer), but what about the 3rd party purchaser? After all Sec. 550(b)(1) protects bona fide purchasers (“BFPs”) if they give value, in good faith, without any knowledge concerning the voidability of the transaction.

In this case the 7th Circuit found that merely because the 3rd party purchased a tax deed, and merely because the resulting tax deed arose from taxes bought at a sale, the buyer did not lose his BFP status altogether. Instead, his purchase is free and clear up to the value of relevant State-law exemptions ($15,000 per person) in the value of the property.

All’s Well That Ends…?

In this case the Debtors were able to retain up to $15,000 per person (their Illinois Homestead Exemption) in the value of the underlying property. Additionally, the debtors were awarded costs under Bankruptcy Rule 7054. Was it a “win” for the Debtors? It certainly wasn’t the total loss that it could have – and some would say should have – been.