Among the many protections afforded creditors under the Bankruptcy Code is the estate’s ability to avoid transfers made before the petition date that benefit certain creditors at the expense of others. These so-called avoidance actions are primarily governed by Sections 544, 547 and 548 of the Bankruptcy Code, which set forth the requirements for challenging prepetition transfers as preferential or fraudulent.
It has not always been clear how these avoidance powers apply to prepetition foreclosure sales. Beginning with fraudulent transfers under Section 548 of the Code, the Supreme Court’s decision in BFP v. Resolution Trust Corporation established that the price received for real property at a mortgage foreclosure sale conducted in compliance with state law constitutes “reasonably equivalent value.”1 The Supreme Court noted that it “would not presume that Congress intended to displace traditional state regulation with an interpretation that would profoundly affect the important state interest in the security and stability of title to real property.”2 Accordingly, as long as a prepetition foreclosure sale was conducted in accordance with state law, it could not be avoided as fraudulent.
In contrast, the treatment of foreclosure sales in the context of a preference action under Section 547 of the Code is not as well defined.3 On the one hand, some courts have extended the policy reasoning in BFP to Section 547, finding that if a foreclosure sale is non-collusive and has been regularly conducted, then, as a matter of law, because the sale price constitutes reasonably equivalent value for the transferor for purposes of Section 548, the transferee will not have “received more” than it would have in a chapter 7 liquidation for purposes of Section 547.4 On the other hand, certain courts have reasoned that BFP is inapplicable and relied upon what they considered a “plain meaning” interpretation of Section 547, holding that the only relevant question is whether the creditor received more from the foreclosure sale than it would have in a hypothetical chapter 7 liquidation; in other words, a transfer could be “avoidable notwithstanding the fact that the foreclosure sale was non-collusive and complied with state law.”5
The Third Circuit’s recent decision in In re Veltre seeks to resolve some of this ambiguity by considering whether a properly conducted foreclosure sale can be avoided as a preference under Section 547 of the Bankruptcy Code.6 The court held that it cannot when the sale is governed by Pennsylvania state law, but refused to extend BFP to hold that a foreclosure sale can never be avoided as a preference.
In re Veltre
In In re Veltre, the debtor, Margaret Adeline Veltre, owned a home subject to two Pennsylvania mortgages: the first in favor of Capital One Bank and the second in favor of the appellee, Fifth Third Bank.7 Several months before Veltre filed for chapter 11 protection, Fifth Third Bank purchased Veltre’s home at a sheriff’s sale for $90,000, which was sufficient to fully pay the debt owed to Capital One Bank.8 Upon commencing her chapter 11 case, Veltre initiated a Section 547 preference action against Fifth Third Bank in an attempt to avoid the foreclosure sale.
Bankruptcy Court Decision
The Bankruptcy Court for the Western District of Pennsylvania held that a valid, legal, and non-collusive sheriff’s sale cannot be undone or otherwise avoided under Section 547.9 In reaching this conclusion, the court relied heavily on the Supreme Court’s reasoning in BFP and its subsequent application by the Western District of Pennsylvania in In re Rocco and In re Pulcini.10 Accordingly, the bankruptcy court determined that because the sheriff’s sale had been regularly conducted and non-collusive, Fifth Third Bank “could not and did not ‘receive more’” than it would have in a hypothetical chapter 7 liquidation.11 The bankruptcy court also echoed the policy rationales emphasized by the Supreme Court in BFP: “[t]o hold otherwise would ‘profoundly affect Pennsylvania’s essential interest’ in making title to real property stable and secure [and] [t]itle to real property purchased at a foreclosure sale would be under a federally created cloud.”12
District Court Decision
On appeal, the Western District Court of Pennsylvania affirmed the bankruptcy court’s decision, but on different grounds. Unlike the bankruptcy court, which had reasoned by analogy from the Supreme Court’s decision in BFP, the district court emphasized that the Supreme Court’s BFP ruling only applied to Section 548, and instead first focused on the language of the statute.13 Differentiating itself from prior decisions concerning Section 547, the district court looked to Pennsylvania law, where “it is presumed that the price received at a duly advertised public sale is the highest and best obtainable.”14 Given this presumption, the district court reasoned that a buyer-creditor could not receive more in a properly conducted foreclosure sale than it would in a hypothetical liquidation, and, therefore, Section 547 did not provide a means to avoid the foreclosure sale to Fifth Third Bank.15
The district court also noted that if federal courts were to void sheriff’s sales under Section 547, it would disrupt well-settled foreclosure law and encroach state property law.16 The district court ultimately concluded “that in Pennsylvania a validly conducted sheriff’s sale is not an avoidable preference under § 547.”17
Third Circuit Decision
On appeal, the Court of Appeals for the Third Circuit agreed with the district court that because under Pennsylvania law the price received at a duly advertised public sale is presumed to be the highest and best obtainable, Fifth Third Bank had not received more than it would have in a hypothetical liquidation.18 Accordingly, the foreclosure sale was not avoidable as a preference.
Notably, the district court and Third Circuit relied upon the Pennsylvania state law presumption that the price obtained in a duly advertised public sale is the highest and best obtainable price. It will be interesting to follow how persuasive the Third Circuit’s decision is for courts that are applying state laws that do not have the same presumption. This is especially true given that neither the district court nor the Third Circuit followed the bankruptcy court in applying the Supreme Court’s reasoning in BFP to the context of Section 547. Having said that, one could argue, like each of the bankruptcy and district courts in Veltre and the Supreme Court in BFP, that there are important state interests in the stability of title to real property which warrant upholding prepetition foreclosure sales in the face of avoidance actions.