Prior to the 1984 Amendments to the Bankruptcy Code1 (BAFJA), there was a split as to whether a transfer of title to real estate by virtue of a mortgage foreclosure constituted a transfer as defined in §101 of the Bankruptcy Code.2, 3 However, BAFJA made it clear that a “transfer” included “the foreclosure of a debtor’s equity of redemption.”4 This change in definition has a significant impact on the application of both §547 (preference) and §548 (fraudulent transfer).  

Although Durett was decided before the enactment of BAFJA, its safe harbor of 70% of fair market to avoid the application of §548 was often followed by lenders when pursuing foreclosure. The issue, however, was seemingly resolved with finality by the Supreme Court’s decision in BFP v. RTC.5 In BFP, the court, Scalia, J., held (5 to 4) that for the purposes of determining “reasonably equivalent value” as that term is used in §548, the “price in fact received at the foreclosure sale so long as all of the requirements of the State’s foreclosure law had been complied with” is “reasonably equivalent value.”6  

Thus, an action under §548 to avoid a regularly conducted mortgage foreclosure sale is generally foreclosed by the holding in BFP. Many state adoptions of the Uniform Fraudulent Transfer Act defined “reasonably equivalent value” to include the acquisition of property at a regularly conducted mortgage foreclosure sale.7  

However, if the mortgage foreclosure sale took place within 90 days of the commencement of a bankruptcy proceeding by or against the mortgagor, a recovery may be possible as a preference under §547. A recent case highlighting this issue is In re Gregorio Villarreal.8 In Villarreal, the debtor granted a third mortgage on a parcel of real estate to secure a debt of $70,000. The two prior mortgages secured debts aggregating $750,000. Debtor defaulted. Mortgagee bid in for the amount of the third mortgage debt. The foreclosure took place within 90 days of the commencement of the Chapter 13 proceeding. The debtor brought an adversary proceeding to avoid the transfer as a preference. The court found the fair market value of the real estate to be $4,020,000. The court held that the creditor had received $3,250,000 by reason of the transfer, and this was more than the creditor would have received in the Chapter 7 liquidation, and therefore the foreclosure was voidable as a preference under §547.  

There are cases, however, which refuse to apply §547 to the mortgage foreclosure on two different grounds:

  1. Applying the thinking of the court in BFP that the Bankruptcy Code, absent a clear and manifest purpose, should not be used to upset State regulation of real estate transactions.9  
  2. In a regularly conducted sale, the creditor who bids in does not receive “more” in his status as a creditor but may receive more on a subsequent resale. Had the bidder been a third party, there could be no contention that a preference was received. The mortgagee should be in no worse position than the third party purchaser. 10  

Clearly, the matter is not free from doubt and it does not take a totally egregious difference between fair market value and the mortgagee’s bid at foreclosure to result in a claim that a preference has been received.