Whittle Development, Inc. v. Branch Banking & Trust Co.
It is common practice for mortgagees, such as banks, to foreclose on the collateral securing their loans and, in the absence of a third party purchaser for a reasonable value, to purchase such collateral by credit bidding their debt at the foreclosure sale. Due to the circumstances of foreclosure sales, however, often such sales do not result in as a high a sale price as would a private sale transaction. In the recent case of Whittle Development, Inc. v. Branch Banking & Trust Co. (In re Whittle Development, Inc.), 2011 WL 3268398 (Bankr. N.D. Tex. July 27, 2011), the United States Bankruptcy Court for the Northern District of Texas (the "Court") held that a bankruptcy trustee can avoid a prepetition foreclosure sale of a debtor's property as a preferential transfer under section 547 of the Bankruptcy Code despite the fact that the sale was non-collusive and conducted in accordance with applicable state law. Section 547 provides for the avoidance of a prepetition transfer made to a creditor, on account of an antecedent debt, if the debtor was insolvent and the transfer enabled the creditor to receive more than it would have in a hypothetical chapter 7 liquidation. Whittle is significant not only because it calls into question the long-accepted notion that foreclosure sales are final, but also because it represents a departure from Supreme Court precedent in the related area of fraudulent transfers under section 548 of the Bankruptcy Code.
In 2007, Whittle Development, Inc. ("Whittle") borrowed $2.7 million from Colonial Bank, N.A. ("Colonial"). Branch Banking and Trust Company ("BB&T") later acquired Colonial and became the successor-in-interest to Colonial's loan to Whittle. In 2010, BB&T declared a default under the loan, accelerated the outstanding payments owed by Whittle and foreclosed on the real property securing the loan. The foreclosure sale complied with all relevant state law requirements. A subsidiary of BB&T purchased the property at the foreclosure sale for $1.22 million.
Within ninety days of the foreclosure sale, Whittle filed a Chapter 11 petition. BB&T subsequently filed a proof of claim, claiming a debt owed of $2,855,243 of which BB&T alleged $1,181,513 represented a deficiency from the foreclosure sale. Thereafter, Whittle brought an action to avoid, as a preferential transfer, the foreclosure sale. Whittle took the position that the approximate value of the property was $3.3 million, that BB&T's claim on the property at the time of foreclosure was approximately $2.2 million, and thus BB&T had received approximately $1.1 million more that it would have received in a chapter 7 case.
Whittle and BB&T agreed that the foreclosure sale effected a transfer of Whittle's interest in property and that Whittle stated a "facially plausible" claim as to all the requirements of 11 U.S.C. section 547(b) except subsection (5), which "requires a finding that the creditor received more than it would have under chapter 7." BB&T argued that the price paid at the foreclosure sale was the fair-market value of the property based on the Supreme Court's decision in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994). Whittle asserted that since the property was worth more than the amount due to BB&T, BB&T received more than it would have received in a chapter 7. Whittle reasoned that BB&T received a total of $3,261,513, comprised of a deficiency claim in the amount of $1,181,513 and the net property value of $2,080,000 (calculated by subtracting the amount paid at foreclosure of $1.22 million from $3.3 million, the value of the property). Whittle argued that BB&T's maximum recovery in chapter 7 would have been $2.2 million, the amount of BB&T's claim at the time of foreclosure.
BFP v. Resolution Trust Corp.
In BFP, a partnership formed for the purpose of buying a home defaulted on its mortgage payments, resulting in a foreclosure by the bank. A third party purchased the home for $433,000 at a properly noticed foreclosure sale shortly before the partnership filed for bankruptcy. Acting as a debtor in possession, the partnership sued to avoid the transfer as a fraudulent conveyance, alleging that the property had an actual value of $725,000.
In BFP, the Supreme Court addressed whether a foreclosure sale could be avoided as a constructively fraudulent transfer under section 548. The key issue in BFP was whether the foreclosure sale price could qualify as "reasonably equivalent value" or whether the purchaser has to pay fair market value for the property to be insulated from avoidance under section 548. The Supreme Court held that a "fair and proper price, or a 'reasonably equivalent value,' for foreclosed property, is the price in fact received at the foreclosure sale, so long as all the requirements of the state's foreclosure law have been complied with." To hold otherwise, the Supreme Court stated, would interfere with the essential state interest in ensuring the security of title to real property. This ruling effectively insulated regularly conducted foreclosure sales from avoidance under fraudulent conveyance law. In Whittle, BB&T requested that this result be extended to preference actions.
Despite the differences in the language of sections 547 and 548 of the Bankruptcy Code, the Court in Whittle noted that some courts have simply held that the test for preferences -- a transfer which enables a creditor to receive more than in a chapter 7 liquidation -- is essentially the same as the Supreme Court's test for "reasonably equivalent value" in the fraudulent conveyance context. See Chase Manhattan Bank v. Pulcini (In re Pulcini), 261 B.R. 836 (Bankr. W.D. Pa. 2001); Glaser v. Chelec, Inc. (In re Glaser), 2002 WL 32375007 (Bankr. E.D. Va. 2002).
In contrast, other courts analyzing the preference test simply highlight the plain language of the statute and point out that the test for whether a transfer is a preference is fundamentally different than the test used in the fraudulent conveyance statute. In Whittle, the Court sided with this second group of cases, holding that BFP was inapplicable in the preference context based on the clear language of the statute. "[L]ooking at the unambiguous language of the statute, it would seem that the only thing that must be shown is that the creditor did, in fact, receive more from the pre-petition transfer than it would have under a chapter 7 liquidation . . . ." The Court found BFP's assessment of "reasonably equivalent value" wholly inapplicable to the preference context.
The Whittle court denied BB&T's motion to dismiss and allowed Whittle's preference action to proceed. As such, the critical issue remaining is whether the value of the property was the appraised value of $3.3 million or the price paid at the foreclosure sale of $1.2 million. Whittle's position is sustainable only if it rebuts the claim that the selling price of the property did not reflect its true value of $3.3 million and that the deficiency claim of $1,181,513 is worth its face amount. If Whittle's position on value is correct, BB&T did receive a preference in the amount of $1.1 million. However, if BB&T's position on value is correct, then BB&T did not receive a preference because it did not receive more than it would have in a chapter 7. It only received the sum of the amount paid at foreclosure and a deficiency claim.
Although the Whittle decision does not stand for the proposition that all valid prepetition foreclosure sales are susceptible to avoidance as preferential transfers, it does carve out a narrow subset of such sales for which the foreclosure sale may be anything but final. Based on this ruling and others like it, secured creditors and purchasers of foreclosed property who are also creditors of the estate should be cautious. These parties should view this case as a clear warning that, depending on the jurisdiction, the foreclosure sale may not be final. Additionally, purchasers of a foreclosed property must also take into account the risk that the property owner will file bankruptcy and seek to avoid the sale as a transfer under section 547 of the Bankruptcy Code. Purchasers may discount the price they are willing to pay for foreclosed properties to account for this additional risk, a result that is detrimental to the secured creditor, the debtor and its general creditors. If the Whittle opinion gains a widespread following in other jurisdictions and the market reacts to this risk by low bids from third parties, lenders may experience an increased incidence of being required to credit bid and take such assets into its OREO inventory. The determination of the amount of the credit bid may require re-examination as well in light of the risk that the credit bid will be determined to result in the lender receiving a voidable preference.