Avoiding Powers

10.0 AVOIDING POWERS

10.1 Party Bringing Actions

Avoidance actions are brought by the trustee or by a debtor-in-possession under Chapter 11 or Chapter 12. A debtor may generally bring avoidance actions in connection with exempt property. The debtor may avoid the transfer if (1) it is avoidable by the trustee under Sections 544 or 548, (2) the trustee does not seek to avoid the transfer, (3) the debtor could exempt the property, (4) the transfer was involuntary, and (5) the debtor did not conceal the property. Any avoidance action is an adversary proceeding under Rule 7001 et seq. Some cases recognize the authority of a Chapter 13 debtor to exercise avoidance powers. The trustee cannot avoid the lien simply by noting "intent" to avoid the lien by reference in the proposed plan and disclosure. As a rule, only the trustee or debtor-in-possession may bring the action; however, a creditor committee or creditor may initiate a proceeding if it requests the debtor-in-possession or trustee to prosecute the action, the debtor or trustee refuses, and the committee or creditor demonstrates a colorable claim of benefit to the estate and an unjustifiable refusal by the trustee or debtor to act. A subsequent owner does not have adequate standing to invoke the avoidance powers of Section 549. The creditor may, with court permission, bring a derivative action in the name of the debtor.

Company Policy: Do not rely on an avoidance proceeding (sections 544, 545, 547, 548, 549) as to exempt property being sold unless the discharge has been granted or denied in Chapter 7, 12, or 13, or the Chapter 11 plan is completed. If nonexempt property is being sold where a lien was avoided and the discharge is not yet granted (in Chapter 7, 12 or 13) or plan (Chapter 11) is not completed, require a sale free and clear of the previously avoided interest. Require that any sale free and clear of a lien made pursuant to the procedural requirements for the sale. Require that the sale order provide that it is made free of the lien in question (with adequate verification that the lender received notice of the proposed sale).

10.2 Powers as Purchaser or Creditor

The trustee or debtor-in-possession is treated as a bona fide purchaser and lien creditor in order to set aside various transfers; thus, the trustee can set aside unrecorded liens, deeds, contracts, and suits for which no lis pendens has been filed. These suits or transactions are not void but are simply voidable in an adversary proceeding. Therefore, it is extremely important to file all documents quickly. If a mortgage is improperly attested and not eligible for recordation, the recordation is ineffective to give notice and the bankruptcy trustee can avoid the lien. A mortgage erroneously released and subsequently reflected by the mortgagee's affidavit may be avoidable as a voidable preference or as an unperfected interest voidable by the trustee as a bona fide purchaser. A mortgagor-debtor or trustee of the debtor cannot avoid an unrecorded assignment of mortgage; only the assignor can attack such transfer. A mechanic's lien is not avoidable where the claimant failed to file a notice of lis pendens of the foreclosure, but the lien was properly and timely recorded.  If a debtor collaterally assigns its note secured by a mortgage but does not deliver possession of the note, the collateral assignee's rights are avoidable. Actual knowledge of the debtor-in-possession is not imputed to the debtor as a bona fide purchaser for avoidance under Section 544. The debtor may rely on this section as to exempt property. According to one view, the provisions of Section 544 will authorize the avoidance of unrecorded beneficial interests in the land, notwithstanding Section 541(d) recognizing beneficial interests in third parties, since the sections must be construed together. Under this view, the trustee may avoid unrecorded beneficial interests if the debtor acquires title as "trustee" without disclosure of the beneficiaries or terms of the trust. A trustee does not have the right as a hypothetical bona fide purchaser of personal, as opposed to real, property. Perfection of a deed of trust after filing of the petition and within 10 days after execution is avoidable under Section 544; the provisions of Section 547(e)(2)A are irrelevant. The avoidance power under Section 544 applies only to prepetition transfers, and not to post-petition transfers.

10.3 Statutory Liens

Certain statutory liens may be avoided under Section 545 of the Bankruptcy Code. However, mechanic's liens cannot be set aside if they relate back to a time prior to the filing of the bankruptcy even though they are recorded after the bankruptcy.

Judgment liens are not subject to avoidance under Section 545 (but may be voidable preferences).

Statutory governmental liens which are not perfected by filing a notice in the property records may be avoided under Section 545(2).

Tax liens may be avoided (if not perfected at filing of the case) by a trustee, but not by a Chapter 13 debtor.

According to one view, under prior law, if state law provides that the right to collect real estate taxes was automatically perfected as a lien, the trustee could not avoid the lien for prepetition and post-petition taxes on the property. In a Chapter 13 Bankruptcy, the city is entitled to interest on both prepetition and post-petition taxes.

Pursuant to the Bankruptcy Reform Act of 1994, the stay does not prevent the creation or perfection of an ad valorem tax lien by the District of Columbia or a political subdivision of a state, if the tax comes due after the filing of the bankruptcy.

10.4 Limitations on Avoidance

Under Section 546, actions to set aside transfers or liens under Section 544, 545, 547, 548, or 553 must be commenced within two years after the earlier of the entry of the order for relief or 1 year after the appointment or election of the first trustee if the appointment or election occurs before 2 years after the entry of the order for relief. The running begins from the date of signing of the Order confirming the appointment of the trustee; not from the date of docketing of the Order. According to one view, the date of the questioned event is omitted in calculating the limitations. The limitation period may be irrelevant if the lien is avoided pursuant to Section 506 because it is a preference, fraudulent transfer or other voidable transfer. However, if a cause of action exists under state law, longer state time limits (for example, fraudulent conveyances) may control. (Indeed there may be no time limit if an applicable creditor is a governmental unit). According to one view, an action under Section 549 to recover a post-petition transfer by a debtor is governed by a two year limit after the transfer, regardless of whether there is a trustee and regardless of whether the Bankruptcy in converted to a different chapter. According to one view, if state limits have not run, the two-year limitation of Section 546 will control, if shorter. Even if the time limit has passed to set aside a voidable lien or other transfer, the court may reject the claim and void the lien or other transfer. Confirmation of a plan does not bar a subsequent avoidance action, particularly where the possibility of action was disclosed in the Disclosure Statement and Plan. There is no express time limit for assertion of equitable subordination.

10.5 Preferences

A preference occurs if a transfer was made when the debtor was insolvent and if the transfer is made for or on the account of an antecedent debt (such as a deed in lieu of foreclosure). The transfer must be made within 90 days of the bankruptcy. If the recipient of the deed or transfer is an insider (such as a partner), the time limit is one year. A creditor who has a stranglehold over the debtor is an insider with control. Actual management is control: it includes control of personnel or contract decisions, protection schedules, and accounts payable.

Where the debtor pays or satisfies debt which is guaranteed by an insider third party (e.g., stockholder), the payment of debt may be a transfer benefiting an insider of the debtor as a creditor of the debtor. In that event, the transfer may be voidable under prior bankruptcy law as a preference if a bankruptcy is filed within a year (e.g., after a deed in lieu of foreclosure). A transfer to an unrelated third party does not "benefit" an insider partner simply by reduction of its liability for the debt as a matter of law as a partner (and thus the one-year time was inapplicable). As to cases commenced on or after October 22, 1994, the trustee or debtor in possession may not recover a voidable preference from a creditor that is not an insider if the transfer was made between 90 days and one year before the bankruptcy filing. This amendment overrules the Deprizio line of cases.

The preference must enable the recipient to receive more than it could in a Chapter 7 liquidation proceeding. Insolvency is presumed within 90 days of the bankruptcy. The debtor who is not a debtor-in-possession may avoid a voidable preference if it involves an exemption.

A judgment lien may be a voidable preference. A mechanic's lien claim is not a voidable preference.

The recording of a lis pendens may be an avoidable preference.

A transfer of a mortgage to a title company that had advanced funds based on the assignor's dishonored check may be a voidable preference.

Prior to the case of BFP v Resolution Trust Corp., 511 U.S. 531, 128 L. Ed.2d 556, 114 S. Ct. 1757 (1994), it appeared that a foreclosure sale could be an avoidable preference if occurring within 90 days of the debtor's bankruptcy (or one year if the lender is an insider or if a guarantor of the debtor is an insider of debtor) if the bidder received property valued in excess of the amount bid. Under that reasoning a bid in excess of 70% of fair market value could be a voidable preference. Under this reasoning a foreclosure sale bid in by the creditor could be a voidable preference; a foreclosure sale bid in by a third person could not be a voidable preference. Since the BFP case held that a regularly conducted noncollusive mortgage foreclosure is not a fraudulent transfer (because the bid is "reasonably" equivalent value), it is reasonable to assume that a mortgage foreclosure will not be avoidable as a voidable preference. This policy should not be adopted for foreclosures of other liens or for deeds in lieu of foreclosure.

The cancellation of a note and replacement with a new note within 90 check days prior to the bankruptcy is not a preference. The payment in exchange for a release of a perfected lien is not a preference; it represents a contemporaneous exchange for new value. A substitution of collateral is not a voidable preference, at least where the value of the collateral is approximately the same. The payment prior to a bankruptcy of a lien that would be voidable in the bankruptcy is a preference. A Deed in cancellation of existing indebtedness may constitute a voidable preference. Transfers to post-confirmation creditors of post-confirmation property of a Chapter 11 debtor may be voidable preferences if the debtor's bankruptcy is then converted to a Chapter 7 proceeding.

Forbearance by a creditor from exercise of its rights does not constitute new value. The substitution of a new obligation for an existing obligation is not new value under Section 547(a)(2). Substitution of a new lease for a prior lease is not new value. Substitution of a new lien for a prior unenforceable lien on land subject to a prior mortgage securing an amount greater than the land value may be a preference.

Generally, the transfer by a third party to the credit of the debtor is not a voidable preference, but if a creditor initiates the transfer for eventual repayment to itself, the transfer is a voidable preference. As a result, if the creditor loans money to a debtor and takes a lien on the debtor's property knowing that the loan will be used to pay off an unsecured creditor (such as the creditor, who is owed by an affiliate of debtor), then the lien is a voidable preference. According to a different view, payment by a creditor to a debtor's other creditors qualifies as new value for the benefit of the debtor and is not a voidable preference.

Company Policy: If you are asked to insure a loan modification made by the same lender where the lender receives more advantageous interest rate or other benefits (such as contingent interest), add the following creditors ' rights exception:

Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors' rights laws.

Upon request you may limit the exception to any claim arising out of the modification or substitute the 1992 policy creditor's rights exclusion. You do not need to add this exception if the policy issued to the lender is the ALTA 4-6-90 policy or ALTA 10-17-92 policy (with the creditors' rights exclusion retained) or if the loan is made by an institutional lender on a single-family residence.

If the loan is refinanced by a different lender, you do not need to add the exception in the absence of other creditors' rights issues.

The consolidation of three unsecured loans into one new loan secured by a mortgage was a partial preference: the only new value was a lower interest rate and favorable payment terms.

A purchase money mortgage is not avoidable as a preference where the deed and mortgage were effective and recorded on the same day. The mortgage had been executed more than 10 days before the deed, pursuant to a prior contract. The mortgage was not effective until the deed was delivered.

A transfer by a predecessor of the debtor is not avoidable in the bankruptcy proceeding of the debtor as a preference. A transfer by a partnership is not avoidable in a partner's bankruptcy.

A transfer of a security interest in property is not an avoidable preference made to secure debt of a third party.

In calculating the 90-day period for a preference (since the preference normally must occur on or within 90 days of bankruptcy), the first day of the time period (date of transfer) is included and the last day (date of filing of bankruptcy) is excluded. The period is calculated by counting backward from the date of the petition to the date of the transfer (relevant if the last day is a weekend or holiday).

A voidable preference has not occurred if the creditor receives no more than it would in a Chapter 7 liquidation. For example, if the secured debt exceeds the value of the property at the time of the foreclosure or deed in lieu of foreclosure, there is no preference.

A transfer is not a voidable preference if it is made for substantially contemporaneous consideration. However, a delay of two months in recording the security document will prevent it from being substantially contemporaneous. Where the security documents are not recorded contemporaneously with the loan, then the encumbrance may be a preference. Untimely perfection may be protected following inquiry into the reason for the delay, intent of parties, and contemporaneous nature of the exchange. If the loan is made to enable the purchase of the collateral described in the security document, one line of cases holds that the documents must be perfected within 10 days to be contemporaneous; another line holds that the former 10-day limit of 547(c)(3) is not controlling and that other factors can be considered. "There is a split of authority among federal courts regarding whether a non-purchase money security interest that is perfected more than 10 days after the date of transfer can be considered substantially contemporaneous in fact." One line of cases requires perfection within 10 days to avoid a claim of preference. The second line applies a more flexible standard and allows a delay in perfection beyond 10 days where there are circumstances beyond the control of the lender. Pursuant to the Bankruptcy Reform Act of 1994, a security interest is substantially contemporaneous if the security interest secure new value to enable the debtor to acquire the property and if the security interest is perfected on or before 20 days after the debtor receives possession of the property. In other circumstances the transfer is made at the time the transfer takes effect, if the transfer is perfected within 10 days. A mortgage is a voidable preference if it is executed and delivered more than 10 days before the filing of the bankruptcy, even though the mortgage is recorded within 10 days after disbursement of loan proceeds.

To determine a partnership's solvency, the court must consider nonpartnership assets of general partners.

A mortgage granted on the eve of Bankruptcy to secure previously unsecured debt may, in addition to characterization as a preference, be considered a fraudulent transfer since it hinders, delays, or defrauds creditors.

Deeds not recorded in timely fashion may constitute voidable preferences.

A transfer by a tax deferred exchange company (accommodator) that is not made simultaneously with the receipt by the company of the funds may be a voidable preference.

Company Policy: If you are insuring a mortgage securing previously outstanding unsecured debt, or if you are insuring a deed in lieu of foreclosure, place the following exception in the policy:

Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors' rights laws.

Upon request you may substitute the 1992 creditor's rights exclusion.

This exception will not be necessary if the insured transaction (such as a current loan to finance prior unsecured debt) creates the "creditors' rights" issue and if the 4-6-90 or 10-17-92 ALTA policy is issued. The 4-6-90 ALTA policy and 10-17-92 ALTA policy contain a similar "creditors' rights" exclusion. However, if the "creditors' rights" issue arises out of a prior transaction within one year (such as prior mortgage financing unsecured debt and now being refinanced), add this creditors' rights exception to the 4-6-90 or 10-17-92 policy. The creditors' rights exclusion in the 4-6-90 or 10-17-92 ALTA policies may be irrelevant since it extends only to a claim arising out of the insured transaction.

10.6 Fraudulent Conveyances

Under Section 548, a transfer made within one year before bankruptcy may be set aside as a fraudulent conveyance if the debtor was insolvent or had insufficient capital at the time and if the debtor received less than reasonably equivalent value. The one-year period commences from the recordation of the deed which evidences the fraudulent conveyance.

The preponderance of evidence (instead of clear and convincing evidence) standard applied in bankruptcy proceedings grounded in allegations of fraud.

To determine solvency, contingent liability is valued at its present, or expected, value (not the total liability).

A timely disclaimer of an interest in inheritance is likely not a fraudulent conveyance.

The estate may, instead of recovering property fraudulently transferred, recover the value of the property.

A deed in lieu of foreclosure may be a voidable preference or fraudulent transfer. A deed to a "lender" is for reasonably equivalent value if the total of prior liens, secured lenders? mortgage and closing costs (such as broker?s commission) on resale total 87% of fair market value.

A voluntary transfer by a debtor within one year of bankruptcy while insolvent and for less than reasonably equivalent value is a fraudulent transfer.

A friendly foreclosure allowing sale to another entity controlled by debtor's principals may be a fraudulent transfer.

A termination of a lease or other contract may be a fraudulent transfer. According to one view a prepetition, ordinary course of commercial business, non-collusive termination of an executory contract in accordance with the contract because of material default is not a fraudulent transfer.

According to one view, a termination of a real estate contract can be a fraudulent transfer that is perfected at time of recordation of the buyer's deed to the seller.

A cancellation of debt owed by the general partner in consideration of a transfer of the partnership's note is not reasonably equivalent value.

A grant of an encumbrance and new guaranty in substitution for a prior guaranty may not be made for reasonably equivalent value if the prior debt was adequately secured by adequate collateral of the primary obligor.

An award of property in a divorce decree may be a fraudulent transfer if the debtor does not receive reasonably equivalent value.

A modification of mortgage is a transfer to the extent of increased secured debt; consequently, the modification may be a fraudulent transfer.

Hotel casino bets may constitute reasonably equivalent value; under the particular facts the bets are not fraudulent transfers. A title to a church may be recovered as a fraudulent transfer because any value from the church was not "in exchange for" contributions. Value means property, not spiritual commitment.

A civil in rem forfeiture under 21 U.S.C. sec. 881 is not avoidable under Section 548; the title vested in the U.S. no later than the date the government seizes the property and thus occurred more than one year before the bankruptcy filing (and more accurately, at the time of the illegal action).

If a portion of the advances are retained by the mortgagor and the remainder are upstreamed, a good faith creditor may retain a lien for the amount retained by the borrower; the lien will be subordinated for the funds upstreamed.

Use of loan proceeds to pay off antecedent debts to the debtor's principal shareholder were fraudulent conveyances under state law. The scheme for use of the proceeds would be collapsed if the lender knew of the circumstances that would lead it to inquire further into the transaction.

A guarantee secured by a deed of trust will not be a fraudulent transfer if the party receives benefits (direct or indirect) from the loan and the benefits are reasonably equivalent to the obligation. The basic issue involving guarantees usually is whether the consideration flows downstream (e.g., a stockholder mortgages its property to secure a loan to its wholly owned corporation) or upstream (a corporation mortgages its assets to secure a loan made to its parent stockholders).

If the proceeds flow downstream, the mortgagor generally has received the benefits of the loan by advances to its owned entity and no fraudulent transfer has occurred. This position is not conclusive; it may be only a rebuttable presumption. If the subsidiary is insolvent at the time of the parent's guaranty, the net effect may not benefit the parent's creditors.

However, if the proceeds flow upstream, a possible fraudulent transfer has occurred. Similarly, a guarantee by an affiliate may, in appropriate circumstances, constitute a fraudulent transfer.

Where the sole stockholder of the debtor corporation had the corporation guarantee his personal loans and pledge corporate property as security for a $135,000 loan of which the corporation received a benefit of only $8,000 for payment of its taxes, the guarantee and pledge could be avoided under Section 548. Similarly, a fraudulent conveyance may occur if a subsidiary transfers assets to a creditor of its parent and receives no benefit from the creditor.

If a corporation pays a line of credit, on which its stockholder was the maker, a fraudulent transfer has not occurred if it received all advances on the line.

If the identity of interests of affiliated corporations is sufficiently close, payment of affiliate debts will not be a fraudulent conveyance. A cross-collateralization transaction by several affiliates will not be avoidable as a fraudulent transfer if the affiliates are a single business enterprise: one corporate office pays the bills for affiliates; each affiliate pays its share of office expenses; the same principals have overlapping ownership among the entities; operation occurs from the same office; there is use of same telephone number and post office box; there is centralized accounting; and the companies are referred to by a single name.

Financing of a leveraged buyout of a corporation or partnership (by mortgaging of the target corporation's assets to fund a loan to buy out its owners or by sale of the target corporation's assets or stock) may be a fraudulent transfer.

The court may collapse various LBO transactions and treat them as one transaction. "Regardless of the number of steps taken to complete a transfer of debtor's property, such as in a leveraged buyout transaction, if they reasonably collapse into a single integrated plan and either defraud creditors or leave the debtor with less than equivalent value post-exchange, the transaction will not be exempt from the Code's avoidance sections." However, LBO transactions should not be a fraudulent transfer as to the seller of the corporation if the seller is not aware that the corporation's assets will be mortgaged to fund the purchase. If a transferee from a purchaser in a leveraged buyout is a bona fide purchaser for value without notice, then the transfer is not subject to avoidance. The transaction will not be avoidable if the target continues to have sufficient capital and is not rendered insolvent by the leveraged buyout. If the target is able to pay its bills as they mature for several months after the leveraged buyout, this will evidence solvency, particularly where the evidence of balance sheet insolvency is inconclusive.

Courts may have a variety of perspectives on the nature of complicated leveraged buyouts: one case analyzed a spinoff to a newly formed subsidiary of assets followed by a sale of stock of the new subsidiary and encumbrance of its assets. It concluded this was not truly a finance of stock sale of an existing corporation, but, rather, was a sale and finance of an asset purchase by a newly formed corporation. Consequently, the court concluded that fair value was given for the purchase (and finance).

A leveraged buyout may constitute settlement payment exempted by Section 546(e) from advance where paid in the securities or commodities market.

Actual intent to defraud creditors may be evidenced by a mortgage to an insider (including a "close friend") to secure pre-existing debt when the mortgagor was insolvent. Actual intent to defraud creditors was found where substantially all of the assets of the debtor were transferred to a successor corporation but one of the significant debts of the debtor was not assumed by the successor. Indicia of fraudulent intent also include corporate transfers to directors and transfers for inadequate consideration between closely related entities.

A transfer may be a fraudulent transfer if the debtor did not receive reasonably equivalent value and if the debtor retained unreasonably small capital to continue its business. Unreasonably small capital has been variously interpreted as (1) insolvency, (2) the encumbrance of all assets (as unreasonably small capital per se), or (3) insufficient cash flow.

A leveraged buyout may not be avoidable unless a creditor is unpaid and is prejudiced. A trade creditor may be prejudiced if the relationship arose before the leveraged buyout and the debt is owed for a period after the leveraged buyout.

A lien granted to a new lender refinancing a prior loan may be avoidable as a fraudulent transfer.

Redemption of corporate stock when a corporation is insolvent may constitute a violation by state corporation law and therefore may be voidable.

A claim of the United States government shall be paid first if the person indebted to the U.S. is insolvent and the debtor makes a voluntary assignment of property, property is attached, or an act of bankruptcy is committed.

Company Policy: In any case of upstream or downstream guarantees, leveraged buyouts or gift deeds in your transaction, even though no bankruptcy is pending, the following "creditor's rights" exceptions should appear:

Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors' rights laws.

Upon request you may substitute the 1992 creditor's rights exclusion.

This exception will not be necessary if the insured transaction (such as a current loan to finance a leveraged buyout) creates the "creditors' rights" issue and if the 4-6-90 or 10-17-92 ALTA policies are issued. The 4-6-90 and 10-17-92 ALTA policies contain a similar "creditors' rights" exclusion. However, if the "creditors' rights" issue possibly arises out of a prior transaction (such as a leveraged buyout now being refinanced), add this creditors' rights exception to the 4-6-90 or 10-17-92 policy. The creditors' rights exclusion in the 4-6-90 or 10-17-92 ALTA policies may then be irrelevant since it extends to a claim arising out of the insured transaction.

If we are asked to delete the creditor's rights exclusion (from the 1990 or 1992 policy) or to issue the 1970 policy without a creditor's rights exception, you may do so (where lawful):

1. On a loan policy if the property is a 1-4 family residence, and on purchase money loan by an institutional lender.

2. If our underwriting personnel approve such issuance in other cases. See our checklist of questions. We will consider on a case-by-case basis, such issuance where cross guarantees by affiliates will occur. Factors include:

(1) debt to equity ratios;

(2) adequacy of case flow to service debt;

(3) relationship of affiliates (e.g., are they related partnerships with common partners; or sister corporations; do they engage in same type of business);

(4) type of business of mortgagors (e.g., are they single asset real estate related entities, or do they engage in industrial mining or other business);

(5) unsecured creditors of the mortgagors (do they have many; how much; current?; Do they owe income taxes);

(6) any pending suits against the mortgagors (these may reflect debts and potential claimants);

(7) do the mortgage documents have a savings clause (e.g., not secure more than 95% of new worth; no more than maximum amount that would not cause insolvency, etc.);

(8) will each mortgagor receive some loan benefits, or will some mortgagors simply guaranty debt of affiliates?;

(9) will we have a "deductible" (e.g., lender may assume initial loss or initial defense cost, for example, up to $1,000,000);

(10) are all improvements complete;

(11) is the land fully leased?

If a prior loan transaction is subject to a creditor's rights issue (e.g., leveraged buyout financing), the refinance also may be tainted and should be subject to the broad creditor's rights exception.

A cross default clause alone does not appear to affect the validity of the mortgage.

A creditor loaning money to a debtor and taking a security interest with knowledge that the loan will be used to pay off an unsecured creditor has made a fraudulent transfer since it hinders collection of other debts. Benefits to affiliates may be sufficient value if they are so closely connected to be an "economic unit" or to have "identity of interest."

Value can be present or antecedent debt. There are different views on whether an exchange involving security from a antecedent debt is receipt of less than reasonably equivalent value.

The case of BFP v. Resolution Trust Corp., 511 U.S. 531, 128 L. Ed.2d 556, 114 S. Ct. 1757 (1994) held that reasonably equivalent value at a nonjudicial or judicial mortgage sale is the price bid at the noncollusive sale conducted in accordance with state foreclosure law. The sweep of this case does not extend to statutory lien foreclosure or deeds in lieu of foreclosure.

Under the 1984 amendments to this Section, a fraudulent transfer expressly included a transfer which is either voluntary or involuntary. The term "transfer" includes foreclosure of debtor's equity of redemption. In the concurring opinion of Madrid v. Lawyers Title Insurance Corp., 725 F.2d 1197, 11 B.C.D. 945, 10 C.B.C. 2d 347 (9th Cir. 1984) cert. denied, 469 U.S. 833, 105 S. Ct. 125, 83 L.Ed. 2066 the judge stressed that the Act did not expressly apply to transactions that were involuntary conveyances. The majority opinion in the Madrid case said that the transfer of relevance where there has been a foreclosure is the initial deed of trust and not the trustee deed. That case may also have been rejected by the 1984 amendments. The case of In re Alsop, 14 B.R. 982, 8 B.C.D. 335, 5 C.B.C.2d 797 (Bankr. D. Alaska 1981), aff'd, 22 B.R. 1017, 6 C.B.C.2d 669 (D. Alaska 1982), agreed with the reasoning of Madrid in holding that the time of perfection under Section 548 in connection with the foreclosure is the recordation date of the deed of trust, as did the case of In re Ehring, 91 B.R. 897 (Bankr. 9th Cir. 1988) on appeal 900 F.2d 184 (9th Cir. 1990) (acknowledging that the Code definition of "transfer" had been amended).

The case of Durrett v. Washington National Insurance Co., 621 F.2d 201, 6 B.C.D. 954 (5th Cir. 1980) held that actual foreclosure itself was a fraudulent conveyance if fair (reasonably equivalent) consideration was not given. It held that the 57.7% of fair market value was not fair consideration and that 70% probably would be so. A transfer arguably for 68.5% of fair market value was not for reasonably equivalent value. A transfer for 62% of fair market value was not reasonably equivalent value. The case of In re Hulm, 738 F.2d 323, 11 C.B.C.2d 154 (8th Cir. 1984), cert. denied, 469 U.S. 919, 105 S. Ct. 398 (1984) agreed with Durrett that a foreclosure following the statutory redemption period was a transfer under Section 548.

However, in a second approach the case of In re Winshall Settlor's Trust, 758 F.2d 1136 13 B.C.D. 839, 12 C.B.C.2d 605 (6th Cir. 1985) held that (in accordance with state law), there must be a showing of some element of fraud, unfairness, or oppression accounting for the inadequacy of price. The case of In re Strauser, 40 B.R. 868, 12 B.C.D. 171, 10 C.B.C.2d 1323 (Bankr. N.D. Ohio 1984), held that consideration received at a noncollusive and regularly conducted judicial foreclosure in Ohio is reasonably equivalent value, although less than 70% of fair market value. Similarly, In re Madrid, 21 B.R. 424 (Bankr. 9th Cir. 1982), aff'd on other grounds, 725 F.2d 1197 (9th Cir. 1984), cert. denied, 469 U.S. 833, 105 S. Ct. 125 (1984), and In re BFP, 974 F.2d 1144 (9th Cir. 1992), aff'd, BFP v RTC, 511 U.S. 531, 128 L. Ed.2d 556, 114 S. Ct. 1757 (1994), held that, in accordance with state foreclosure law, a price obtained at a non-collusive foreclosure sale properly conducted under state law was irrebuttably presumed to be reasonably equivalent value.

A third approach stated that the value equivalent is too uncertain, and instead requires that a commercially reasonable sale occur in order for reasonably equivalent value to be considered to have been bid. Factors involved in such analysis include advertising in real estate sections of newspapers and mailings to various brokers as well as the amount bid at sale.

Some cases, in a fourth approach analogous to the third approach, provided no absolute guideline as to what reasonably equivalent value was, and stated that reasonably equivalent value must be determined in an evidentiary hearing.

In analyzing whether the foreclosure on a senior lien was made for reasonably equivalent value, the balance owing on junior liens was irrelevant.

If the lien foreclosed was a subordinate lien, one analysis compared the value of the equity in the property to the amount bid. Another method compares the amount of prior liens and bid to the fair market value. As noted in the case of In re Richardson, 23 B.R. 434, 9 B.C.D. 895 (Bankr. D. Utah 1982), there were several ways to analyze whether a fraudulent transfer has occurred: bid on second lien plus amount of first lien owed compared to fair market value; bid compared to fair market value; bid compared to fair market value less post-sale liens; and bid compared to fair market value less presale liens.

There was conflicting thought on whether the debt cancelled must be added to the amount bid at sale to determine whether reasonably equivalent value was bid. The amount of debt cancelled also must be considered.

The rulings in these cases no longer apply to mortgage foreclosure sales, although the reasoning is still relevant in the context of a tax foreclosure or other involuntary sale. Deeds in lieu of foreclosures may still be vulnerable as fraudulent transfers or voidable preferences. Some cases have extended the reasoning of BFP v RTC to tax foreclosure sales (holding that the bid price is reasonably equivalent value).

The transfer of property sold at a tax sale occurs upon expiration of the redemption period (for calculation of the time to attack a transfer under Section 548).

According to one case, BFP will apply to executory contract forfeitures so that the courts should consider the effect that the distressed contract has on the land?s worth on date of transfer; therefore, the property?s value is likely less than the fair market value.

According to another case, BFP applies to contract forfeitures. This view applied under state law because the forfeiture of contract did not shock the court?s conscience so as to make the contract forfeiture unenforceable under state law; the transfer is for reasonably equivalent value and is not a fraudulent transfer. According to another view, a contract forfeiture may be a fraudulent transfer.

State fraudulent conveyance statutes with language similar to Section 548 may apply under Section 544. Those laws may provide longer limitation statutes. Some state fraudulent transfer acts (such as in Texas) provide that the amount bid at a regularly conducted noncollusive foreclosure is reasonably equivalent value. This risk, however, is minimal, in light of the BFP case in other states that do not exempt foreclosures sales. If several states have contact with the transaction, the sale of the conveyed property will often, but not always, be the state with the most significant relationship to a fraudulent conveyance action in order to determine applicable state law.

Company Policy:

(1)You do not need to use a Durrett or creditor's rights exception in connection with a judicial or nonjudicial foreclosure of a mortgage or resale after that foreclosure.

(2)If there has been recordation of a deed in lieu of foreclosure of a mortgage, a deed pursuant to foreclosure of taxes or involuntary liens, sheriff's deed or other deed in connection with a tax sale or involuntary lien foreclosure within the year prior to your examination or if the right of redemption from a tax sale or other involuntary lien foreclosure under state law ended within the year prior to your examination, you should place the following exception in your commitment and/or policy to be issued to the grantee of the deed in lieu or (foreclosure) deed:

"any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors' rights laws."

If this exception is to be placed in a policy covering single-family residential property, you may add the following language to the exception:

"as adjudicated or claimed in any present or future bankruptcy proceeding by or against ___________ (here place names of parties whose interests were foreclosed) provided that the bankruptcy petition is filed within one (1) year after __________________ (here place date on which redemption rights end or deed is recorded)."

(3) You do not need to use this exception in connection with a resale after the foreclosure of a tax lien or other involuntary lien or deed in lieu of foreclosure (if that transaction is otherwise satisfactory) provided that:

(1) the party whose interest was foreclosed is not in possession of the property;

(2) that party has not filed a bankruptcy according to your records; and

(3)(a) the property constitutes a single-family residence and (not a sale of multiple residences); or

(b) the party who acquired by foreclosure is conveying by sale an unrelated third party and the amount of indebtedness either bid in or cancelled pursuant to the foreclosure (in some states, the full amount owing at time of foreclosure is deemed to be cancelled or not subject to collection after foreclosure) is at least 70% of the amount of the resale price; or

(c) you are issuing on an arms length sale only to unrelated persons (not to the party that acquired by foreclosure) and the sales price does not exceed $1,000,000; or

(d) you otherwise secure express underwriter approval for issuance without exception (for example, in some cases we will rely upon indemnities or, if there is no current sale, we will rely upon appraisals to determine current value).

(4) If more than one (1) year has passed since the recordation of the deed pursuant to the involuntary lien foreclosure or deed in lieu of foreclosure and if more than one (1) year also has passed since all redemption rights have ended, then you will not need to make an exception under any circumstances where insuring a resale. The party whose interest was foreclosed or conveyed by deed in lieu of foreclosure must no longer be in possession of the property and that party must not have filed a bankruptcy after the recordation of the deed or end or redemption rights.

(5) If the party whose interest was foreclosed in a tax or involuntary lien foreclosure or conveyed by deed in lieu of foreclosure subsequently filed a bankruptcy after foreclosure (of an involuntary lien or end of redemption rights), then you will need to place the above exception in the policy. You should secure express underwriter approval before deleting the exception.

(6) If the foreclosure occurred during the bankruptcy proceeding of the owner pursuant to proper lifting of the stay, you will not need to make any exception.

(7) If the rights of a purchaser under a contract for deed were forfeited within the year prior to your examination, then you will not need to make an exception, provided that the purchaser has not filed a bankruptcy proceeding according to your records, the purchaser is not in possession of the property, and the amount owed on the contract was at least 70% of the amount of the resale price. If more than one (1) year has passed since the forfeiture, and if the purchaser did not file a bankruptcy thereafter, no exception is necessary. If the purchaser did file a bankruptcy after the forfeiture, you should place the exception in the policy.

Company Policy: If you reasonably suspect that a seller in a voluntary transfer may file a bankruptcy shortly, do not insure unless you are satisfied that the sale approximates fair market value.

Company Policy: Do not rely on this section (protecting innocent purchasers) if you are aware of the bankruptcy: e.g., the purchaser may have knowledge or may not have bought in good faith.

A foreclosure (after the stay is lifted) during the pendency of a bankruptcy proceeding is not avoidable in that bankruptcy proceeding as a fraudulent transfer. If a debtor is dissatisfied with the lift of stay, the debtor may appeal (and secure a stay pending appeal) or secure a dismissal and wait 180 days to refile. A foreclosure during a Chapter 11 proceeding pursuant to a lift of stay is not subject to attack as a fraudulent conveyance when the proceeding is converted to Chapter 7, since the foreclosure still occurred after the date of filing of petition.

10.7 Post-Filing Transfer

A post-filing foreclosure or sale to a good faith purchaser without knowledge for present fair equivalent consideration will not be set aside if no copy or notice of the petition has been filed in the real property records prior to the filing of the good faith purchaser's deed.

Company Policy: Do not rely on this section (protecting innocent purchasers) if you are aware of the bankruptcy: e.g., the purchaser may have knowledge or may not have bought in good faith.

A mortgagee buying in at its foreclosure is not protected under Section 549(c) since by bidding in its preexisting debt it has not paid present consideration.

The purchaser at a foreclosure sale must perfect the foreclosure by recordation of the foreclosure deed before a notice of bankruptcy is recorded. In the event the purchaser fails to do so, the post-bankruptcy foreclosure is avoidable under Section 549, even if the sale is effective against any bona fide purchaser.

A post-petition third-party purchaser at a foreclosure sale must record its deed to rely upon Section 549. A post-petition transfer by the debtor (or perfection of transfer by recordation), as opposed to an involuntary foreclosure in violation of the automatic stay, is not void, but is merely voidable during the bankruptcy proceeding.

An action to set aside the transfer must be filed within two years of the transfer, and is not tolled by conversion of the bankruptcy. The time to set aside the transfer may be tolled until the trustee knows or should know of the transfer. It will be tolled by inequitable conduct of the debtor (e.g., deceit and nondisclosure).

A third party, such as a creditor, lacks standing to attack a post-petition transaction as a violation of Section 549 (in the absence of court authorization to act on behalf of the trustee of debtor-in-possession) and may only seek damages for violation of Section 362.

Company Policy: Do not rely upon a violation of section 362 or section 549 to waive a lien perfected after the filing of a bankruptcy.

The assignment of a note secured by a mortgage during a bankruptcy proceeding is not protected by Section 549(c); this provision extends only to a purchaser of real estate and not to an assignee of a note secured by a lien.

A post-petition deed of trust by the debtor is avoidable as a violation of Section 364 if it is not approved by the court (and cannot be protected under Section 549(a)). However, since the loan was a purchase money lien, the lender, as a matter of equity, may recover the principal but will not be protected under section 549(c) because a deed of trust is not a protected "transfer."

A third-party purchaser at a post-petition foreclosure sale could not qualify as a good faith purchaser where the foreclosure trustee knew of the bankruptcy and the trustee also acted as attorney for a third-party agent of the purchaser. The trustee's knowledge was imputed to the agent and, through the agent, the knowledge was imputed to the purchaser. If the third-party buyer at the post-petition foreclosure sale has no other relationship with the trustee, the knowledge of a trustee under a Deed of Trust of the bankruptcy of the mortgagor will not be imputed to the buyer at the foreclosure sale. Good faith depends on (1) whether the transaction was an arms length bargain and (2) whether the transferee possess sufficient facts to cause a reasonable person to investigate whether the debtor was in bankruptcy or whether bankruptcy was imminent.

A third-party purchase at a post-petition foreclosure sale is conclusively deemed to be made for present fair equivalent value if the sale is conducted in compliance with state law. Present "fair equivalent" value may require payment of a higher percentage of fair market value than "reasonably equivalent" value. According to another case, "present fair equivalent value" implies a more exacting standard than "reasonably equivalent value": it contemplates fair market value or "something very close to it." However, this view is not universally accepted.

According to one case, the protection afforded a post-petition purchaser will not apply to a transfer that violates the automatic stay (such as a tax sale). It will be limited to transfers by the debtor not in the ordinary course of business.

10.8 Innocent Transferees

Innocent transferees from parties to a fraudulent conveyance or a voidable preference or other voidable transfer, will not have their transfer set aside if they pay value without knowledge of the voidability of the transfer. It has been said that "knowledge" means actual knowledge of the voidability of the transfer and not constructive notice by matters of record. Otherwise, good faith transferees may be given a lien to secure the amounts they paid and the amount spent in good faith for improvements. A party may not take in good faith if aware of a foreclosure which is the transfer in issue, since this may be sufficient evidence of a debtor's financial difficulties. "Value" has been construed by one case as denoting fair market value. According to one case, if a secured party acquired title to the property in a voidable transaction, it is entitled to have its lien reinstated if the transfer of title is voided, even if it did not acquire title in good faith.

Company Policy: Do not rely on the innocent transferee provisions to issue without exception to fraudulent transfer or voidable preference issues except as provided in our guidelines of fraudulent transfers.

10.9 Preservation

Any transfer avoided under these sections shall be preserved for the benefit of the estate. Any avoidance of a transfer or lien will not allow any parties, such as an inferior lienholder, to step up in priority.

10.10 Equitable Subordination

A lien or claim can be equitably subordinated to other claims against a corporation (i.e., recharacterized as capital) formerly controlled by the creditor if the creditor dominated the corporation at the time and had knowledge that might render the loan unrepayable, the payment depended on a business turn around, and the transaction was made due to inside information giving an unfair advantage. Three categories of conduct sufficient to warrant equitable subordination are (1) fraud, illegality, or breach of fiduciary duty; (2) undercapitalization; and (3) use of the debtor as a mere instrumentality or alter ego.

In deciding that equitable subordination would not lie, one court cited several factors: the lender did not own controlling stock in the borrower; the lender did not make management decisions for the borrower (e.g., which creditors to pay); the lender did not place its employees as directors or officers of the borrower; the lender did not influence the removal of borrower personnel; the lender did not request particular action at any shareholders meeting; the lender did not direct the borrower not to pay vendors; the lender did not coerce the borrower to execute security agreements after the borrower became insolvent; the control over finances and reduction in loan advances was based on the prior loan agreement. Subordination has been allowed where a lender also was in substance the owner of the corporation by holding (as collateral security) over 90% of the stock and controlling the income. Subordination has been denied where the creditor was a shareholder-principal; the capitalization of the debtor was sufficient; and the loan preserved valuable debtor property rights. Subordination has also been denied where the creditor had a pledge of stock of the debtor without exercise of control over the business. Subordination has been allowed where the lender acquired a mortgage pursuant to a guaranty on which the guarantor was obligated to the third-party lender.An insider loan is subjected to rigorous scrutiny, however, and the burden is on the director or stockholder not only to prove the good faith of the transaction but also its inherent fairness. Factors of relevance include: whether the corporation is grossly undercapitalized; where corporate formalities are observed; whether dividends are later paid; whether the insider siphons funds; whether other officers or directors function; whether corporate records exist; whether the corporation is a mere facade or has independent existence; whether the consideration for the corporation's mortgage is "debt" owed by it to its insider.

Situations that must be carefully scrutinized include mortgages by subsidiaries to their parents and mortgages by a joint venture to a lender which is a parent of one of the venturers. The doctrine of equitable subordination may be employed for recharacterization of secured loans as unsecured capital contributions by insiders bound by their fiduciary duty to the mortgagor.

Company Policy: If the lender is one of the joint venturers or general partners in the mortgagor, we generally add the following exception in the loan policy (although the exclusions already exclude liability):

"any loss, claim, or damage because the insured mortgage is attacked, set aside, or subordinated by reason of the fact that the insured is a partner or venturer in the mortgagor."

A transaction would not be subordinated to other creditors where the lender acquired the land from the borrower and leased it back, received a conversion option to convert to an equity ownership in the project, received a shared appreciation mortgage, received 50% of cash flow, gave an option to the borrower to repurchase the land at fair market value, and received the option to convert the loan to a 60% interest in the borrower. The lender actually did not overreach: it consented to all leases, it did not select management, it did not exercise its conversion option, and it did not otherwise virtually control the borrower. The fact that the loan provided "Kickers" to the lender does not itself amount to inequitable conduct that amount to fraud or overreaching. Its access to records, annual financial statements, approval of rental leases and additional financing are simply prudent acts of a lender.

Company Policy: If you are asked to issue an endorsement concerning shared appreciation or contingent interest, call our underwriting personnel. We will analyze the extent of control by the lender, amount of appreciation shared, continuation of contingent interest feature after payment, and applicable law in deciding whether to offer the endorsement.

Section 510 may not be employed to avoid a transfer.

"When an insider makes a loan to an undercapitalized corporation, a court may recast the loans as contributions to capital."

A loan in connection with a leveraged buyout may be treated as a redemption of the debtor?s block interests and claims on equity interests. Such claims may be subordinated to claims of unsecured creditors.

There is no limitation period for equitable subordination.

According to some cases, recharacterization of loans as contributions to capital is a subset of the court's equitable subordination powers; however, others view the doctrine (of recharacterization and subordination) as serving different purposes. Factors considered in reviewing recharacterization include: "(1) The adequacy of capital contributions; (2) The ratio of shareholder loans to capital; (3) The amount or degree of shareholder control; (4) The availability of similar loans from outside lenders; and (5) Certain relevant questions, such as (a) whether the ultimate financial failure was under-capitalization; (b) whether the note included payment provisions and a fixed maturity date; (c) whether a note or other debt document was executed; (d) whether advances were used to acquire capital assets; and (e) how the debt was treated in the business records."

A noninsider lender adhering to terms of a loan agreement is not vulnerable to equitable subordination.

10.11 Liquidated Damages

A liquidated damage provision in a mortgage (such as prepayment penalty) will be enforced if (1) the provision is not a penalty but is reasonable, and (2) the damages are difficult to ascertain, and (3) there is an attempt to calculate the amount of damages at the time of contracting, with a discount for present value. Even if a clause, such as a prepayment penalty, is enforceable under state law, it may not represent an allowed claim under Section 506(b) if it does not provide an appropriate discount based upon conditions when applicable; if it fails to provide only for actual costs, charges, and fees; or if it provides post-petition interest beyond time of principal repayment.

10.12 Secured Claim

In a Chapter 7 proceeding, the lien cannot be "stripped down" to the judicially-determined value of the claim under Section 506(d) since the claim was fully allowed under. A Chapter 13 debtor cannot bifurcate a mortgage lien claim only on the debtor's principal residence into secured and unsecured claims.

10.13 Interest Rate Swaps

Public Law 101-311 enacted Section 560. This section authorizes exercise of any contractual rights created in sw