Pre-Bankruptcy Real Property Foreclosure as a Preference
by Jason T. Rodriguez
Most bankruptcy cases are filed prior to foreclosure of the borrower/debtor’s real property. It is rare that a borrower would not file bankruptcy in time to stop a foreclosure, but file after. In these cases, the borrower/debtor may attempt to claw back the foreclosure using the preference cause of action in the bankruptcy under 11 U.S.C. § 547.
A preference is a transfer that enables a creditor to receive payment of a greater percentage of its claim against the debtor than he would have received if the transfer has not been made, and he participated in the distribution of the assets of the bankrupt estate in a chapter 7 liquidation. Because most chapter 7’s do not provide payment to unsecured creditors anywhere close to 100 percent, the delta between distribution from the bankrupt estate and the amount received by the creditor pre-bankruptcy may be recoverable as a preference (subject to defenses not discussed herein). The typical time frame that the transfer is exposed to preference liability is 90 days before the bankruptcy filing. The time frame can be as far as one year prior to the bankruptcy filing.
Some bankruptcy courts in Texas have considered whether non-collusive foreclosures on real property can be clawed back as a preference. This article is an overview of them.
The first was In re FIBSA Forwarding, Inc., 230 B.R. 334 (Bankr. S.D. Tex. 1999) aff’d 244 B.R. 94 (S.D. Tex. 1999). FIBSA found the secured bank had foreclosure on property worth more than the debt owed within the preference period. The bank was properly secured so FIBSA determined that in chapter 7, the bank would only be entitled to its secured portion of its claim. However, FIBSA concluded the foreclosure bid by the bank equated to reasonably equivalent value. Thus, the bid credited by the bank was reasonably equivalent to the property value and therefore no preference arose.
In re Villarreal, 413 B.R. 633 (Bankr. S.D. Tex. 2009), followed. Villarreal found the pre-bankruptcy foreclosure by the secured creditor was proper. Like FIBSA, Villarreal concluded the property was over-secured when credit bid. Villarreal concluded the chapter 7 bankruptcy sale would give the chapter 7 trustee time to “orchestrate an orderly sale that produces a greater value than would be received at a foreclosure sale.” Thus, concludes Villarreal, the preference calculation is not made at the time of the foreclosure, rather at the time of the hypothetical chapter 7 distribution.
In re Whittle Development, Inc. 463 B.R. 796 (Bankr. N.D. Tex. 2011), followed. The basic facts fall within the prior cases and Whittle essentially tracked Villarreal. Whittle is notable because it discusses remedies for recovery. Whittle notes that if an over-secured creditor received the real property at foreclosure, “the additional amount of benefit conferred to the creditor is simply brought back into the estate.” Whittle proceeds if a non-creditor purchases the real property at foreclosure, then such purchaser “is not subject to a preference action, regardless of the price it pays at the foreclosure sale since the statute only allows avoidance of transfers to or from the benefit of a creditor.”
The final case is FW Valencia Palms Apartments, LP v. LSREF2 Baron, LLC (In re FW Valencia Palms Apartments, LP), adversary no. 12-3014, United States Bankruptcy Court for the Western District of Texas (August 23, 2012), which presents the similar fact pattern. The Valencia Court concluded: “In general, a creditor’s realizing on its collateral in partial satisfaction of its claim will not give rise to a preference because the creditor is deemed to have received no more than it would otherwise have received in a chapter 7 liquidation case anyway—its collateral.” Stated differently, Valencia concluded a secured creditor was entitled to receive it collateral without regard to preference liability. However, Valencia held that the deficiency which may be claimed by the creditor in the bankruptcy is subject to adjustment as a preference.
All of the issues surrounding a foreclosure preference are beyond the scope of this article. Regardless of whether you represent borrowers or creditors, the implications of such a suit are considerable.
Jason T. Rodriguez is an associate at Higier Allen & Lautin, PC and can be reached at firstname.lastname@example.org.