SettlePou Scores Trial Win in Arkansas Bankruptcy Preference Case of First Impression

02.28.18

SettlePou successfully secured a take-nothing judgment following a bench trial on September 28, 2017, in the adversary proceeding styled Judith Nations Aaron v. Embrace Home Loans, Case No. 4:16-ap-07082 in the United States Bankruptcy Court for the Western District of Arkansas, Texarkana Division.

In this case of first impression in the 8^th Circuit, Debtor Judith Nations Aaron sought to avoid as a preference under 11 U.S.C. § 547 a foreclosure sale that occurred 3 weeks before Debtor filed bankruptcy and that Debtor admitted fully complied with Arkansas state law. Debtor did not seek any monetary damages as a result of the alleged preference, instead asking only that the Court rescind the foreclosure sale so that the property and loan could be part of the Chapter 13 bankruptcy estate. The creditor, Embrace Home Loans, was represented by lead counsel Michael R. Steinmark of SettlePou and local counsel Sammy High of Wilson & Associates in Little Rock, Arkansas.

The case ultimately turned on the issue of whether the creditor had obtained more via the foreclosure than it would have obtained via a hypothetical Chapter 7 liquidation sale of the property on the date the bankruptcy was filed. Debtor argued that where, as here, the property is struck off to the creditor at foreclosure for a credit bid, the Court should find that what the lender obtains at foreclosure is the property valued at an arm’s-length fair market value. Embrace Home Loans argued that the Court should follow the U.S. Supreme Court’s holding in BFP v. Resolution Trust Corporation, 511 U.S. 531, 538; 114 S.Ct. 1757; 128 L.Ed.2d 556 (1994) (a § 548 fraudulent transfer case), to find that the value of what the lender obtains is the foreclosure sale price, provided the foreclosure complied with state law. Alternatively, Embrace argued the Court should apply the reasoning from BFP to find that what the lender obtains at foreclosure is a “forced-sale value,” which Justice Scalia recognized in BFP is the “very antithesis” (emphasis in original) of an arm’s-length fair market value due to the distressed nature of a forced sale like a foreclosure, REO sale, or hypothetical Chapter 7 liquidation sale. See 511 U.S. at 537.

The key evidence admitted at trial showed that:

1. the total debt balance was roughly $73,000 as of the date of foreclosure and roughly $75,000 as of the date Debtor filed bankruptcy;

2. the property sold at foreclosure for roughly $49,000 and was subsequently sold out of REO for roughly $45,000;

3. the Tax Assessor of Hempstead County, Arkansas, valued the property at $67,950; and

4. the several appraisals of the property by the debtor’s and creditor’s appraisers indicated an arm’s-length fair market value between $67,000 and $117,000.

Debtor’s testifying appraiser admitted, however, that a property would not be expected to sell for fair market value at foreclosure, out of REO, or in a liquidation sale. She further admitted the reason for this is that each of those distressed situations differs significantly from an arm’s-length transaction. For example, Debtor’s testifying appraiser acknowledged that the purchaser in a foreclosure, REO sale, or bankruptcy liquidation sale would not have the same opportunities to inspect and object to the property condition or title issues and would not obtain the same warranties of title as in an arm’s-length transaction.

Debtor’s own expert thus admitted the facts underlying Justice Scalia’s reasoning in BFP, significantly undercutting Debtor’s argument that the Court should not apply BFP or even follow its reasoning. In addition, Debtor’s expert admitted that while she had not appraised anything other than an arm’s-length fair market value, she believed $67,000 sounded like a reasonable expected foreclosure, REO, or other liquidation value of the property. That amount was less than the amount of the debt, and defense counsel thus argued Plaintiff had failed to meet her burden to prove the lender obtained more via the foreclosure than it would have in a hypothetical Chapter 7 liquidation, because in each instance the lender obtained the same thing, namely, the property and a deficiency claim.

After the close of evidence and arguments, the Court recited on the record at length its findings of fact and conclusions of law. Beginning with the latter, the Court noted that it is atypical and a relatively new development in bankruptcy practice for debtors to attempt to use a § 547 preference claim to avoid a foreclosure of a lien that existed more than 90 days before the bankruptcy filing. The Court further noted that, traditionally, a § 547 preference claim is used to avoid either a payment of too much money to one creditor or the encumbering of property with a lien within 90 days of the bankruptcy filing, with the usual remedy being to strip either the money or the lien to pull the funds or unencumbered property back into the bankruptcy estate. But the Court found that neither of those situations is the same as foreclosure of a lien that already existed more than 90 days before the bankruptcy filing, and the remedy sought is not the same either, because even if the foreclosure is avoided the property would remain encumbered by the lien.

Based upon its analysis of the limited § 547 preference cases attacking lawful foreclosures, the Court found that generally there have been two types of cases: (a) those with an obvious inequity, such as a lender foreclosing a $70,000 lien against a property undisputedly worth over $3 million; and (b) those where the lien amount and property value are closer. As to the first category of cases, the Court reasoned that a § 548 fraudulent transfer claim might be more appropriate, based upon a ‘constructive fraud’ theory, but found that such a claim has been eliminated by the BFP decision, so long as the foreclosure complied with state law, leading to the otherwise ill-fitting use of § 547 preference claims to attack foreclosures. Further, the Court found that while it has doubts about whether all other elements of a preference claim could be satisfied in the foreclosure context, the analysis of what the lender received via foreclosure versus what it would have received in a Chapter 7 liquidation sale is relatively easy when the values involved are significantly disparate.

As to the second category of cases, the Court noted that other courts often had not engaged in a detailed analysis of what the lender received via foreclosure versus what it would have received in a Chapter 7 liquidation sale. The Court thus noted the results appeared inconsistent among those other cases. While the Court agreed that “mathematical precision” is not necessary in evaluating this issue, as some other courts have held, it nevertheless disapproved of the less-detailed analysis employed by some of those courts and, instead, found it appropriate to analyze specifically what the creditor received via foreclosure and what it would have received in a hypothetical Chapter 7 liquidation sale.