April 6, 2023 Article

Bankruptcy Court Injects Uncertainty in Municipal Tax Foreclosures

Last October, the U.S. Bankruptcy Court for the District of Maine issued a ruling of concern for municipalities. The case (In re Riendeau, 645 B.R. 321 [Bankr. Me. 2022]) established that, under bankruptcy law, a debtor in bankruptcy may be able to seek to recover property that has been automatically foreclosed by a municipality for taxes or seek money damages related to the foreclosure. The case may put municipalities that use Maine’s automatic tax foreclosure process at risk.

The Facts

Timothy and Mariette Riendeau owned property in the Town of Sabattus with a purported value of $110,000. They fell behind on municipal taxes to the Town. The Town properly recorded and noticed a tax lien against the Riendeaus’ real property on June 21, 2019, and a second lien on July 24, 2020. Pursuant to Maine’s automatic tax lien foreclosure process, 36 M.R.S. § 943, the Town automatically foreclosed on the property. The Riendeaus owed $4,500 in municipal taxes. The bankruptcy court did not note any deficiencies in the Town’s processing of the automatic foreclosure.

The Town issued a notice of intent to sell the property on or before April 19, 2021, to the highest bidder. Christopher Ames was the high bidder at $38,100, and he purchased the property on April 15, 2021.

The Bankruptcy Case

Four days after the sale to Ames, the Riendeaus filed for bankruptcy under chapter 13 of the U.S. Bankruptcy Code (which is for consumer debtors that can make payments over time to creditors). On April 20, the Town approved the sale to Ames, and the Town transferred title to Ames on May 18. Ames sold the property to Ann French on May 28, 2021, for $50,000.

In their bankruptcy case, the Riendeaus filed a lawsuit against the Town, and Ames and French. The Riendeaus sought to reverse the Town’s foreclosure and the subsequent transfers to Ames and French. The Riendeaus asserted that the foreclosure by the Town was a constructive fraudulent transfer of their property to the Town.

The Reindeaus asserted a claim under the Bankruptcy Code that allows for a trustee or debtor to avoid a transfer to a transferee and subsequent transferees where (1) the debtor was insolvent and (2) property was transferred without the debtor receiving reasonably equivalent value. They argued in their complaint that they did not receive reasonably equivalent value as the amount owed to the Town was only $4,500 and the property was worth much more. They also argued that they can avoid the transfers to Ames and French on the same basis as subsequent transferees.

The Town, Ames, and French filed motions for summary judgment on the Riendeaus’ complaint.

The Bankruptcy Court’s Ruling

Chief Judge Peter G. Cary of the Maine Bankruptcy Court viewed this as a matter of first impression in the District of Maine and denied the Town’s motion for summary judgment. The Bankruptcy Court reviewed the relevant case law, including the Supreme Court case of BFP v. Resolution Trust Corp., which found that the sale price in a mortgage foreclosure was reasonably equivalent value. However, subsequent courts have limited BFP to ordinary judicial foreclosure where there is competitive bidding in the sale process. Courts are divided on whether the BFP case applies to a municipal tax foreclosure.

Agreeing with other courts that have found strict foreclosure, such as Maine’s, “eliminates” the competitive market, the Bankruptcy Court sided with the Riendeaus. The Bankruptcy Court stated that it “is mindful . . . that this determination may inject uncertainty in the automatic tax foreclosure process which is apparently the most commonly used method for collecting delinquent taxes in Maine,” but cited the need for uniformity in applying fraudulent transfer law under the Bankruptcy Code and noted that there is no exception for municipal liens in the law.

The Bankruptcy Court, however, granted judgment for Ames and French as good faith purchasers for value, based on a protective provision in the Bankruptcy Code for real estate purchasers.

The ruling left the Riendeaus with claims of monetary damages against the Town, but no way to get the property back. The Riendeaus filed an appeal on their claims against Ames and French, but that appeal was dismissed as not being “ripe” for review. The claims against the Town are pending.

What This Means for Municipalities

There are several observations of note from the Riendeau case that municipalities should consider:

  • Cities and towns may be at risk of a debtor or trustee seeking money or return of property in automatic foreclosures. The Bankruptcy Code has a two-year statute of limitations for debtors and trustees to file lawsuits for turnover or damages. The case does not address Maine’s Uniform Fraudulent Transfer Act, which has a longer statute of limitations.
  • This law is still developing. As of this writing, only one of the two bankruptcy judges in Maine has ruled on this issue and the other judge is not constrained by Chief Judge Cary’s ruling, although it is persuasive authority.
  • Municipalities may consider other options for foreclosing properties. Title 36 M.R.S. § 1071 provides for a judicial foreclosure of properties, which may eliminate the risk, but is more expensive and time consuming.
  • Municipalities should take extra care to confirm their lien and notice documents are in order. This case would have been significantly worse for the town and subsequent buyers had there been a notice or other paperwork issue.
  • This case presents a new defensive maneuver for former owners of tax-acquired property. Until there is additional clarity on this case, it makes sense for municipalities to provide ample notice to the foreclosed-upon taxpayer prior to advertising the sale so that they have the opportunity to file for bankruptcy before the sale, rather than after.
  • Finally, the Legislature is considering a bill (LD 101 (HP 69)) that would require municipalities to return any funds recovered above the tax amount to the former homeowner. This provision may alleviate the risk for municipalities, as the law would require “value” to go to the former property owner. As of this writing, that bill has been tabled in the legislature.

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