Bulletin: NY000045

Dear Associates:

Back in 1980, the U.S. Court of Appeals set aside a foreclosure sale in the case of Durrett v. Washington National Insurance Co. (621 F. 2nd 201, 5th Cir. 1990) in which the sales price represented 57% of the fair market value of the property. As a result of the holding in Durrett, the guideline applied by many Courts was that a foreclosure sale in which the property was sold for less than 70% of its fair market value could be set aside as a fraudulent conveyance.

Although several later cases [including In Re Madrid, 725 F. 2nd 1197, 9th Cir. cert denied 469 U.S. 833 (1984)] disagreed with the decision in Durrett, the ruling by the 5th Circuit gave title insurers concern over insuring titles through foreclosures where properties were sold for nominal or less than "fair market value" amounts.

The U.S. Supreme Court has recently rejected the Durrett rule in a matter entitled BFP v. Resolution Trust Corp. (N.Y. Law Journal Monday 6/13/94, Page 1 Col. 1). In the BFP case, a partnership purchased a house in California, subject to a first mortgage of $356,250.00. The seller took back a purchase money second mortgage for $200,000.00. The first mortgagee became insolvent and the Resolution Trust Corporation (RTC) was appointed as the Receiver. When the partnership defaulted on the first mortgage, the RTC foreclosed and an individual named Osbourne made a bid of $433,000 for the property. Since Osbourne was the highest bidder at the foreclosure sale, the property was conveyed to him.

Several months later, BFP filed a Chapter 11 bankruptcy petition and an attempt was made to set aside the sale to Osbourne, alleging that the fair market value of the house was $725,000.00 at the time of sale and that the amount bid by Osbourne did not constitute "reasonably equivalent value". The Bankruptcy Court dismissed the complaint against Osbourne and the District Court affirmed. An appellate bankruptcy panel also affirmed the Bankruptcy Court ruling, finding that "a non-collusive and regularly conducted foreclosure sale... cannot be challenged as a fraudulent conveyance because the consideration received in such a sale establishes reasonably equivalent value as a matter of law".

The U.S. Supreme Court apparently agrees with that reasoning. In writing the majority opinion, Justice Scalia noted that the term "fair market value" does not appear in Section 548 of the Bankruptcy Code. As a result, Scalia concluded that Congress did not intend ?fair market value? to be the benchmark for bids at foreclosure sales. Since a foreclosure is, in effect, a "forced sale", Scalia argued that the property to be sold was actually worth less than fair market value. Consequently, the Court held that a "fair and proper price or a reasonably equivalent value for foreclosed property, is the price received at the foreclosure sale, so long as all the requirements of state foreclosure law have been complied with".

From a title perspective, the BFP case, although extremely important in deciding a perplexing legal issue, should not have much impact in New York. Although title insurers in this jurisdiction were concerned about the Durrett case, and some companies raised exceptions to title because of it, Durrett was really never followed by the New York Courts.

The cases in this state have generally held that mere inadequacy of price alone is not enough to set aside a mortgage foreclosure sale. Other factors, such as fraud, collusion or unfairness in the conduct of the foreclosure proceeding would have to be present before the court would set aside the conveyance. In fact, as long as the sale was commercially reasonable, taking into account all of the circumstances surrounding it, a court in New York would not , as a general rule, set aside a foreclosure sale.

However there are two points which must be emphasized in this area. First, while the possibility of a Durrett type attack may have been removed as the result of the BFP decision, attempts can still be made to challenge these sales for failure to strictly comply with state foreclosure statutes. Consequently, title examiners and underwriters should continue to carefully examine foreclosure proceedings to make sure they have been conducted in accordance with state law.

Secondly, as a general rule, properties being insured through mortgage foreclosure sales should not be insured for amounts in excess of the successful bid at the sale.

Should you have any questions, please contact the New York Office.