Villarreal v. Showalter, et al. (In re Villarreal), Case No. 08-7001, 2009 WL 2432338 (Bankr. S.D. Tex. August 5, 2009)

 The bankruptcy court in Villarreal held that the purchase of property at a prepetition foreclosure sale constituted a preferential transfer to the buyer.  At issue was a piece of property in Hidalgo County, Texas consisting of a restaurant and a ballroom.  The defendant had a lien on the property in the amount of $70,000 and foreclosed on it.  While the property was appraised at over $4 million, the foreclosure sale was properly administered and the defendant was the high bidder at $70,000.  The former owners of the property, the Villarreals, subsequently filed for relief under chapter 13 of the Bankruptcy Code. 

 The main legal issue disputed in the case was whether the foreclosure sale to the defendant fulfilled all the requirements of a preferential transfer, and, in particular, whether the defendant received more than it would have if the case were a chapter 7 liquidation, as required by section 547(b)(5) of the Bankruptcy Code.  That section states that for a transfer to be “preferential,” it must enable the recipient to receive more than it would receive if (A) the case were a case under chapter 7 of the Bankruptcy Code; (B) the transfer had not been made; and (C) the recipient received payment of the debt to the extent provided by the Bankruptcy Code.

 The defendant argued that since it had paid reasonably equivalent value for the property, because it made the highest bid at the foreclosure sale, it could not have received a preference.  In support of its position, the defendant cited the Supreme Court’s holding in BFP v. Resolution Trust Corp., 511 U.S. 531 (1994).  The Supreme Court in BFP considered whether a non-collusive mortgage foreclosure sale that produced less than the amount that would likely have constituted fair market value outside a foreclosure sale was a fraudulent transfer under section 548 of the Bankruptcy Code.  To prevail on a fraudulent transfer claim, the plaintiff must prove that the debtor received “less than a reasonably equivalent value in exchange for such transfer.”  In BFP, the Supreme Court held that the amount obtained at a properly-administered, non-collusive foreclosure sale was, as a matter of law, “reasonably equivalent value.” 

 Courts in the Fifth Circuit are split as to whether the BFP holding applied to cases brought to avoid a preferential transfer under section 547, however the Fifth Circuit has never addressed the issue.  The bankruptcy court in Villarreal found that the language of section 547 of the Bankruptcy Code required a different analysis than that in section 548, which applied in BFP.  While acknowledging that the policy concerns expressed in BFP applied equally to cases arising under section 547, the bankruptcy court held that section 547(b)(5)’s requirement that the transferee receive “more than such creditor would receive if…the case were a case under chapter 7 of this title” was not susceptible to differing interpretations by courts.  Thus, the bankruptcy court would not “ignore Congressional language in favor of judicial policy.”  

 Applying the language of section 547(b)(5), the bankruptcy court held that the defendant would have been entitled to far less than the appraised value of the property after a chapter 7 foreclosure sale.  Therefore, the transfer fulfilled this element of the statute by receiving more than it would have in a chapter 7 liquidation.  The bankruptcy court therefore ruled that the transfer to the defendant should be avoided.

 Commentary: The analysis in Villarreal is somewhat counterintuitive, in that two sections of the Bankruptcy Code – sections 547 and 548 – that are motivated by the same policy would treat similar transactions differently.  The Villarreal case illustrates that purchasers of property from distressed sellers, which is common today’s market, need to be aware of the potential avoidance of the sale if the seller subsequently files for bankruptcy, even if the sale was conducted at arm’s length.