Sale of Delinquent Tax Certificates Leads to Fraudulent Transfer Decision

Tax CertificatesOn January 20, 2016, the 7th Circuit issued a decision that can affect any purchaser of delinquent tax certificates in Illinois. The decision related to whether a tax sale lawfully conducted pursuant to Illinois statutes can constitute in bankruptcy a fraudulent conveyance if the buyer takes the certificate to deed. In Illinois, counties are authorized pursuant to state law to sell delinquent real estate taxes. The price paid by an original purchaser is normally the amount of the delinquent taxes due to the county which normally is only a fraction of the value of the real estate. The winning bidder is awarded a Certificate of Purchase. The property owner has a right to redeem the property for a period of two years by paying the tax purchaser the amount bid plus interest. If the taxes are not redeemed within this period, the holder of the tax certificate has the ability to commence the process to take title to the real estate unencumbered by any liens.

In In re Keith Smith and Dawn Smith vs SIPI, LLC and Midwest Capital Investments, LLC (In re Smith), No. 1:13-cv-06422 (7th Cir. Jan. 20, 2016), the 7th Circuit Court of Appeals held that if a tax certificate purchaser obtains a deed to a property it might constitute a fraudulent conveyance. The court held that there is no correlation between the amount bid at the tax sale and the value of the property. Competitive bidding on tax certificates in Illinois is limited to the amount of the penalty interest rate to be charged. Based on this, the court looked at Illinois tax sales in the same light normally used in allegations of a fraudulent conveyance: whether a reasonably equivalent value was obtained. Factors in that determination include (i) an analysis of the fair market value of what was transferred and obtained, (ii) whether the transaction took place at arm’s length and (iii) the good faith of the transferee.

The 7th Circuit determined that protections afforded to other types of purchasers, such as purchasers at foreclosure sales, do not apply to sales of taxes. The court rejected the argument that because the tax sale was provided by statute, the sale must be protected from a fraudulent conveyance claim. The court distinguished tax sales from other statutory methods of disposal such as foreclosure sales. In Smith, the court only looked to the fair market value of the real estate versus the amount paid for the tax certificate to determine whether reasonably equivalent value was obtained. The Court determined that the amount of the purchase of the taxes was so small versus the value of the real estate that it would not qualify as a defense to a claim of fraudulent conveyance. The end result is that the tax certificate holder was only able to recover the amount paid (plus interest) and if the property was sold by the tax deed holder any amount over the amount bid belonged to the land owner.

In another part of the decision, the court addressed whether the liability also falls to subsequent purchasers of the Certificate of Purchase. The court held that a subsequent transferee can present a defense showing that it took the Certificate or the property for value, in good faith and without knowledge of the voidablilty of the transfer. In other words, a subsequent transferee does not need to conduct extensive research into the chain of title or pour through financial statements of the debtor.

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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