The Supreme Court ruled May 23 that all mortgage holders have to do to bar future court challenges is to sell a foreclosed property at "reasonably equivalent value."

The ruling ends a concern that a lender cannot dispose of a distressed property without concern that the borrowers will later seek to get more for the property by filing for court protection under Chapter 11 of the bankruptcy code and then sell it for a higher price while a debtor is in possession.

Lenders meet those tests for "reasonably equivalent value" if the price received, such as at a foreclosure auction and if the process conforms to the rules of the state's foreclosure law. The court made its ruling in a 5-4 decision.

It reverses precedent in the 2nd, 5th, 7th, 8th and 11th Circuits on the issue. "It appears they are trying to uphold the sanctity of security agreements where they can," said Michael R. Sment, a partner in Ezer, Sment and Williamson in Los Angeles.

"I think the most important part of this ruling is the part that says secured lenders can now dispose of distressed properties and not worry that years later these sales could be set aside through a bankruptcy filing" he said.

A similar loophole in the Senate's bankruptcy bill, S.540, was also closed. The Senate passed the bill by a 94-0 vote, and has referred the bill to the House Committee on the Judiciary. No action, however, has been scheduled.

Sment represented some of the lenders in BFP vs. Resolution Trust Corp. as receiver of Imperial Federal Savings Association, et al, No. 92-1370.

Sment argued the case before the Supreme Court on behalf of Paul Osborne, who purchased a California home that had been foreclosed on and sold at auction by Imperial Federal in 1989. The foreclosure proceedings had been temporarily delayed by the filing of an involuntary bankruptcy petition by BFP - A partnership formed by Wayne and Marlene Pedersen and Russell Barton in 1987 - to buy a home in Newport Beach, Calif. After the home was sold, the partnership filed for protection under Chapter 11 of the bankruptcy act, and sought to set aside the transfer of the home to Osborne on the grounds that the foreclosure sale constituted a fraudulent transfer under Section 548 of the bankruptcy laws.

The partnership made this argument because the home was sold by Imperial for $433,000; the partnership argued the actual value of the property was $725,000. A bankruptcy court upheld the sale, an appellate bankruptcy panel affirmed the finding and a panel of the 9th U.S. Circuit Court of Appeals in San Francisco agreed with the lower court rulings.

The rulings appeared to be consistent with Supreme Court rulings over the last several years in U. S. vs. Ron Pair Enterprises 1989; Dewsnup vs. Timm, 1992; Nobelman vs. American Savings Bank, 1993; and Rake vs. Wade, 1993, where the court upheld secured lending agreements.

The philosophy behind the rulings was best expressed last year by Justice John Paul Stevens, who said in a concurring opinion in Nobelman, "At first blush it seems... strange that the bankruptcy code should provide less protection to an individual's interest in retaining possession of his or her home than of other assets. The anomaly is, however, explained by the legislative history indicating that favorable treatment of residential mortgagees was intended to encourage the flow of capital into the home lending market."

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