Bulletin: IL2016001

Dear Associates:

Pursuant to the case described below, when insuring a tax deed in Illinois, an exception should be raised to exclude coverage provided under Covered Risk 9 (ALTA Owner’s Policy 2006) or Covered Risk 13 (ALTA Loan Policy 2006) if the date of policy will be two years or less from the date of recording of the tax deed.

“Notwithstanding Covered Risk 9 (or 13), this policy should not be construed as insuring the insured against loss or damage resulting from a court order finding that the tax deed, recorded as document number _________________, constitutes a fraudulent or preferential transfer under federal bankruptcy, state insolvency, or similar creditor’s rights laws.”

Case Discussion:

Is compliance with state law for tax sales sufficient to establish that the sale was for “reasonably equivalent value?”

This is the question that was posed to the 7th Circuit in Smith v. SIPI, LLC, No. 15-1166 (7th Cir. 2016). The answer was a resounding no. Compliance with state law for tax sales is insufficient to establish that the sale was for reasonably equivalent value, and the debtor in bankruptcy may try to set aside the sale as a fraudulent conveyance under 548(a)(1)(B).

Background – Cook County held the annual tax sale in 2001, which included the property owned by Keith and Dawn Smith (Smiths). SIPI, LLC (SIPI) purchased the real estate taxes for the Smiths’ property in 2001 for approximately $5,000. No redemption of the sold taxes was made, and after full compliance with the IL laws surrounding tax sales, on April 15, 2005, SIPI received and recorded the tax deed issued for the property. In August of 2005, SIPI sold the property for $50,000 to Midwest Capital Investment, LLC. On April 13, 2007, the Smith’s filed for bankruptcy and sought to avoid the tax sale as a fraudulent transfer. The Smith’s filed their motion within the proper two-year window.

The bankruptcy judge found in favor of the Smiths. On cross-appeals, the district court reversed, and the case was appealed to the 7th Circuit. The 7th Circuit held that 1) because of the type of method that Illinois uses for their tax sale (interest rate method), which is not designed to produce bids that are “reasonably equivalent value”, 2) any fraudulent transfer remedy creates a level of uncertainty, and 3) because there is a limited amount of time for the uncertainty, the decision by the bankruptcy court was upheld.

The decision by the 7th Circuit included a discussion regarding good faith transferees. The only protection granted to good faith transferees is pursuant to 11 U.S.C. sec. 550. The initial transferee is granted a lien on the property to the extent that any work done increases the property value. Subsequent good faith transferees are shielded from liability.

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