Justices Clear Up Bankruptcy Law Property Dispute

A property’s sale price at foreclosure, not its market value, determines its worth in bankruptcy proceedings, the Supreme Court ruled Monday.

The 5-4 decision resolves a longstanding dispute in bankruptcy law, and it upholds the existing practice in California. Lawyers for the state’s lenders and title insurers applauded the result and said it removes a cloud that could have hung over many recent property sales.

But the ruling, which grew out of a tangled transaction involving a Newport Beach home, deals a setback to some property owners and creditors in bankruptcy proceedings. They argued that they should not have to accept the fire-sale prices that can result from a foreclosure sale.

The high court stepped in to the Newport Beach case to resolve a growing dispute in bankruptcy law.

The U.S. Bankruptcy Code seeks to protect creditors by disallowing recent “fraudulent transfers” of property if it appears the debtor was seeking to hide his assets or to transfer them to others. Under the law, a bankruptcy judge can void a transfer if the debtor “received less than a reasonably equivalent value in exchange” for his property.

Relying on those words, federal courts in some regions, including the U.S. appeals court in Texas, have voided foreclosure sales that yielded a price far below the accepted market value for the property.

This approach, if adopted by the high court, would have called into question any past foreclosure sales where the price fell well below market value.

But writing for the court, Justice Antonin Scalia rejected this “radical departure” from “over 400 years . . . of Anglo American jurisprudence.” A foreclosure sale, so long as it is announced and follows lawful rules, establishes the accepted price for the property, even if the amount is below the earlier established market price, he said.