Moskowitz v. Smith et al
Filing
15
MEMORANDUM Opinion and Order. Signed by the Honorable Harry D. Leinenweber on 9/22/2014. Mailed notice. (as, )
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
KEVIN SMITH and DAWN SMITH,
Appellants,
v.
SIPI, LLC and MIDWEST CAPITAL
INVESTMENTS, LLC,
Appellees,
and
HAROLD MOSKOWITZ,
Case Nos. 13 C 6422
and 14 C 1034
Hon. Harry D. Leinenweber
Appellant,
v.
KEITH SMITH and DAWN SMITH,
Appellees.
MEMORANDUM OPINION AND ORDER
Before the Court are two appeals arising out of an adversary
proceeding in bankruptcy.
The first concerns the adversary case
itself, in which Plaintiffs Keith Smith and Dawn Smith (“the
Smiths”) sought to use the fraudulent transfer provision of the
Bankruptcy Code, 11 U.S.C. § 548, to avoid the sale of their house
pursuant to Illinois tax law.
The home had been purchased by
Defendant SIPI, LLC (“SIPI”) and transferred to Defendant Midwest
Capital
Investments,
LLC
(“Midwest”).
As
explained
below,
Plaintiffs fail to state a claim under § 548 because they do not
allege any defect in the tax sale conducted under state law.
The
adversary case should have been dismissed, and the Bankruptcy
Court’s contrary conclusion is therefore reversed.
In the second appeal, Harold Moskowitz (“Moskowitz”), counsel
for SIPI, challenges an order of sanctions entered against him by
the Bankruptcy Court.
Because the Smiths did not comply with the
procedural requirements of Bankruptcy Rule 9011 when they moved for
sanctions, the Court lacked the authority to grant the Motion and
issue sanctions.
Thus, the sanctions imposed on Moskowitz are
vacated.
I.
A.
BACKGROUND
Factual and Legal Background
Starting in 1998, the Smiths (then-married) resided in a home
in Joliet, Illinois (“the Property”) that was owned by Dawn’s
great-grandfather.
free
and
clear
of
On March 25, 2004, Dawn inherited the Property
any
mortgage;
however,
the
Property
was
encumbered by a tax lien for unpaid real estate taxes for the 2000
tax year.
Under Illinois law, if a judgment is rendered against any
property for unpaid taxes, “the county collector shall . . . offer
the property for sale.”
35 Ill. Comp. Stat. 200/21-190.
An
Illinois tax sale is a special form of auction that begins the
process of transferring the property from the original owner to a
person or entity known as a “taxbuyer.”
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At the auction, potential
taxbuyers bid on the lowest monetary penalty that they will accept
from the property owner to redeem the property.
Id. § 21-215.
The
winning bidder pays the outstanding taxes on the property and
receives a certificate of purchase.
Id. § 21-250.
After the sale,
the owner may redeem the property within the statutory period by
paying the taxes plus the penalty established at the tax sale.
§ 21-355.
Id.
The owner must also pay any subsequent taxes paid by the
taxbuyer (plus interest) and various fees and costs provided by
statute.
Id.
This auction process works to the advantage of the
owner because competitive bidding drives down the penalty to be
paid should the owner seek to redeem the property.
Phoenix Bond &
Indem. Co. v. Pappas, 741 N.E.2d 248, 252 (Ill. 2000) (explaining
that the Illinois tax sale provisions were designed “to enable
owners to exercise their right of redemption . . . at the lowest
possible cost”).
If the property owner fails to redeem within the statutory
period, the taxbuyer may petition the Illinois circuit court for a
tax deed.
“The taxbuyer must comply with an array of procedural
safeguards, including providing notice of the tax deed proceedings
to all occupants, owners and persons interested in the property.”
In re Smith, 614 F.3d 654, 656 (7th Cir. 2010) (internal quotations
and citations omitted).
After the court issues the tax deed, the
purchaser has one year to record the deed in the county recorder’s
office, otherwise the taxbuyer’s rights are “absolutely void.”
- 3 -
35
Ill. Comp. Stat. 200/22-85. Grounds for setting aside the tax deed
are very narrow – the property owner can challenge the issuance of
the deed by appeal from the court issuing the deed or by collateral
attack upon proof that (1) the taxes were paid prior to the tax
sale, (2) the property was exempt from taxation, (3) the tax deed
was procured by fraud or deception, or (4) that a party holding
recorded ownership did not receive proper notice. Id. § 22-45.
If
those grounds for challenging the deed are unavailable, the tax
deed is “incontestable,” at least under state law.
Id.
At the end
of the day, if the original owner does not redeem the property, and
if the taxbuyer endures the redemption period and fulfills all
procedural requirements, the taxbuyer takes title to the property
and the transfer is complete.
The delinquent taxes on the Smith residence were offered for
sale and purchased by SIPI’s predecessor (hereinafter “SIPI”) on
November 2, 2001. The Smiths failed to redeem the delinquent taxes
or pay the subsequent real estate taxes.
SIPI applied for a tax
deed to the property, which it obtained on April 15, 2005 after it
certified that it had satisfied all of the tax sale procedural
requirements.
SIPI recorded the deed in May of that year and later
sold the property to Midwest.
B.
Prior Proceedings
On April 13, 2007, the Smiths initiated this action by filing
an Adversary Complaint against SIPI and Midwest.
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The Bankruptcy
Court dismissed the Complaint as untimely, and the District Court
affirmed.
The Seventh Circuit reversed, explaining that the
taxbuyer’s interest is perfected against bona fide purchasers once
the tax deed is recorded, and the date of the recording fell within
the two-year look back period in § 548.
In re Smith, 614 F.3d 654,
659 (7th Cir. 2010).
With the Complaint now deemed timely, proceedings resumed in
the Bankruptcy Court.
But due to a clerical error, nothing
happened in that court for five months after the Seventh Circuit
issued the mandate.
Eventually, SIPI filed a Motion for Status so
that it could prosecute its defense of the matter and remove the
cloud over its title to the Property.
earnest in April 2011.
Proceedings resumed in
The next month, unbeknownst to SIPI and
Midwest, Keith Smith filed a divorce action in the Circuit Court of
Will County.
On September 21, 2011, the Bankruptcy Court granted another
Motion to Dismiss and allowed the Smiths to replead.
Three weeks
later, the Smiths filed a Second Amended Adversary Complaint that
asserted that both Keith and Dawn were entitled to compensation for
the transfer of the house, including for Keith’s loss of his
homestead exemption.
The Complaint’s two counts sought (1) to
avoid the transfer of the house under § 548 and (2) to obtain
relief from Midwest as a transferee of the Property under § 550.
Again, SIPI and Midwest moved to dismiss; they argued (1) that the
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court lacked jurisdiction under Rooker-Feldman to review the state
court’s judgment, (2) that § 548 does not apply to real estate tax
sales, (3) that the Smiths had failed to state a claim under § 550
against Midwest, and (4) that Keith lacked standing because the
property was owned by Dawn and a homestead interest alone was
insufficient to confer standing.
On December 16, 2011, while the Motions to Dismiss were
pending, a divorce decree was entered by the state court in the
matter that Keith had filed seven months earlier.
Per the decree,
any and all rights to proceeds from the Property or this litigation
were given to Keith.
The Smiths did not inform the Bankruptcy
Court or the other parties that Keith claimed an ownership interest
in the Property.
The Bankruptcy Court ruled on the Motions to Dismiss on
April 5, 2012.
The court decided in favor of the Smiths when it
held that it had jurisdiction and that the Smiths had stated a
claim under § 548 against SIPI and under § 550 against Midwest.
The court sided with SIPI, however, in finding that Keith, who had
not alleged that he had an interest in the Property, lacked
standing.
Discovery commenced.
On December 13, 2012, SIPI took Keith’s
deposition, at which he disclosed for the first time information
about the divorce decree and his asserted interest in the Property.
Two months later, Dawn appeared telephonically for her deposition
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and testified that although she knew of the divorce filing and that
the divorce had been granted, she was unaware that Keith claimed to
own the proceeds from the Property.
In its Motion for Summary Judgment, SIPI noted that, per the
state court divorce decree, Keith was granted sole and exclusive
rights to the Property.
For that reason, SIPI argued that Dawn
lacked an interest in the Property and thus lacked standing.
In
response, Dawn challenged the validity of the divorce court’s
assignment to Keith on the ground that the property was hers by
reason of inheritance and thus was not marital property.
The
Bankruptcy Court denied all of the Motions for Summary Judgment on
March 13, 2013.
Moskowitz spoke with counsel for the Smiths and brought up the
issue of a conflict of interest:
proceeds
from
withdraw.
the
case.
both Smiths claimed to own the
Counsel
for
the
Smiths
refused
to
Moskowitz then raised the issue in court, and counsel
for the Smiths said that his clients had agreed to proceed for the
time and resolve any conflict after the lawsuit with the assistance
of their respective divorce counsel.
The Bankruptcy Court stated
that it thought the issue was a litigation trick by SIPI to delay
trial.
SIPI responded that the issue had just been revealed (in
Dawn’s response to the motion for summary judgment), that it had a
duty under Illinois law to report the potential conflict, and that
the record lacked any evidence of dilatory tactics by SIPI –
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indeed,
SIPI
filed
a
Motion
proceedings had stalled.
for
Status
in
early
2011
after
SIPI then filed a written Motion to
Disqualify that was denied.
On June 5, 2013, the Smiths filed a Motion to rejoin Keith
(who had been dismissed for lack of standing) as a party plaintiff.
SIPI opposed that motion and argued that, based on the law-of-thecase doctrine, Keith should not be allowed to join.
The court
granted the motion and the case proceeded to trial that summer.
On
July 31, 2013, the court issued a memorandum opinion in which it
found for the Smiths against SIPI for the amount of $15,000 (one
homestead exemption) and sided with Midwest on Count II.
A
judgment order was entered the next day.
One week later, on August 8, 2013, the Smiths filed a Motion
seeking sanctions against Moskowitz for three arguments that he had
presented to the court: (1) the contention that the divorce decree
divested Dawn of standing, (2) the argument that counsel for the
Smiths should be disqualified based on a conflict of interest
between Keith and Dawn, and (3) the opposition to the motion to
join on the basis of law-of-the-case.
the
Smiths
Moskowitz
contended
had
that
maintained
sanctions
his
For each of those grounds,
were
arguments
characterized them as frivolous.
warranted
even
after
because
SIPI
had
After the Motion was fully-
briefed, the court granted the motion and ordered Moskowitz to pay
a fine.
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II.
STANDARD OF REVIEW
A bankruptcy court’s “findings of fact shall not be set aside
unless clearly erroneous, and due regard shall be given to the
opportunity of the bankruptcy court to judge the credibility of the
witnesses.”
Mungo v. Taylor, 355 F.3d 969, 974 (7th Cir. 2004).
The bankruptcy court’s rulings on questions of law, as well as its
resolution of mixed questions of law and fact, are reviewed de
novo.
Id.
III.
A.
ANALYSIS
Rooker-Feldman
SIPI argues that the bankruptcy court should have dismissed
the case for lack of federal jurisdiction.
Feldman doctrine,
jurisdiction
to
federal
hear
district
“cases
courts
brought
by
Under the Rookerlack
subject-matter
state-court
losers
complaining of injuries caused by state-court judgments rendered
before
the
district
court
proceedings
commenced
and
inviting
district court review and rejection of those judgments.”
Exxon
Mobil Corp. v. Saudi Basic. Indus. Corp., 544 U.S. 280, 284 (2005).
The thrust of the restriction is that federal district courts do
not sit in appellate review of state-court judgments – such appeals
must be taken through the state system and then to the United
States Supreme Court.
In their Adversary Complaint, the Smiths seek to use the
fraudulent transfer provision of the Federal Bankruptcy Code, 11
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U.S.C. § 548, to invalidate the transfer of their property that
resulted from state-court tax foreclosure proceedings. They do not
argue that the state court applied state tax foreclosure law
improperly or that the state court should not have issued the tax
deed.
Rather,
the
Smiths
assert
that
the
transfer
may
be
invalidated under the Federal Bankruptcy Code, an issue that was
not presented to the state court (nor could it have been, as the
Smiths filed for bankruptcy after the state court issued the deed).
In other words, whether the tax foreclosure can be undone pursuant
to federal bankruptcy law is a federal question that was not
addressed in state court.
To answer that question, the Bankruptcy
Court was asked to exercise original jurisdiction, not sit in
appellate review of the state court’s judgment on a purely statelaw matter.
Rooker-Feldman
The Bankruptcy Court concluded correctly that the
doctrine
does
not
apply
and
that
it
had
jurisdiction.
B.
SIPI
argues
that
Fraudulent Transfer
§
548
delinquent taxes in Illinois.
does
not
apply
to
the
sale
of
Section 548(a)(1) of the Bankruptcy
Code allows a bankruptcy trustee to avoid fraudulent transfers,
including both those that were “infected by actual fraud” and those
that were merely “constructively fraudulent.”
Trust Corp., 511 U.S. 531, 535 (1994).
BFP v. Resolution
At issue in this case is
the latter category, under which a debtor will prevail if she
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proves that (1) the transfer occurred on or within two years before
the date of the filing of the petition, (2) she “received less than
a reasonably equivalent value in exchange” for the transfer, and
(3) she was insolvent on the date of the transfer or became
insolvent because of the transfer.
11 U.S.C. § 548(a).
The
Seventh Circuit already has determined in this case that the
transfer occurred within the two-year look-back window.
Smith, 614 F.3d 654, 660 (7th Cir. 2010).
In re
The Bankruptcy Court
found that the Smiths had met the insolvency requirement, and SIPI
does not dispute that conclusion.
Thus, only the “reasonably
equivalent value” element is contested.
Analysis of the “reasonably equivalent value” requirement
begins
with
BFP,
511
U.S.
531,
in
which
the
Supreme
Court
considered the application of § 548 in the context of a mortgage
foreclosure.
equivalent
The Court noted that in many situations “reasonably
value”
means
“fair
market
value,”
so
a
court
can
evaluate whether a debtor received “reasonably equivalent value” by
comparing the fair market value of the property lost to the amount
that the debtor received from the transfer.
Id. at 545.
But the
Court rejected fair market value as the benchmark for mortgage
foreclosures, stressing that “fair market value presumes market
conditions that, by definition, simply do not obtain in the context
of a forced sale.”
Id. at 538.
Real estate that must be sold to
satisfy a mortgage “is simply worth less” than property “that could
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be sold at leisure and pursuant to normal marketing techniques.”
Id. at 539. Accordingly, the Court concluded that mortgage debtors
are deemed to have received reasonably equivalent value for their
foreclosed property, regardless of the amount yielded by the
foreclosure sale, “so long as all the requirements of the State’s
foreclosure law have been complied with.”
Id. at 545.
The BFP Court stated that its opinion covered only mortgage
foreclosures,
as
“[t]he
considerations
bearing
upon
other
foreclosures and forced sales (to satisfy tax liens, for example)
may be different.”
Id. at 537 n.3.
As far as this Court is aware,
neither the Seventh Circuit nor any district court has decided
whether BFP applies to a tax foreclosure conducted pursuant to
Illinois law.
Bankruptcy Courts in this district are split.
Compare In re Murray, 276 B.R. 869, 878 (N.D. Ill. 2002) (“BFP
logically applies to tax sales”), with In re Butler, 171 B.R. 321,
326 n.6 (N.D. Ill. 1994) (BFP does not apply to tax sales in
Illinois because “[u]nlike a foreclosure sale, [Illinois tax sale]
bids are in no way based on the value of the subject property”).
Across the country, federal circuit and district courts appear
to agree generally that BFP applies to tax sales.
The Fifth
Circuit was the first to so hold when it emphasized that both tax
sales and mortgage foreclosure are forced sales where the concept
of fair market value “is especially inappropriate.” Matter of T.F.
Stone Co., 72 F.3d 466, 471 (5th Cir. 1995).
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The court also noted
that, regardless of whether the forced sale is a tax sale or a
mortgage foreclosure, courts are ill-equipped to determine “a
‘reasonable’ or ‘fair’ forced sale price.”
Id.
Finally, the T.F.
Stone court stressed that “the essential state interest in ensuring
‘security of the titles to real estate’ is equally salient in both
mortgage foreclosure sales and tax sales of real property.”
Id.
The Tenth Circuit agrees, at least where the tax sale involves
competitive bidding.
In re Grandote Country Club Co., 252 F.3d
1146, 1152 (10th Cir. 2001) (extending BFP and concluding that a
tax sale conducted under Colorado law pursuant to a competitive
bidding procedure “constitutes transfer for ‘reasonably equivalent
value’”).
This Court is aware of no circuit or district court
holding to the contrary, although bankruptcy courts are split.
Compare In re Samaniego, 224 B.R. 154, 162 (E.D. Wash. 1998)
(applying the rule from BFP to a tax sale), with In re Murphy, 331
B.R. 107, 120 (S.D.N.Y. 2005) (declining to apply BFP to New York’s
tax forfeiture law).
With no binding precedent on point, this Court returns to BFP.
The BFP Court observed first that reasonably equivalent value does
not mean fair market value in the context of a forced sale.
511 U.S. at 537-38.
BFP,
That point applies equally to tax sales and
mortgage foreclosures: just as “state foreclosure law permits the
mortgagee to sell [the property] at forced sale,” Illinois tax law
compels the county collector to sell the rights to the property at
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a tax sale.
Id. at 539; 35 Ill. Comp. Stat. 200/21-190.
More
broadly, both sales involve circumstances that obscure the market
value of the property: a mortgage foreclosure involves property
that must be sold, often on a strict timetable, and an Illinois tax
sale
involves
the
sale
of
rights
to
property
guaranteed to ripen into actual ownership.
that
are
not
The Fifth Circuit
recognized this similarity between tax foreclosures and mortgage
foreclosures when it extended BFP to tax sales.
T.F. Stone, 72
F.3d at 471 (characterizing the tax foreclosure under Oklahoma law
as “a forced sale”).
The reasoning from BFP instructs that fair
market value is not an appropriate benchmark for determining
reasonably equivalent value in the context of a tax foreclosure.
The inapplicability of fair market value is not the only
consideration.
The BFP Court emphasized that, “[a]bsent a clear
statutory requirement to the contrary,” the bankruptcy code must be
interpreted in harmony with the “state-law regulatory background.”
BFP, 511 U.S. 539-40 (“The existence and force and function of
established institutions of local government are always in the
consciousness of lawmakers and, while their weight may vary, they
may never be completely overlooked in the task of interpretation.”)
(internal quotation omitted). Of course, there is no question that
Congress may regulate bankruptcies, U.S. Const. Art. I, § 8, cl. 4,
and that congressional regulation is supreme over state law, U.S.
Const. Art. VI, cl. 2.
But when confronted with a similar conflict
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(between the Bankruptcy Code and state mortgage foreclosure law),
the BFP Court scoured the Code for a clear and manifest purpose to
displace state regulation of mortgages and found none.
After
noting the state interest in securing title to real estate through
orderly mortgage foreclosures, the Court observed that mortgage
foreclosure processes “vary considerably from State to State,
depending upon, among other things, how the particular State values
the divergent interests of debtor and creditor.”
540.
BFP, 511 U.S. at
Accordingly, the Court rejected the idea of setting “a
federal ‘reasonable’ foreclosure-sale price” because doing so would
“extend federal bankruptcy law well beyond the traditional field of
fraudulent transfers, into realms of policy where it has not
ventured before.”
Id.
That point resonates here:
Illinois’s tax foreclosure rules
form part of the state-law regulatory background that Congress is
presumed to have considered. Tax sale procedures – just like those
for mortgage foreclosures – vary from state to state, depending on
many factors including the policy judgments of state lawmakers (how
long should the redemption period be, what sort of notice should be
required, and so on).
For both property tax sales and mortgage
foreclosures, the state’s regulation helps property owners secure
their title.
In fact, the state’s interest in enforcing its property tax
system is more compelling than its interest in facilitating orderly
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mortgage foreclosures.
States and municipalities rely on property
tax revenue to fund police and emergency personnel, administer
public schools, and provide other basic public services – all
quintessential state interests.
Because the state interest in
securing title to real estate prevented the BFP Court from reading
§ 548 in a way that displaced the state’s mortgage foreclosure
process, a fortiori the state interest in collecting property tax
revenue precludes this Court from using § 548 to undo a tax sale
that was valid under state law.
BFP instructs that, in the absence
of a statutory requirement to the contrary, “the Bankruptcy Code
will be construed to adopt, rather than to displace, pre-existing
state law.”
Id. at 544-45; see also, Midatlantic Nat’l Bank v.
N.J. Dep’t of Envtl. Prot., 474 U.S. 494, 505 (1986) (bankruptcy
trustee must comply with background state laws because “Congress
did not intend for the Bankruptcy Code to pre-empt all state laws
that otherwise constrain the exercise of a trustee’s powers”);
Kelly
v.
bankruptcy
Robinson,
code
479
not
to
U.S.
36,
interfere
49
(1986)
with
(reading
fines
and
federal
orders
of
restitution imposed by state criminal courts, with deference to
“the States’ interest in administering their criminal justice
systems free from federal interference”).
Finally,
the
BFP
Court
discussed
the
underpinnings
of
foreclosure law and fraudulent transfer law, two separate doctrines
that, together, balance several important creditor-debtor dynamics.
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First, the debtor is protected by the equity of redemption, by
which he may redeem property conveyed as security by paying the
secured debt after the original due date.
The creditor, in turn,
is protected by the foreclosure process, through which he may
foreclose the debtor’s equity of redemption – that is, after some
period of time (the redemption period), he may secure his title by
preventing the debtor from redeeming the forfeited property.
Second, the creditor benefits independently from fraudulent
transfer rules, which were designed to “invalidate[] covinous and
fraudulent transfers designed to delay, hinder or defraud creditors
and others.”
omitted).
BFP, 511 U.S. at 540 (internal quotation marks
English
courts
that
developed
the
principle,
and
American laws that incorporated it, sought to prevent secret
transfers to close relatives or other transfers for “grossly
inadequate consideration” when those transfers were calculated to
evade repayment of debts.
Id. at 540-41.
These rules were
separate, and in view of this “peaceful coexistence” of foreclosure
law and fraudulent transfer law, the Supreme Court declined to use
the latter to set aside a foreclosure sale that was valid under the
former – doing so would “disrupt the ancient harmony” of the two
doctrines.
Id. at 542-43.
These dynamics are no different when the transfer is by means
of a tax foreclosure instead of a mortgage foreclosure.
The tax
sale process in Illinois – like the mortgage foreclosure process
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considered by the BFP Court – balances the interests of the parties
involved.
The state’s interest in collecting its tax revenue is
secure, as the revenue from the sale replaces the unpaid taxes.
The taxbuyer’s interests are accounted for because he either earns
a return on his investment (if the owner redeems the property) or
acquires the property (if the owner never redeems). The delinquent
taxpayer,
meanwhile,
is
protected
by
a
redemption
procedural safeguards, and judicial oversight.
period,
In the end, the
taxbuyer is supposed to earn rights to the foreclosed property that
are “incontestable.”
35 Ill. Comp. Stat. 200/22-45.
The Smiths’ proposed use of fraudulent transfer rules would
wreak havoc on this balance.
The Smiths did not transfer their
property to evade creditors; they forfeited it pursuant to state
tax law because their property taxes went unpaid. It is undisputed
that SIPI fulfilled all of its obligations under Illinois law and
thereby was entitled to own the property.
It would turn the
fraudulent transfer statute on its head to use it to allow the
debtors to
recover
property
lost
years earlier by
their
own
inaction, to the detriment of their creditors.
Nonetheless, Congress has the power to disrupt this historical
balance.
The Smiths’ Adversary Complaint relies on the premise
that Congress has done exactly that:
for the Court to return the
Property to the Smiths, the Court would have to use the Bankruptcy
Code’s fraudulent transfer provision to displace state law of tax
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sales, as the transfer to SIPI was already complete under state law
when the Smiths filed this action.
More bluntly, it is clear that
the Smiths cannot succeed without displacing state law because
SIPI’s right to the property would not really be “incontestable” if
it could lose the property in the delinquent taxpayer’s subsequent
bankruptcy proceedings.
absent
sufficiently
But just as with mortgage foreclosures,
clear
guidance
from
Congress
that
the
Bankruptcy Code overrides the traditional balance between state law
of tax foreclosures and fraudulent transfer principles, § 548 must
be applied in a way that preserves both doctrines.
To permit the
Smiths to use the fraudulent transfer provision to claw back the
Property would interfere with the already-completed tax foreclosure
process, making their proposed use of § 548 thoroughly inconsistent
with the reasoning in BFP.
BFP, 511 U.S. at 542-43 (explaining
that using § 548 “to set aside a foreclosure sale” would have been
a “radical departure” from “the ancient harmony [of] foreclosure
law
and
fraudulent
conveyance
law,”
one
not
sanctioned
by
Congress).
Moreover, the availability of a remedy through bankruptcy for
delinquent taxpayers would create a cloud over the taxbuyer’s
title, a problem that the BFP Court sought to avoid.
BFP, 511 U.S.
at 544 (expressing discomfort with the possibility that “[t]he
title of every piece of realty purchased at foreclosure would be
under a federally created cloud”).
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In a similar situation, the
Seventh Circuit expressed concern about the effect on title when
bankruptcy intervenes following a forced sale.
Matter of Tynan,
773 F.2d 177, 179 (7th Cir. 1985) (rejecting a rule that “would
cloud every title secured through a foreclosure sale due to the
possible filing of a voluntary petition in bankruptcy”). Precedent
instructs that the effect on title is not to be ignored.
Some courts have seen fit to extend BFP to tax sales only
where the sale involves competitive bidding.
See, e.g., In re
Grandote Country Club Co., 252 F.3d at 1152 (opining that “the
decisive factor in determining whether a transfer pursuant to a tax
sale
constitutes
procedure
for
procedure”).
‘reasonably
tax
sales,”
equivalent
value’
particularly
is
a
state’s
“competitive
bidding
Competitive bidding may be important in a situation
where market price helps determine reasonably equivalent value, as
competitive bidding can indicate an efficient market.
But a tax
sale is a forced sale that takes place outside normal market
conditions.
judgment
is
35 Ill. Comp. Stat. 200/21-190 (Providing that, after
rendered
for
unpaid
property
taxes,
“the
county
collector shall . . . offer the property for sale”).
And the
Supreme
“market
Court
has
instructed
that
the
concept
of
value . . . has no applicability in the forced-sale context.”
BFP,
511 U.S. at 537.
So although the temptation to do so is great, it simply does
not make sense to try to compute a reasonable tax sale price.
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Courts are ill-equipped to perform such an audit: “any judicial
effort to determine . . . a ‘reasonable’ or ‘fair’ forced-sale
price . . . would require policy judgments that are inappropriate
for courts.”
omitted).
T.F. Stone, 72 F.3d at 471 (internal quotation
Nor is it sensible for the Court to try to calculate the
consideration received by the tax debtor.
That sort of analysis
would be meaningful only if it managed to account for the public
goods provided by the state at no cost to the delinquent taxpayer
– another inquiry best left to elected policymakers.
Id. at 470
(noting that “the BFP Court's analysis of § 548 expressly eschewed
any consideration of the substantive value received in a forcedsale context”).
These principles do not change if the tax sale
involves five competitive bidders or only one (whose first bid
wins).
Perhaps the biggest problem with scrutinizing tax sales for
the specifics of their process (and the value they deliver to the
tax debtor) is that it construes federal bankruptcy law to displace
state law of tax sales.
To measure a state’s tax sale rules
against the requirements of § 548, the Court would have to place a
layer of federally-defined reasonableness on top of the state’s
regulation.
But in the mortgage foreclosure context the BFP Court
did no such thing; the Court refused to use “the fraudulent
transfer
provision
of
the
Bankruptcy
Code
[to]
require[]
a
foreclosure sale to yield a certain minimum price beyond what state
- 21 -
foreclosure law requires.”
BFP, 511 U.S. at 543.
This Court
discerns no indication that the Bankruptcy Code prescribes anything
different in the context of a tax sale.
Id. at 546 (explaining
that “where [Congress’s] intent to override is doubtful, our
federal system demands deference to long-established traditions of
state regulation”); see also T.F. Stone, 72 F.3d at 471 (noting
“the inappropriateness of using a fair-market-value benchmark as a
federally imposed constraint on the ability of states to permit
forced sales of real property”).
The Court cannot simultaneously
interpret the Code to adopt the state-law regulatory background and
impose strictures above those required by the State.
To conclude, both mortgage foreclosures and tax sales are
“forced sales” where market value cannot inform the determination
of reasonably equivalent value.
More importantly, applying § 548
of the bankruptcy code to undo a transfer conducted in full
compliance with state tax law would disrupt the state regulatory
system and subject taxbuyers to a federally-created cloud on their
title,
results
Bankruptcy Code.
not
intended
with
sufficient
clarity
by
the
And using § 548 to undo a transfer of property
that was valid under state tax law would disrupt the historical
balance between foreclosure law and fraudulent transfer law.
Bankruptcy
Code
does
not
contain
any
“clear
and
The
manifest”
indication that Congress intended to override state tax sale law
and compel this result.
English v. General Elec. Co., 496 U.S. 72,
- 22 -
79 (1990) (“congressional intent to supersede state laws must be
‘clear and manifest’”).
Thus, a tax creditor is deemed to have
received “reasonably equivalent value” for the foreclosed property
if all of the state’s tax foreclosure laws have been complied with.
Here, it is uncontested that the sale of the Property, and the
subsequent issuance of the tax deed by the state court, comported
with Illinois law of tax sales.
Therefore, the Smiths received
reasonably equivalent value for the Property and they cannot obtain
relief under § 548.
Neither can they recover against Midwest as a
subsequent transferee, as that claim depends on the § 548 claim.
The Adversary Complaint should have been dismissed for failure to
state a claim.
In light of this ruling, other points raised in the
Smiths’ appeal and SIPI’s cross-appeal are moot.
C.
Sanctions
Appellant Harold Moskowitz asks the Court to reverse an order
of sanctions imposed by the Bankruptcy Court pursuant to Bankruptcy
Rule 9011.
The decision to impose sanctions is committed to the
discretion of the Bankruptcy Court, reviewed only for an abuse of
discretion.
Matter of Generes, 69 F.3d 821, 826 (7th Cir. 1995).
Bankruptcy Rule 9011 – the bankruptcy court’s analogue to
Rule 11 of the Federal Rules of Civil Procedure, see Matter of
Excello Press, Inc., 967 F.2d 1109, 1111 (7th Cir. 1992) – requires
candor before the court.
By presenting a written motion or other
paper to the court, an attorney certifies that:
- 23 -
1.
it is not being presented for any improper
purpose, such as to harass or to cause
unnecessary delay or needless increase in the
cost of litigation;
2.
the
claims,
defenses,
and
other
legal
contentions therein are warranted by existing
law or by a nonfrivolous argument for the
extension,
modification,
or reversal
of
existing law or the establishment of new law;
3.
the allegations and other factual contentions
have evidentiary support or, if specifically
so identified, are likely to have evidentiary
support after a reasonable opportunity for
further investigation or discovery; and
4.
the denials of factual contentions are
warranted on the evidence or, if specifically
so identified, are reasonably based on a lack
of information or belief.
Rule 9011(b).
Transgressions are punishable by sanction, subject
to several conditions outlined in the Rule.
Sanctions may be
initiated by a party’s motion, but “[t]he motion for sanctions may
not be filed with or presented to the court unless, within 21 days
after service of the motion (or such other period as the court may
prescribe),
the
challenged
paper,
claim,
defense,
contention,
allegation, or denial is not withdrawn or appropriately corrected.”
Rule 9011(c)(1)(A).
To impose sanctions on its own motion, the
Court first “enter[s] an order describing the specific conduct that
appears to violate subdivision (b) and directing an attorney, law
firm,
or
party
subdivision (b).”
initiating
to
show
cause
why
Rule 9011(c)(1)(B).
sanctions
provide
the
- 24 -
it
has
not
violated
Both of these methods for
offending
party
with
an
opportunity
to
correct
or
explain
its
conduct,
whether
by
withdrawing or amending a written submission or by responding to a
show cause order.
Here,
the
Order
of
sanctions
against
Mr.
Moskowitz
was
initiated by a Motion filed by the Smiths on August 8, 2013.
The
Smiths admit that they did not serve Moskowitz with a copy of the
Motion before they filed it, and they concede that they did not
abide by the literal text of the Rule.
the analysis:
But that is not the end of
although the text of the Rule indicates that notice
must be by service of a draft motion, the Seventh Circuit has
explained that “a letter informing the opposing party of the intent
to
seek
sanctions
and
the
basis
for
the
imposition
sanctions . . . is sufficient for Rule 11 purposes.”
of
Matrix IV,
Inc. v. Am. Nat’l Bank & Trust Co. of Chicago, 649 F.3d 539, 552
(7th Cir. 2011).
To comply substantially with the Rule, the party
moving for sanctions must alert opposing counsel to the problem and
the intent to seek sanctions, and then give him at least 21 days to
desist; “[o]nly if the adverse party maintains its position may the
movant inform the court and request sanctions.”
Nisenbaum v.
Milwaukee Cnty., 333 F.3d 808, 811 (7th Cir. 2003).
The Smiths contend that they complied with this understanding
of the Rule.
They say that when Moskowitz argued that Dawn lost
standing by virtue of the divorce decree, the Smiths notified
Moskowitz by email, and later argued to the Court, that the
- 25 -
standing argument was false and frivolous because it contradicted
Federal Rule of Civil Procedure 25. After Moskowitz filed a Motion
to Disqualify (on the basis that Dawn and Keith had conflicting
interests), the Smiths submitted a memorandum that called the
motion frivolous.
When presented with Moskowitz’s law-of-the-case
argument regarding Keith’s standing, the Smiths countered that the
argument was frivolous because it ignored Federal Rule of Civil
Procedure 54(b).
Despite these notices that the Smiths considered
his arguments frivolous, Moskowitz stood by his claims and did not
withdraw any of his Motions.
The question in this case, then, is whether these notices
sufficed for Rule 9011.
It is clear that on several occasions the
Smiths accused Moskowitz of advancing frivolous arguments.
There
is no indication, however, that the Smiths informed Moskowitz of
their intent to seek sanctions.
It is one thing to tell an
attorney that he has made a bad argument; it is quite another to
threaten him with sanctions if he does not withdraw his argument.
The notice mandated by Rule 9011 must “describe the specific
conduct
alleged
to
violate
subdivision
(b)”
requiring candor before the bankruptcy court.
–
the
provision
Rule 9011(c)(1)(A).
Thus, Rule 9011 requires not just notice than an argument is
frivolous but a warning in no uncertain terms that sanctions will
be sought unless the offending argument is corrected or withdrawn.
It
does
so
for
good
reason:
if
- 26 -
every
response
brief
that
characterized
“unsupported”
an
argument
could
suffice
as
as
“false”
notice
or
of the
“frivolous”
intent
to
or
seek
sanctions, the 21-day safe-harbor period would be meaningless.
So
while the Seventh Circuit has relaxed the rule that this notice
take the form of a formal draft motion, there is no authority for
ignoring the requirement that the notice, whatever its form, inform
opposing counsel that his conduct violates Rule 9011.
The Smiths’ emails and memoranda may have notified Moskowitz
that, in their view, his arguments were frivolous.
been correct.
They may have
But nowhere did they suggest that his conduct
“violate[d] subdivision (b).”
basis for any sanctions.
Nor did they explain the purported
The Smiths first disclosed their intent
to seek sanctions when they filed their Motion with the court.
For
that reason, they find little support in Nisenbaum, where the party
moving for sanctions first sent the lawyer “a letter or demand
rather a motion,” or in Matrix, where the moving party sent “a
letter informing the opposing party of the intent to seek sanctions
and the basis for the imposition of sanctions.”
F.3d at 808; Matrix, 649 F.3d at 552.
Nisenbaum, 333
Although the Smiths could
have served Moskowitz with a draft version of the motion and waited
the
required
three
weeks
to
file
it
with
the
Court,
or
alternatively sent him a letter or other notice of the intent to
seek sanctions, they did neither.
It is clear that the Smiths did
not comply with the 21-day requirement.
- 27 -
The
Smiths
asserting,
with
attempt
no
to
bypass
citation
to
the
any
21-day
requirement
authority,
that
by
“where a
frivolous contention is made . . . shortly before trial, it is
appropriate, and no abuse of discretion, for the court to either
shorten
the
initiative
21-day
so
circumstances.”
as
period
to
not
or
initiate
render
Rule
sanctions
9011
on
vacuous
No. 14-C-1034, ECF No. 14 at 6.
its
in
own
such
The Smiths are
correct that a Court may at any time initiate sanctions on its own
motion, provided that it follow Rule 9011(c)(1)(B), which includes
the requirement that the court enter a show-cause order and allow
an opportunity to respond before imposing sanctions.
method of initiating sanctions is not at issue here.
But that
As it applies
to this case, the Smiths’ assertion contravenes a consensus among
courts that compliance with the 21-day period is “a mandatory
procedural prerequisite.”
In re Soriaga, No. 00-B-33466, 2001 WL
837918, at *15 (N.D. Ill. July 23, 2001); see also, In re VMS Sec.
Litig., 156 F.R.D. 635, 641 (N.D. Ill. 1994) (“Only if the opposing
party does not take advantage of the 21–day ‘safe harbor’ period to
correct or withdraw the challenged representation may the party
seeking sanctions file the sanctions motion in court.”).
Thus, it
simply cannot be maintained that a court may disregard the Rule’s
21-day safe harbor requirement when it is convenient to do so.
Because the Smiths did not comply with the mandatory 21-day
waiting period, the Bankruptcy Court lacked the authority to grant
- 28 -
the Motion for Sanctions.
“A court that imposes sanctions by
motion without adhering to this twenty-one day safe harbor has
abused its discretion.”
1026 (7th Cir. 1999).
Divane v. Krull Elec. Co., 200 F.3d 1020,
Therefore, the award of sanctions against
Moskowitz is vacated. See also Johnson v. Waddell & Reed, Inc., 74
F.3d 147 (7th Cir. 1996) (Trial court’s failure to comply with
procedural
requirements
of
Rule
11
constitutes
an
abuse
of
discretion, requiring sanction to be vacated); Hadges v. Yonkers
Racing Corp., 48 F.3d 1320, 1329 (2d Cir. 1995) (Rule 11 sanctions
vacated
for
failure
to
comply
with
the
Rule’s
procedural
requirements, “particularly . . . the 21-day safe-harbor period”).
IV.
CONCLUSION
Because the adversary proceeding should have been dismissed
for failure to state a claim, the decision of the Bankruptcy Court
is reversed and the case is dismissed.
The sanctions imposed
against Mr. Moskowitz are vacated.
IT IS SO ORDERED.
Harry D. Leinenweber, Judge
United States District Court
Date:9/22/2014
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