We have previously discussed the procedures for a sheriff’s sale, and the effect that a bankruptcy may have to prevent a sheriff’s sale. However, what happens when a surplus exists after a sheriff’s sale on a tax sale foreclosure? One may think that any surplus funds would have automatically been returned to the homeowner, rather than be kept by the state performing the sale. However, that is not the case in many states, including New Jersey. In these states, the government entity that forecloses on a property through a tax sale foreclosure have historically kept the surplus funds. Recently, however, the Supreme Court of the United States has caused a change in that process.
Tax Sale Foreclosures
If you own real estate, you must pay property taxes to keep your property. Property taxes only attach to the real property, meaning a monetary judgment cannot be entered against an owner for failure to pay their taxes. Normally, an owner that has a mortgage on their real estate would include their property tax payments into their monthly mortgage payment.
A tax sale foreclosure is exactly what it sounds like. A homeowner failed to pay property taxes, and the government will attempt to recoup the property taxes owed. The municipality where the property exists will eventually hold an auction where either a third party or the municipality itself will buy the right to pay off the outstanding taxes. This right is called a tax sale certificate, and grants a tax lien against the property.
Once the buyer has a tax lien against the property, the buyer must wait two years prior to filing a foreclosure complaint to seek to take ownership of the property from the original owner. If no third party buys the tax sale certificate, the state must wait six months to commence foreclosure proceedings. Once the foreclosure occurs, the original owner is given a date of redemption to pay all arrears on their property. If the arrears are not paid, the property is foreclosed upon and ownership passes to the buyer.
New Jersey Law
Under existing New Jersey law, what happens if a successful bid exceeds the amount due in taxes at auction? For example, if the original owner owes $10,000.00 in unpaid county taxes, the property is auctioned in a foreclosure proceeding and the winning bid is $100,000.00, who is entitled to the $90,000.00 in surplus funds? Unlike in a sheriff’s sale for unpaid mortgage payments, the county in which the property is located would receive the entire $100,000.00. The county would receive a windfall of $90,000.00.
While this may seem unreasonable, around a dozen states, including New York and Massachusetts, have laws similar to New Jersey in this case. Surplus funds at a tax sale foreclosure are kept by the taxing entity.
Tax Sale Foreclosure in Bankruptcy
Section 547 of the Bankruptcy Code provides guidelines for preference actions by granting powers to the trustee to avoid the transfer of any interest of the debtor in property to or for the benefit of a creditor. The trustee must show the transfer was made an account of a debt that existed before the transfer was made, the debtor was insolvent, the transfer was made within 90 days prior to the petition, and the creditor received more than they would have under a chapter 7 bankruptcy. The purpose of this statute is to prevent debtors from paying certain creditors prior to filing bankruptcy at the detriment to the other, unpaid creditors.
The Third Circuit has repeatedly found that the transfer of a tax sale certificate is, in fact, a transfer of an interest belonging to the debtor for the benefit of a creditor. The primary defense to these actions, that the property was transferred for reasonably equivalent value, was not available as the “relationship between the winning bid and the value of the underlying property is not merely attenuated but nonexistent.” The courts have found that where a property is transferred at auction does not immediately prove that the property was sold for reasonably equivalent value. One important note is the owner should file for bankruptcy before the right to redeem the property expires.
Tyler v. Hennepin County
On May 25, 2023, the Supreme Court of the United States decided Tyler v. Hennepin County, Minnesota. In this case, plaintiff Geraldine Tyler accumulated $15,000.00 in overdue property taxes to her county. Hennepin County, Minnesota, followed the prescribed process to seize and ultimately sell the real estate, a condo owned by Tyler. The county profited approximately $25,000.00 from the sale after satisfying Tyler’s delinquent tax bill. Instead of returning the surplus funds to Tyler, the county retained them.
Tyler sued the county, alleging that the county’s retention of the excess proceeds violated the Takings Clause of the Fifth Amendment and the Excessive Fines Clause of the Eighth Amendment. The Takings Clause prohibits any government entity from taking private property for public use without just compensation. The Excessive Finds Clause, while self-explanatory, prohibits any government entity from ordering fines against a party that may overburden that party without due process. Here, Tyler was arguing that the county was not only unjustly keeping the funds, but was treating the funds as a fine for her failure to pay taxes.
The county argued that the surplus funds were defined by Minnesota law which provided any surplus funds belonged to the government entity foreclosing. Using this argument, the Appellate Court found that Tyler had no property interest in the profits because the forfeiture proceeding was remedial rather than punitive. Essentially, the Appellate Court found that because the foreclosure was happening to recoup the losses of the county rather than to punish Tyler, Tyler had no interest in the funds.
The Supreme Court, however, felt differently. The Court found that the Takings Clause protects private property interests beyond those defined by state law. Using its own precedent to determine the scope of those protected property rights, it found that the government was limited to take only what it was owed, rather than retain a windfall from the sale of a property.
While this case specifically analyzed the law in Minnesota, it does still apply to the other 49 states. This means other states will no longer be able to commit what is widely called “home equity theft.” This is a major win for homeowners, as it protects at least a portion of their equity should they fall into the unfortunate situation of a tax sale foreclosure. It is unclear yet what changes will come to the New Jersey’s municipal tax lien process, but this can be seen as a major step in protecting the rights of property owners.
