MORTGAGE FORECLOSURE
Special Problems with Federal Tax Liens
By: Mark A. Glitto
Federal tax liens pose special procedural and substantive problems in mortgage foreclosure. Section 2410 of title 28 of the United States Code prescribes special requirements for a foreclosure action seeking to foreclose a subordinate lien held by the United States of America. Other federal statutes may be used to change your forum from state court to federal court.
Procedural Requirements
Procedurally, the existence of a subordinate federal tax lien against property encumbered by the foreclosing lienor's mortgage means additional allegations in the complaint and delay in the actions's being at issue.
The foreclosure complaint must state with particularity the nature of the interest the U.S. holds in the property. In the case of a federal tax lien, the taxpayer whose liability created the lien must be identified, as well as the internal revenue office that filed the notice of the lien, and the date and place such notice was filed. 28 U.S.C. Sec. 2410((b). A copy of the notice of the tax lien should be attached to the complaint as a an exhibit.
The foreclosure complaint must be served specially. The state court's process, along with a copy of the complaint, must be served on the U.S. Attorney for the federal judicial district in which the state court is located (or an assistant U.S. attorney or clerical employee designated in writing by the U.S. Attorney with the clerk of the court in which the action is brought) and on the Attorney General of the United States in Washington, D.C. The Attorney General's service copy is served by registered or certified mail. 28 U.S.C. Sec. 2410(b).
The U.S. is permitted 60 days, not the standard 20, within which to serve its responsive pleading
or defensive motion. 28 U.S.C. Sec. 2410(b). The foreclosure complaint must seek a judicial sale, i.e., one pursuant to Section 45.031, Florida Statutes, as opposed to a nonjudicial sale. 28 U..S.C. Sec. 2410(c).
Removal
The existence of a federal tax lien could also mean a unanticipated change in forum if the U.S. seeks removal to federal court. An action seeking to foreclose a lien held by the U.S. is removable to the federal district court in the federal judicial district and division in which the state action is pending. 28 U.S.C. Sections 1441, 1444.
Removal is self-executing upon the filing of a notice of removal with the district court, thus a motion and order are not required. The notice must be filed within 30 days of receipt of the complaint, even if the complaint has not been formally served. Attorney's representing lender's may want to begin the running of the 300 day removal period prior to formal service of process by mailing a courtesy copy to the U.S. Attorney. The notice must contain the grounds for removal and a copy of all papers served in the action. 28 U.S.C. Sec. 1446(a),(b). The removal becomes effective when a copy of the notice of removal is served on all adverse parties and is filed with the clerk of the state court, which must be accomplished promptly after the notice is filed with the district court. 28 U.S.C. Sec. 1446(d).
Removal is a tactic that can be employed to delay the foreclosure. Civil actions in federal court most certainly progress slower than in state court, and the setting of hearings is generally not within the control of the litigants, but rather the court's discretion. Thus, counsel should look for grounds to remand back to state court. Counsel may want to check for a defect in the removal procedure and file a motion for remand. This motion must be filed within 30 days after the notice of removal, or else the removal objection is waved. If the district court loses jurisdiction of the action at any time during its pendency, such as by satisfaction of the tax lien, counsel may seek a remand. 28 U.S.C. Sec. 1447(c). See also, J. Moore, A. Vestal & P. Kurland, Moore's Manual Federal Practice and Procedure, Sec. 8.01 et seq. (1992).
Right of Redemption
Substantively, a federal tax lien enjoys a right of redemption. If the U.S. is a defendant to the foreclosure action by virtue of a tax lien, it has a right to redeem the property sold by paying a certain amount to the winning bidder. This redemption right lasts 120 days from the date of the sale. 26 U.S.C. Sec. 7425(d)(1), 28 U.S.C. Sec. 2410(c), 26 C.F.R. Sec. 301.7425-2. Note that most federal non-tax liens have a year long redemption period, while some have no redemption period at all. See 28 U.S.C. Sec. 2410(c).
The amount that must be paid by the U.S. in the redemption of a federal tax lien is determined with reference to 28 U.S.C. Sec. 2410(d). See also 26 U.S.C. Sec. 7425(d)(2). 28 U.S.C. Sec. 2410(d) in redeeming property the U.S. must pay the sum of:
(1) the actual amount paid to the purchaser at such sale (which, in the case of the of a purchaser who is the holder of the lien being foreclosed, shall include the amount of the obligation secured by such lien to the extent satisfied by reason of such sale),
(2) interest on the amount paid (as determined under paragraph (1) at 6 percent per annum from the date of such sale, and
(3) the amount (if any) equal to the excess of (A) the expenses necessarily incurred in connection with such property, over (B) the income from such property plus (to the extent such property is used by the purchaser) a reasonable rental value of such property.
Case law indicates that the amount payable to a foreclosing lienor/winning bidder under the first element of the redemption price depends on the state law of the jurisdiction in which the foreclosure action is brought. Equity Mortgage Corp. v. Loftus, 504 F. 2d 1071 (4th Cir. 1974); Black v. U.S., 683 F. Supp. 770 (N.D. Ala. 1987). The applicable Treasury Regulation, 26 C.F.R. Section 301.7425-4(b)(2),(5), discusses several methods of calculations of the first element of the redemption price, depending on different schemes of state law relating to the availability of a deficiency judgement. Some of these examples are:
1. In a state where a mortgage obligation id deemed fully satisfied as a result of a foreclosure sale and the foreclosure lienor cannot obtain a deficiency judgement, the U.S. must pay the full amount of the mortgage obligation to redeem, regardless of the amount paid at the foreclosure sale.
2. In a state where a mortgage obligation is legally satisfied upon foreclosure to the extent of the fair market value of the property foreclosed, the U.S. must pay the fair market value of the property regardless of the foreclosure sale price or the total amount of the mortgage obligation.
3. In a state where a foreclosing lienor has the right to sue for the full deficiency judgement for any amount owed above the foreclosure sale price, the U.S. need only pay the foreclosure sale price in order to redeem.
Florida follows the second example: the first element of the redemption price is equal to the amount of indebtedness deemed satisfied by the foreclosure sale, up to the fair market value of the property. The amount of indebtedness deemed to be satisfied is not necessarily the amount of the winning bid. If the foreclosure lienor is the winning bidder, case law generally holds that the foreclosing lienor's lien is satisfied to the extent of the fair market value of the property on the date of the sale, regardless of any lesser amount bid. See, e.g., Community Bank of Homestead v. Valois, 570 So. 2d 300 (Fla. 3d DCA 1990) and cases cited therein, Wilson v. Adams & Fusselle, Inc., 467 So. 2d DCA 1985). In Florida the deficiency amount is within the discretion of the judge, and the amount may be considered, Florida Statutes (1991) Sec. 45.031(8) and Sec. 702.06, counsel should consider bidding an amount that is closer to fair market value, rather than a minimum bid intended to reduce documentary stamp taxes.
The following are two examples of how the first element of redemption price would be established.
Example 1:
Fair market value of property $ 100,000
Foreclosing lienor's foreclosure judgement 80,000
Foreclosing lienor's winning bid 70,000
U.S. redemption price 80,000
In this example, the foreclosing lienor's judgement is deemed 100 percent satisfied, even though it bid less than the judgement amount, because it received property of a value in excess of the judgement amount. The U.S. need only pay the foreclosing lienor/winning bidder the amount of the judgement. Thus the equity inures to the benefit of the U.S.
Example 2:
Fair market value $ 90,000
Foreclosing lienor's foreclosure judgement 150,000
Foreclosing lienor's winning bid 1,000
U.S. redemption price 90,000
In this example, the foreclosing lienor's judgement is not deemed to be fully satisfied by the property because the property's value is less than the judgement. The foreclosing lienor is thus entitled to a deficiency judgement for the difference between the value and the judgement amount (not the nominal amount of the bid). The U.S. need only pay the value of the property, and the foreclosing lienor is left with the deficiency judgement. In order to maximize the U. S.'s redemption price, lender's counsel should obtain an appraisal based on fair market value fairly close in time to the foreclosure sale.
The U.S.'s right of redemption can have a chilling effect on competitive bidding at the sale. For 120 days after taking title, the winning bidder cannot be sure of divestment of title. Thus, the successful bidder cannot make plans for the property, and the redemption right is a cloud on title for title insurance purposes.
Release of redemption right
A winning bidder may apply for release of the redemption right. The U.S.'s answer typically provides the foreclosing lienor's attorney an Application for Release of Right of Redemption, Form OBD-225. Counsel who represents the foreclosing lienor and it is the winning bidder, you should process the application and attach the foreclosure title insurance commitment and adopt it by reference. The right of redemption may be realized if there is no equity available to the U.S. This is established by comparing the value of the property versus liens having priority over the federal tax lien. 26 U.S.C. Sec. 63325(b)(2)(B).