Tax Claims: Good Investment (Maybe)?

In re Kopec, 473 B.R. 597 (Bankr. D. N.J. 2012) –

Does the purchaser of a tax sale certificate hold a “tax claim” for purposes of Section 511 of the Bankruptcy Code?  In Kopec the answer to that question meant the difference between interest on the claim of 18% versus 4%.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) included several amendments to the Bankruptcy Code that were favorable to tax authorities, including Section 511, which provides:

If any provision of this title requires the payment of interest on a tax claim or on an administrative expense tax, or the payment of interest to enable a creditor to receive the present value of the allowed amount of a tax claim, the rate of interest shall be the rate determined under applicable non bankruptcy law.

Typically under state law ad valorem real property taxes are secured by a super priority lien on the taxed property.  Historically, debtors argued that those taxes should be treated like any other secured claim, which meant that they could be paid over time as long as the payments had a net present value equal to the value of the claim.

Even in times when interest rates were not the miniscule rates of today, the rate used to calculate present value of a claim was almost always substantially less than the statutory interest rate for property taxes.  As a result, a debtor could pay considerably less for delinquent property tax claims than it would have been required to pay outside of bankruptcy.

Today Section 511 clearly precludes this treatment for tax claims asserted by governmental authorities.  However, most states have a delinquent tax system that provides for some sort of sale of the tax lien or property.  The question addressed by Kopec is whether the tax purchaser holds a “tax claim” within the meaning of Section 511 so that it is entitled to non-bankruptcy interest.

The answer turns on the status of the tax purchaser under applicable state law.  The Kopec court reviewed a Fifth Circuit case holding that a tax lien holder had a “tax claim” for purposes of Section 511 under Texas law, since the transferee was subrogated to the rights of the governmental entity.  Although that debtor argued that the tax claim was extinguished and replaced with a new obligation, the Fifth Circuit questioned whether the tax lien could be transferred if the tax debt was extinguished.

Another bankruptcy case discussed by the Kopec court concluded that a tax sale purchaser in Ohio held a tax claim for purposes of Section 511.  Among other things, that decision noted the use of the term “creditor” as opposed to “governmental unit” in Section 511, suggesting that it was intended to be broader than just tax authorities and would include a third party tax sale purchaser.  A third opinion discussed by the court reached the same conclusion under New York law.

Kopec was governed by New Jersey law.  The court noted that there were two prior bankruptcy decisions applying New Jersey law.  In re Princeton Office Park, L.P., 423 B.R. 795 (Bankr. D. N.J. 2010) held that the purchaser did not hold a tax claim because the underlying taxes were paid in full at the conclusion of the tax sale.  Thus, the purchaser acquired a statutory lien, but not a tax claim.  The Princeton Office Park decision was followed by a second bankruptcy court.

The Kopec court disagreed because (1) the governmental tax claim was not extinguished at the end of the sale based on its statutory analysis, (2) if the tax debt is extinguished, then there would be no basis for the lien continuing, and (3) the language in Section 511 suggests broader coverage, since it uses “tax claim” instead of “tax” (as used in the administrative expense section) and “creditor” as opposed to “governmental unit.”

Consequently, the court found that the holder of a tax sale certificate under New Jersey law had a “tax claim,”  and thus was entitled to the statutory interest rate of 18%.  The court also noted that the Third Circuit is considering the Princeton Office Park decision on appeal.  (It certified a question to the New Jersey Supreme Court in 2011, which accepted the question in mid-2012, but has not provided any response as of early 2013.)

This case is a good illustration of several continuing themes:  (1) state law is frequently determinative of issues in bankruptcy; (2) often you can find a bankruptcy case to support either side of an argument, and (3) a bankruptcy court does not view itself as bound by decisions of other bankruptcy courts in its jurisdiction.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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