Delinquent Property Tax Collection: Dancing Around the Automatic Stay

In re Killmer, 513 B.R. 41 (Bankr. S.D.N.Y. 2014) –

After reopening a bankruptcy case, a mortgagee moved for a determination that a post-petition delinquent property tax sale was void because it was held in violation of the automatic stay.  In response, the tax authority requested retroactive annulment of the stay.

The debtor filed bankruptcy and the case was converted to a chapter 7 liquidation in 2007.  The debtor’s bankruptcy schedules listed property valued at $255,000, subject to a mortgagee’s secured claim of $239,000.

  • 2008: The debtor received a discharge.
  • 2008: The county published a list of properties with delinquent taxes, including the debtor’s property.
  • February 2010: The county filed a petition and notice of foreclosure with the county clerk.
  • July 2010: A judgment was entered giving possession of the debtor’s property to the county, which was followed by a deed conveying the property to the county.
  • October 2010: The county sold the property to an individual for $70,000 plus an $11,000 auctioner’s commission. (The county noted that the purchaser also subsequently spent over $100,000 on renovations.)
  • April 2011: The bankruptcy case was closed.
  • 2013: When the mortgagee sought to foreclose its mortgage in state court, the tax sale purchaser obtained a determination that the mortgage was extinguished by the tax sale.
  • 2013: The bankruptcy court granted the mortgagee’s motion to reopen the bankruptcy case so that it could raise the county’s violation of the automatic stay and request that the tax sale be declared void. While acknowledging that it violated the automatic stay, the county asked the court to retroactively annul the stay and permit the tax sale to stand.

Section 362 of the Bankruptcy Code contains an exception from the automatic stay that permits governmental authorities to give notice and assess tax deficiencies.  There is also an exception for creation or perfection of a statutory lien for property taxes.  However, a tax authority is not allowed to enforce the tax lien without obtaining relief from the automatic stay.

In this case, although the county had actual knowledge of the bankruptcy case, a county employee erroneously believed that the discharge of the debtor meant that the case was no longer open.  However, there is a distinction between a debtor’s discharge and closing the case: Even after the debtor was discharged, the chapter 7 trustee could still seek to liquidate assets and make distributions.

Consequently, the automatic stay remained in effect with respect to the estate’s property even after the discharge.  Under applicable circuit law, actions in violation of the automatic stay are void ab initio even if there is no notice of the bankruptcy.  So the tax sale would be void absent retroactive annulment of the stay.

Retroactive annulment is to be used “only sparingly and in compelling circumstances.”  The court first considered a standard set of factors, including whether: (1) the creditor had knowledge of the bankruptcy, (2) the debtor acted in bad faith, (3) there was equity in the property, (4) the property was necessary for an effective reorganization, (5) a stay would likely have been granted if it had been requested prior to the violation, (6) failure to grant relief would cause unnecessary expense to the creditor, and (7) the creditor has detrimentally changed its position.

In reviewing the factors, the court found that several factors weighed against annulment (knowledge of the stay, equity in the property) or were at best neutral (bad faith, grounds for relief from the stay); one factor weighed in favor of annulment (not necessary for reorganization); and the remaining factors (unnecessary expense, detrimental change in position) were caused by the county’s own violation of the stay so that it would be inequitable to consider them in support of the annulment.  In sum, the factors weighed against granting annulment of the stay.

The court also considered a “balancing of the equities” test that included 12 similar factors.  Once again, the court’s conclusion was that it should not grant the annulment.

It is clear that the court’s decision was heavily influenced by its view that the county procedures for identifying and tracking bankruptcy cases were and continued to be “wholly inadequate.”  The court described the county’s bankruptcy policy as “unorganized if not completely lacking” and found that the five county witnesses provided “wildly different accounts” of the county’s practices.  The testimony, as described by the court in graphic detail, included the following:

  • Town receiver of taxes (position held for more than 28 years): Her duties included preparing a list of taxes that were not collected and sending it to the county.  She did not take steps to stop collection if she received notice of a bankruptcy filing.  No notations of any notices were made to any paper or electronic files, “rather, the receiver of taxes simply places the paper notice into storage.”
  • Commissioner of finance for the county: This was the chief fiscal officer of the county whose duties included managing the delinquent tax process.  She described the tax sale procedures and initially testified that a bankruptcy search was done and no bankruptcy found.  Subsequently she testified that a bankruptcy case was found but was not considered relevant because the debtor had received a discharge.  She did not know how records were marked to show that a bankruptcy had been filed.
  • Title searcher for the county: According to her testimony there were three bankruptcy searches performed for each delinquent tax parcel.  She had no formal training other than training by the person who held the position prior to her.  She just looked at PACER (electronic docket) to see if a case is “open.”  She believed that once the debtor was discharged, there was no longer a bankruptcy.  She drew an analogy to a mortgage:  “when a mortgage is satisfied, there is a discharge filed and that means that the mortgage is satisfied.  So with the PACER, it’s the same – it’s the same thing.”
  • Tax collection supervisor for the county (position held for 26 years): When she received bankruptcy notifications from title searchers, she labeled an account in the computer system with a “B” for bankruptcy, and stopped collection.  She was never notified of the debtor’s bankruptcy filing.
  • Senior assistant county attorney (position held since 1985): He contended that he had corrected the county’s procedures by notifying county employees – including the tax collection supervisor – that only he could make a decision about whether a bankruptcy case had been closed.  However, he did not advise the title searcher of this new policy because he said she did not make any decisions about whether to move forward.  He was not aware of any electronic files.

In this case, not only did the county knowingly violate the stay (albeit without recognizing that its actions were improper), it did not correct the problem.  Telling statements made by the court include: “If the Court forgives this infraction, Duchess County may be less likely to institute policies that will prevent future stay violations. … The County is the root of its own problem and it must figure out a way to prevent similar situations going forward.”

As indicated by the court’s analysis, the decision to annul the stay is not a bright line test.  It is likely that a court could come out either way under most circumstances, so a court’s perception of the equities is likely to be determinative.

Epilogue:  An appeal and motions for reconsideration and modification of the court’s order were settled about 6 months later.  Terms included vacating the court’s order and annulling the stay retroactively for the benefit of the county in exchange for a $130,000 payment by the county to the mortgagee.

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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