Statutory Liens: May Not Necessarily Be Unassailable

Los Angeles County Treasurer v. Mainline Equipment, Inc. (In re Mainline Equipment, Inc.), 865 F.3d 1179 (9th Cir. 2017) –

A Chapter 11 debtor sought to avoid a county’s prepetition personal property tax liens pursuant to section 545 of the Bankruptcy Code. The bankruptcy court ruled in favor of the debtor; the Bankruptcy Appellate Panel (BAP) affirmed; and the county appealed to the Ninth Circuit.

The debtor failed to pay property taxes assessed by the county assessor on its personal property. As a result, the county recorded tax delinquency certificates with the county recorder in 1993, 2010, and 2012. Under the applicable state statute “‘[f]rom the time of filing’ tax delinquency certificates, ‘the amount required to be paid together with interest and penalty constitutes a lien upon all personal and real property in the county’ owned by the taxpayer.” The debtor owned only personal property. The county acknowledged that it did not record any tax certificates with the Secretary of State but contended that was not necessary to perfect its liens.

When the debtor filed bankruptcy in 2012, it listed the county as an unsecured creditor and brought an adversary proceeding seeking to set aside the county’s liens. Under section 545(2) of the Bankruptcy Code a statutory lien on the debtor’s property may be avoided to the extent that it is not perfected against a hypothetical bona fide purchaser that buys the property at the time of the commencement of the case (with certain limited exceptions).

As a preliminary matter, the Ninth Circuit addressed whether the appeal was constitutionally or equitably moot. Although the county had obtained a stay of the bankruptcy case during its appeal to the BAP, by the time the case came before the Ninth Circuit, the debtor’s assets had been disbursed and the bankruptcy case had been dismissed. However, when the bankruptcy court dismissed the case and authorized payment of remaining claims from available cash, the payment was “subject to any disgorgement ordered by the Ninth Circuit” in connection with the appeal.

An appeal may be constitutionally moot if events make it “impossible for the appellate court to fashion effective relief.” It can be equitably moot if the appellant does not diligently seek a stay, and thus permits “such a ‘comprehensive change of circumstances’ to occur as to render it inequitable” to continue with the appeal. In this case, the court could grant effective relief by requiring a party to disgorge money for redistribution, and it was not inequitable to proceed with the appeal given that the county had been diligent and the final distribution was made subject to disgorgement.

Turning to the merits, as a threshold matter section 545 applies only to a statutory lien, which is defined under section 101(53) as a lien “arising solely by force of a statute on specified circumstances or conditions.” It does not include liens arising out of common law, judicial proceedings or contract – even if the lien is dependent on a statute or made fully effective by statute. The property tax liens at issue clearly qualified as statutory liens.

The second part of the test is whether the lien was perfected or enforceable against a hypothetical bona fide purchaser of the property as of the commencement of the bankruptcy case (with a limited exception for purchasers who would have priority over IRS tax liens under section 6323 of the Internal Revenue Code or similar state or local statutes).

The Achilles’ heel in the county’s position was that the statute providing that upon filing the tax delinquency certificate with the county recorder the taxes constituted a lien on the debtor’s real and personal property went on to provide: “except that the lien upon unsecured property shall not be valid against a purchaser for value or encumbrancer without actual knowledge of the lien when he or she acquires his or her interest in the property.”

Looking to state law, a bona fide purchaser was one who purchased for “value, in good faith, and without actual or constructive notice of another’s rights.” Thus, the section 545 hypothetical bona fide purchaser would come within the exception under the state tax lien statute.

The county made an additional argument that under the state tax lien statute its lien had “the force, effect, and priority of a judgment lien.” The county argued this meant that its tax liens were enforceable against a bona fide purchaser.

However, under state law judgment liens recorded in the county were perfected against real property purchasers and judgment liens filed with the Secretary of State were perfected against personal property purchasers. Since the county did not file the tax delinquency certificates with the Secretary of State, having the priority of a judgment lien did not give it priority over a purchaser of personal property.

Thus, the court held that the county filing was insufficient to perfect a lien on personal property against a bona fide purchaser, and accordingly the debtor could avoid the county liens under section 545(2).

People are generally aware of the power of a trustee (or debtor in possession) to avoid transfers and obligations as preferences or fraudulent transfers (now referred to as voidable transactions). They tend to be less familiar with the ability to avoid statutory liens. In addition to the avoidance power found in section 545(2) discussed in this case – which focuses on state created “disguised priorities,” section 545 also addresses “ipso facto” liens [section 545(1)], and statutory liens for rent or a lien of distraint for rent [section 545(3) & (4)].

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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