Daily Development for Monday, January 24, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

MORTGAGES; PROPERTY TAX; TAX LIEN FORECLOSURE:  Where a mortgagee, despite being notified of a tax sale, does nothing to let the seller know that the property owner has filed for bankruptcy, it has unclean hands and a bankruptcy court will not set aside the tax sale for the benefit of the mortgagee and will even use its power to validate the sale despite it having been made in violation of the automatic stay.

In re Askew, 312 B.R. 274 (D. N.J. 2004)

A mortgagee obtained a foreclosure judgment in December 2000.  It did not immediately proceed to a sheriff's sale.  During the delay, an investor purchased a tax-sale certificate on the property.  In February 2002, the investor gave the debtor notice of its intention to foreclose on the property, and urged her to redeem the property before a tax sale foreclosure action.  In May, 2001, when the debtor failed to redeem, the investor instituted a tax sale foreclosure action.  It joined debtor and the the mortgagee in that action and served them with copies of the summons and complaint.  Neither the mortgagee nor the debtor filed answers and the tax sale foreclosure action proceeded uncontested.

In July 2001, the debtor filed her first Chapter 13 bankruptcy petition.  The investor was not scheduled as a creditor on the petition and neither the debtor nor the mortgagee ever notified the investor of the bankruptcy filing.  Without knowledge of the filing, the investor continued to prosecute its tax foreclosure action.  In September 2001, it obtained an order fixing the amount, time, and place of redemption.  Despite having notice of the tax sale foreclosure action and of the redemption deadline, neither the debtor nor the mortgagee sought relief from the court or protected its respective rights by filing an answer in the tax sale foreclosure complaint and neither attempted to redeem the property.  In September 2001, the debtor's first bankruptcy case was dismissed.  In October, 2001, a state court then entered a final judgment foreclosing the debtor and the mortgagee from all rights to the equity of redemption.  It vested title in the property to the investor.  The pr!

 operty
 was then sold at sheriff's sale to the investor.

In November 2001, the debtor filed her second bankruptcy case.  It was dismissed in January 2002 based on her failure to file the necessary schedules.  The mortgagee also failed to tell the court that the investor was in violation of the automatic stay by prosecuting its tax sale foreclosure action.

In March 2002, the debtor filed her third bankruptcy case.  In July, the mortgagee filed a motion seeking relief from the automatic stay so it could continue its state mortgage foreclosure action.  Its motion was granted, and the mortgagee continued with its foreclosure action.  A sheriff's sale was held and the mortgagee was the highest bidder.  In the meantime, the debtor's bankruptcy case was again dismissed.  After the dismissal, the debtor filed a motion seeking to set aside the mortgagee's sheriff's sale on the ground that the property had already been sold in the tax sale foreclosure.  The mortgagee filed a motion in the tax sale foreclosure action seeking to set aside the investor's tax foreclosure judgment.  It argued that because the tax sale foreclosure order violated the bankruptcy automatic stay, the final judgment was void, entitling the mortgagee to relief.

The lower court concluded that the mortgagee was not entitled to relief because of its failure to seek relief within a reasonable time.  The Appellate Division affirmed.  The mortgagee had been properly served with the complaint, had defaulted, and had done nothing to defend itself.  Furthermore, it did nothing to bring to the investor's attention the pendency of any bankruptcy action and did not file the current motion until more than a year had passed after the investor received its final judgment in foreclosure.  Finally, the mortgagee had no explanation for its actions.

Then, in the bankruptcy court, the mortgagee sought an order to reopen the debtor's bankruptcy case, to void the investor's tax foreclosure judgment, and to reinstate its own sheriff's sale.  It contended that the investor's prosecuting of the tax sale foreclosure action during the pendency of the debtor's bankruptcy cases rendered the investor's actions void as having been in violation of the automatic stay.

The bankruptcy court pointed out that the section 362 stay is automatic and binds all entities on the filing of a bankruptcy petition, even if the parties are not aware that a petition has been filed.  Ordinarily, judicial actions and proceedings against the debtor during the pendency of the bankruptcy case are void ab initio.  However, recent case law has allowed a bankruptcy court to validate actions taken in violation of section 362 stay when it is in the interests of equity and judicial economy.  For that reason, although the state court's issuance of the order setting the time, place and amount of redemption occurred two days before the dismissal of the debtor's first bankruptcy case, the bankruptcy court exercised its option to validate the investor's tax-sale foreclosure.

The bankruptcy court noted that the mortgagee had notice of the investor's tax sale foreclosure action and was, in fact, a named defendant in that action.  Instead of simply notifying the investor of the debtor's bankruptcy petitions, the mortgagee did nothing to protect its interests.  It intentionally let the investor obtain a judgment without alerting it to the bankruptcy action.  It also failed to make timely application before the bankruptcy court notifying it of the investor's alleged stay violations.  Therefore, the bankruptcy court concluded that the mortgagee acted knowingly for its own purpose and with "unclean hands."  Therefore, it would be inequitable to void a final judgment that had been entered in favor of the investor almost three years earlier.

Comment 1: A few things ought to be noted here.

First, the property tax lien has “superpriority.”  It primes the mortgagee’s lien, even if the mortgagee were to foreclose. Thus the fact that the mortgagee filed for its foreclosure prior to the institution of tax foreclosure proceedings really doesn’t matter.  The mortgagee could not escape the obligation to pay off the lien.  What it was doing in this case was to attempt to assert the continued right to redeem from the tax lien, even after that lien had been foreclosed, on the grounds that the tax foreclosure (not the lien itself) violated the automatic stay.  The mortgagee’s foreclosure, taken pursuant to relief from the stay, presumably was valid to transfer to it the rights of the mortgagor, still subject to whatever rights were created under the tax foreclosure process.

Second, note that Baucum, and not the County, is the party carrying out the tax foreclosure.  This is consistent with a developing trend in a number of jurisdictions to invite in private investors to shoulder the cost of the tax foreclosure process, subject to extensive procedural protections for the judgment debtor.  In many cases, the statutes permit the tax certificate purchaser to work out deals for the payment of the unpaid tax claim that are the equivalent of a refinancing of the debt.  This may create more flexibility in the process of benefit to both government and taxpayer

Comment 2: Also, as noted above, keep in mind that in fact Baucum was stayed by the various bankruptcies of the debtor, whether he knew of them or not.  He had constructive notice if he’d looked in the right places, and he didn’t need to be named as a creditor to be stayed, since he was moving against a critical asset of the debtor’s bankruptcy estate.

Comment 3: What is interesting here is the developing trend, of which this case is an example, to give the bankruptcy court flexibility to ignore breaches of the automatic stay and to recognizes interests created pursuant to such breaches when the equities are appropriate.

Comment 4:Of particular interest is the burden placed upon the mortgagee, even though it had not yet completed its foreclosure, to notify the tax certificate holder of the bankruptcy of the third party debtor or else suffer the consequences of a tax sale in violation of the stay.  This certainly puts a new wrinkle into the work plan of any foreclosure lawyer.

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