The circuits are split 4/3 on the question of whether a real estate tax foreclosure can be attacked as a fraudulent transfer.
If the Sixth Circuit was correct in holding in an October 13 opinion that a tax foreclosure violated the Takings Clause of the U.S. Constitution, then it stands to reason that a tax foreclosure also can be a fraudulent transfer.
The Split
Recently, the Second Circuit joined the Third, Sixth and Seventh Circuits by holding that real estate tax foreclosures can be attacked as fraudulent transfers. To read ABI’s reports, click here, here, here and here.
Extending BFP v. Resolution Trust, 511 U.S. 531 (1994), the Fifth, Ninth and Tenth Circuits hold to the contrary by immunizing tax foreclosures just like mortgage foreclosures. The most recent of those decisions came from the Ninth Circuit. See Tracht Gut, LLC v. Los Angeles County Treasurer, 836 F.3d 1146 (9th Cir. 2016). To read ABI’s report on Tracht Gut, click here.
The Michigan Tax Foreclosures
Homeowners sued in federal district court alleging that tax foreclosures under Michigan law violated the Takings Clause of the Fifth Amendment, which says that “private property” shall not “be taken for public use, without just compensation.”
The county took title when one of the homeowners owed $22,300 in real estate taxes. The county subsequently transferred title to a nonprofit entity that sold the home for $308,000. Another homeowner owed $30,500 in taxes on a home that the nonprofit sold for $155,000 after the county had foreclosed. Neither of the homeowners received any of the proceeds.
The district court dismissed the suit, finding no violation of the Takings Clause because state law defined the homeowners as having no property interest after forfeiture.
The homeowners appealed to the Sixth Circuit.
State Law and History
Circuit Judge Raymond M. Kethledge laid out Michigan law in detail. Briefly, if real estate taxes are not paid for one year, title is forfeited, but forfeiture does not affect title. Rather, the governmental unit is entitled to petition for a “judgment of foreclosure.” Meanwhile, the homeowner is given notices and an opportunity to redeem by paying the taxes, penalties and interest.
About one year later, the state court is required to enter a judgment of foreclosure that vests absolute title if the owner has not redeemed. Thereafter, the government may sell the property at public auction, but the owner is entitled to none of the proceeds.
In the cases on appeal, Judge Kethledge said that the “County forcibly took property worth vastly more than the debts these plaintiffs owed, and failed to refund any of the difference.” Even so, was there a violation of the Takings Clause?
To answer the question, Judge Kethledge embarked on a detailed examination of foreclosure in England and the U.S. going back to the fifteenth century, going back to the notion of a “mort gage,” or dead pledge. He explained how English chancery courts took issue with the “intolerably harsh sanction” handed down by the law courts when someone defaulted and lost equity in the property.
By the seventeenth century, Judge Kethledge said that the chancery courts recognized a landowners’ equity of redemption and “resisted strict foreclosure for the same reasons they recognized the landowner’s equity of redemption.”
In the U.S., Judge Kethledge said that “American courts were uniformly hostile to strict foreclosure.” By the mid-1800s, he said that “foreclosure by sale was ‘firmly established’ in the law of most states, to the exclusion of strict foreclosure.”
The Takings Violation
Judge Kethledge said that “Michigan law flatly contravened all these long-settled principles when it allowed Oakland County to take ‘absolute title’ to the plaintiffs’ homes as payment for their tax delinquencies.” More specifically, he said that “the County took their equitable titles . . . without a public foreclosure sale and without payment to the plaintiffs for the value of those titles.”
“The County’s foreclosure of these properties was thus nothing less than a strict foreclosure — a practice that English courts had steadfastly prevented as far back as the 1600s and that American courts (not least Michigan ones) effectively eradicated as ‘unconscionable’ and ‘draconian’ some 200 years ago,” Judge Kethledge said. In addition, he said that “Michigan law fails to recognize equitable title in other contexts.”
Judge Kethledge reversed the dismissal of the homeowners’ suit because the county had forcibly taken the homes “worth vastly more than the debts these plaintiffs owed.” By taking property without “just compensation,” he said there was a violation of the Takings Clause.
Observation
Courts avoid making constitutional declarations when a case can be decided on more narrow grounds. Thus, we may not see other courts deciding the takings issue raised in the Sixth Circuit, but courts can use the Sixth Circuit’s opinion to allow fraudulent transfer attack on tax foreclosures.
The circuits are split 4/3 on the question of whether a real estate tax foreclosure can be attacked as a fraudulent transfer.
If the Sixth Circuit was correct in holding in an October 13 opinion that a tax foreclosure violated the Takings Clause of the U.S. Constitution, then it stands to reason that a tax foreclosure also can be a fraudulent transfer.