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Mortgagee Prevails In Claim For Indiana Tax Sale Surplus

What happens if a lender’s real estate collateral is sold at a tax sale, which nets a surplus (funds remaining over and above payment of the tax lien)?  Does the money go back to the owner, or can the lender/mortgagee recover it?  Beneficial Indiana v. Joy Properties, 942 N.E.2d 889 (Ind. Ct. App. 2011) helps answer these questions.

Course of events.  In 2003, lender made a mortgage loan to borrowers.  In 2008, following the failure by the borrowers to pay real estate taxes, the county held a tax sale that resulted in a $42,000 surplus.  No party redeemed within the one-year period, so the county issued a tax deed in November of 2009.  However, the tax sale purchaser did not immediately record it.  In December of 2009, lender filed a motion in the county trial court for the auditor to hold the surplus.  At the hearing on the motion, the lender established a default under the mortgage loan and losses of approximately $100,000.  Shortly after the hearing, borrowers, who did not participate in the hearing, deeded the real estate to a third party, which recorded the deed in January of 2010.  In February of 2010, lender filed a motion to compel the auditor to turn over the surplus, and then the the tax sale purchaser recorded its tax deed.

The problem.  Who should have received the $42,000 tax sale surplus - the lender or the third party (subsequent owner)?

Statute.  I.C. § 6-1.1-24-7 is the provision within Indiana’s tax sale statutory scheme that speaks to the surplus issue, and subsection (b) authorizes a claim by the:

 (1) owner of record of the real property at the time the tax deed is issued who is divested of ownership by the issuance of a tax deed; or
 (2) tax sale purchaser or purchaser’s assignee, upon redemption of the tract or item of real property.

Since there was no redemption, subsection (b)(2) did not apply.  Beneficial Indiana focused on subsection (b)(1), which seems to suggest that the borrowers would be entitled to the funds because they were the owners of record at the time the tax deed was issued.  Since they had conveyed their interests to a third party by the time the matter came before the trial court, the third party essentially stepped into their shoes and claimed subsection (b)(1) mandated the turnover of the surplus to it.

Statutory work around.  In Indiana, persons with “an interest in the real estate, including those who did not own the real estate at the time of the tax sale or who did not purchase the real estate at the tax sale, may assert a claim for a tax sale surplus directly with the trial court.”  The lender asserted that it was entitled to the surplus because its mortgage lien attached to the surplus.  Indiana law indeed provides that, even though the lender’s lien against the real estate was extinguished by the tax sale deed, its lien “attached to the tax sale surplus, and has priority over the interest conveyed to [the third party].”

More substantial interest.  The Court’s rationale rested upon the following test:  “which claimant has the more substantial interest in the real estate?”  The Court’s ruling in favor of the lender was, in my view, fair and sensible:

It is undisputed that [lender’s] mortgage was duly recorded on April 21, 2003.  It is further undisputed that the [borrowers] not only failed to pay their property taxes but also were in default on their mortgage, owing a balance that greatly exceeded the tax sale surplus held by the auditor.  Hence, [lender] had a substantial interest in the real estate prior to the issuance of the tax sale deed.  [Third party] acquired its interest in the real estate by a quitclaim deed executed by the [borrowers] after they had failed to make mortgage payments to [lender’s] for more than a year; and they had failed to redeem the real estate during the statutory one-year period following Allen County’s tax sale of real property due to the owners’ failure to pay real estate taxes.  Thus, at the time of the conveyance to [the third party] by the [borrowers], the interest conveyed was subject to the issuance of a tax deed to [the tax sale purchaser] and to [lender’s] recorded security interest.  In other words, the interest conveyed to [the third party] by the [borrowers] is significantly less substantial than and inferior to the interest of [lender].

Favorable to lenders.  As suggested here before on November 16, 2010 and most recently on March 19, 2012, delinquent real estate taxes and resulting tax sales can be a minefield for lenders in Indiana.  In Beneficial Indiana, the lender lost its loan collateral and incurred damages of about $100,000.00.  Luckily, the somewhat unique set of circumstances opened the door for the lender’s recovery of the surplus that mitigated its losses.

Priority Of HOA Liens In Indiana

Last week’s post dealt with a lien priority dispute between a mortgagee and a commercial property management association.  I thought that a natural follow-up post would be to clarify priorities between a more traditional residential homeowner’s association’s lien and a mortgage.  Secured lenders may from time to time foreclose upon its real estate loan collateral and discover that homeowner’s association liens have also been recorded on the subject property.  These issues are not exclusive to consumer foreclosures.  The can bubble up in commercial cases such as foreclosures upon failed residential subdivision developments. 

HOA statute.  Indiana has a separate and distinct statute devoted to homeowner’s association liens at Ind. Code § 32-28-14.  Homeowner’s associations (HOAs) may claim an interest in real estate that is the subject of a lender’s foreclosure case, and the HOA may even file its own case pursuant to I.C. § 32-28-14-8. 

Priority.  In determining priority, the critical question is - when did the HOA record its lien on a particular lot?  Pursuant to I.C. § 32-28-14-5, the priority of the lien of the HOA “is established on the date the notice of the lien is recorded . . ..”  See also, I.C. § 32-28-14-6.  Pursuant to Indiana’s recording statute, I.C. § 32-21-4-1(b), a lender’s mortgage will take priority according to the date of its filing.  Thus both liens take priority according to their filing/recording.  If the mortgage filing predated the filing of the HOA lien, then the mortgage will hold priority.  If, on the other hand, the HOA lien was recorded before the mortgage, then the HOA lien will have priority. 

Nothing unique.  HOA liens carry no special weight or any kind of super priority in Indiana.  Like most other liens, Indiana law determines the priority of an HOA lien based upon the date of its recording.

“Covenants and Restrictions” Maintenance/Assessment Lien Held To Be Subordinate To Mortgage Lien

PNC v. IRC, 2011 U.S. Dist. LEXIS 12389 (S.D. Ind. 2011) (.pdf)  involved a priority dispute between a junior mortgagee and a property management company, both of which possessed recorded liens on commercial real estate subject to a foreclosure case.  The issue was whether the junior mortgagee’s lien recorded in 2003 had priority over the management company’s lien recorded in 2009. 

The covenants and restrictions.  The subject real estate was an office park overseen by a property management company that I’ll call the “Association”.  The Association recorded certain covenants and restrictions against the real estate in 1991 pertaining to property maintenance and tenant behavior.  The covenants and restrictions provided that the Association could assess fees to cover administration of common areas and further provided that, if an owner failed to pay an assessment, the Association could file a lien against the owner’s parcel within the park.  The covenants and restrictions also stated that such lien “shall be subordinate only to the first mortgage, if any, which was on the Parcel at the time the assessments became due and payable.” 

The liens.  The borrower/mortgagor/owner in PNC failed to pay an assessment by the Association, resulting in the Association’s execution of a Notice of Association Lien that the Association recorded in 2009.  The competing lien holder, the United States Small Business Administration (“SBA”), in connection with a loan to the owner, recorded a junior/second mortgage on the subject property in 2003.  (There was no dispute that PNC, the first mortgagee, had the senior lien.)

The Association’s contention.  Even though its lien did not attach until 2009, the Association claimed that its lien should be senior to the SBA’s lien based upon the 1991 recordation of the covenants and restrictions.  The Association reasoned that “any party who might take an interest in the [property] after that date did so subject to the provisions of the [covenants and restrictions].”  The Association went on to claim that all parties with an interest in the case were on notice of the Association’s lien for any outstanding balance in a priority afforded to it by virtue of the 1991 recording.  The 2009 filing, according to the Association, simply was “a notice to the world of the balance existing under the [covenants and restrictions] at that moment in time.”  In short, 1991, not 2009, was the operative recording date.

The Court’s finding.  The Association and the SBA had competing summary judgment motions on the matter of priority.  Judge Lawrence of the United States District Court for the Southern District of Indiana noted that there was no Indiana case law directly on point.  He relied upon an Oregon decision, which essentially held, in the context of residential homeowner’s association fees, that there could be no debt and thus no lien until the Association exercised its power to make an assessment.  Applying the Oregon precedent to the facts of PNC, Judge Lawrence concluded:

Although the [covenants and restrictions] give [the Association] the authority to file a lien against a property owner who fails to pay his or her assessments, the [covenants and restrictions] themselves are not a lien.  No lien existed on the [property] until 2009.  Thus, [the Association’s] priority is based on the 2009 attachment.  This renders its lien junior to that of the SBA.

The Court granted summary judgment in favor of the SBA accordingly.  2009, not 1991, was the date of the recording that ultimately mattered.

First in time.  At its core, the Court basically applied Indiana’s “first to file” rule based upon Ind. Code § 32-21-4-1(b), which provides that mortgages take priority according to the date of their filing.  Since the filing (recording) of the SBA’s mortgage lien predated the filing (recording) of the Association’s assessment lien, the SBA prevailed.  The prior, 1991 recordation of the covenants and restrictions was of no moment.  Generally, therefore, a maintenance-related lien like that in PNC will be junior to a mortgage, assuming the mortgage gets recorded first.