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.