Tax Debt Strict Foreclosures as Takings Clause Violations

Posted by NCBRC - October 19, 2022

Does a state law permitting the government to take and sell a debtor’s home to satisfy a tax debt, and keep the surplus value as a windfall, violate the Takings Clause? That is the question before the Supreme Court in two separate cert. petitions. Fair v. Continental Resources, No. 22-160 (filed Aug. 19, 2022) and Tyler v. Hennepin Cty, No. 22-166 (filed Aug. 19, 2022). It is also the question that was recently answered affirmatively by the Sixth Circuit in the case of Hall v. Meisner, No. 21-1700 (6th Cir. Oct. 13, 2022). These cases could have significant consequences in the bankruptcy context where debtors often challenge tax sales under avoidance principles (the issue raised in another Supreme Court cert petition, County of Ontario v. Gunsalus, No. 22-294). Certainly the Sixth Circuit case adds ammunition to the Michigan bankruptcy debtor’s arsenal.

In Hall v. Meisner, the Sixth Circuit dealt with Michigan’s General Property Tax Act, under which the county has the option to foreclose on the property of a delinquent taxpayer and take absolute title to the property without regard to its value as compared to the underlying debt.

In the three consolidated appeals before the Sixth Circuit, the defendant Oakland County took “absolute title” to the plaintiffs’ homes to satisfy tax debts significantly smaller than the value of the homes (In the case of Hall, the debt was $22,642 and the home ultimately sold for $308,000). The Plaintiffs did not receive any of the difference. They filed suit in the federal district court against the line of title holders, including the County, the City to which the county sold the properties for the amount of the tax debts, and Southfield Neighborhood Revitalization Initiative, a for-profit entity that bought the properties from the City for $1 and sold at market value.

The complaint, filed under 22 U.S.C. section 1983, alleged that the action of the defendants was a violation of the Takings Clause of the Fifth Amendment as applied to the States through the Fourteenth Amendment. Finding that the tax debtors lacked property rights under state law, the district court dismissed the complaint as failing to state a claim.

The Fifth Amendment’s Takings Clause provides that “private property” shall not “be taken for public use, without just compensation.”

Though all states permit a governmental entity to foreclose on property to satisfy a tax debt, the majority limit the amount of the entity’s recovery to the amount of the debt, with any surplus going back to the tax debtor. In what the Sixth Circuit described as an “aberration” and “self-dealing,” it noted that only a handful of states, like Michigan, permit the entity to take absolute title to the property, keeping for itself any surplus in value.

The court acknowledged that property rights are determined by reference to state law, but cautioned that the Takings Clause would be “dead letter” if the state could merely define property rights in such a way that property the state wished to take was excluded. “The government may not decline to recognize long-established interests in property as a device to take them.”

The court discussed Webb’s Fabulous Pharmacies, Inc. v. Beckwith, 449 U.S. 155 (1980), involving a Florida statute giving the county ownership of the interest that was generated on private principal deposited in “interpleader” funds held by county courts. The Florida Supreme Court found that the county’s retention of the interest did not violate the Takings Clause because state law defined the funds in such a way that the owner of the principal did not have a property right to the interest. The Supreme Court found the state had simply recharacterized as “public” funds that were traditionally “private.” It found the transformation of private property to public without just compensation was a violation of the Takings Clause.

With this in mind, the court in Hall looked to “whether Michigan likewise disavowed traditional property interests merely by defining them away in its General Property Tax Act.” The court took a deep dive into the history of home ownership beginning with England’s 12th century creation of what are now called mortgages when a property owner signed over a pledge (“gage) of property to secure a loan. If the borrower failed to pay the pledge, his property became dead to him (“Mortgage” = “mort” (dead) + “gage” (pledge)). From there, out of recognition of the rights of lenders, strict foreclosure was born. Under that process, upon default, the lender could take the land in its entirety regardless of any disparity between its value and the debt. But because of its harsh nature the English Court of Chancery rules governing strict foreclosure were generally “honored in their breach” and the borrowers able to recover their lost property.

In the 18th century the issue moved across the ocean and landed in the American courts which were hostile to strict foreclosures. However, neither did they fully endorse leniency with borrowers that would defeat the rights of the lenders. In an effort to reconcile the borrower’s equitable interest in the property with the lender’s security interest, American jurisprudence settled on allowing the mortgagee to take the property for sale to a third party with the caveat that any surplus over the amount of the debt would go to the property owner. The public sale could generally be relied on to supply the truest value of the property. Thus, foreclosure-by-sale ascended over strict foreclosure, a fact acknowledged by the Michigan Supreme Court in 1888 in Meigs v. McFarlan, 72 Mich. 194, 201 (1888), and extending to tax foreclosure sales.

Having established the historical basis for finding that the borrower retains equitable title to property even when it is used as security for a loan, the court went on to find that the action by the state in this case was an unconstitutional taking of that interest. “The County took the plaintiffs’ equitable titles without paying for them simply because the Michigan General Property Tax Act said it could. Thus—by that ipse dixit—the Act ‘sidestep[ped] the Takings Clause by disavowing traditional property interests long recognized under state law.’” The court noted that “[t]he only context in which Michigan law does not recognize equitable title as a property interest in land, apparently, is when the government itself decides to take it.”

The court was unpersuaded by the defendants’ argument that the plaintiff’s property interests were limited to the surplus after the foreclosure sale by the foreclosing governmental unit, which in this case, was zero because the government sold the property to the City for the amounts of the tax debts. The court observed that right to surplus is equivalent to the plaintiff’s right to recover the value of the equitable title. The property owner’s right to the value of his equity exists independently of the machinations of the actual foreclosure sale.

The court next found that the County was the governmental entity ultimately responsible for the unconstitutional taking because prior to the County’s acquisition of “absolute title” to the plaintiffs’ properties, the plaintiffs held equitable title. After the county took title, the plaintiffs held nothing. Comparing the government’s actions to theft, the court rejected the defendants’ argument that a win for the plaintiffs here would have “serious fiscal consequences.”

The court reversed the district court’s order with respect to the Takings claim and remanded for further proceedings.

Fair Cert Pet Aug 2022

Hall 6th Cir Oct 2022 tax foreclosures

Tyler Cert petition Aug 2022

Gunsalus Cert Petition


Tags: ,

Post a Comment

Your email is never shared. Required fields are marked *