Purchasers of Tax Liens Receive Protection from Interest Rate Modifications under Anti-Modification Statute

By: Andrew Reardon

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re Debenedetto[1] the Bankruptcy Court for the Northern District of New York held that a debtor could not modify the interest rate on tax liens on his property that had been purchased by a creditor from the City of Schenectady, NY (the “City”) because the creditor was the holder of a “tax claim” that cannot be modified under section 511(a) of the Bankruptcy Code.[2]  In Debenedetto, the creditor, American Tax Funding, LLC (“ATF”), purchased a tax lien from the City and claimed that the debtor owed a rate of 21 percent per annum on the lien, which was the interest rate imposed by statute for delinquent real property tax payments owed to the City.[3]  The debtor objected to ATF’s claims, arguing that ATF was not the holder of a “tax claim” under section 511(a) and was therefore not entitled to receive the anti-modification protection afforded by that section. Thus, the debtor argued that the interest rate on AFT’s secured claim was subject to modification  pursuant to the methodology set forth by the Supreme Court in Till v. SCS Credit Corp.,[4] which would likely result in the creditor receiving a significantly lower interest rate on the liens. To determine whether ATF had a “tax claim,” the court looked to two factors: (1) whether the payment by the private purchaser to the government entity extinguished the underlying debt[5] and (2) whether there was a “continuity of rights between the original holder . . . and the private purchaser.”[6] When applying the first factor, the court found that “the underlying tax debt was not extinguished upon payment . . . to the City . . .” because ATF was not required to pay the full face amount of the tax lien.[7]  Furthermore, the court also reasoned that the underlying debt was not extinguished by the sale because the City was entitled to repurchase the tax liens from ATF.[8]  With respect to the second factor, the court concluded that there was a continuity of rights between the City and ATF because by the terms of the Purchase and Sale Agreement, the City assigned its right of claim on the delinquent tax debt to ATF. Thus, the court concluded that ATF, as a secured creditor, held a valid “tax claim” and was entitled to the applicable interest rate as determined by state law.

Under section 511 of the Bankruptcy Code, the applicable interest rate on a “tax claim” shall be the non-bankruptcy interest rate[9], which is typically set by statute[10]. Therefore, section 511 prevents a debtor from modifying the interest rate on the tax claim[11].  In practice, this anti-modification provision is important to the holder of a tax claim because that the corresponding interest rate on a tax claim will normally be higher than the rate that would applied pursuant to the methodology set forth in Till.[12]

The Debenedetto court’s holding, and its attendant reasoning, follows the majority view that a purchaser of a tax lien holds a tax claim that is protected by section 511’s anti-modification provisions. Most courts have decided that a creditor that purchases a tax lien holds a “tax claim” if (1) the sale of the lien did not extinguish the underlying tax debt and (2) the creditor enjoys substantially the same rights under the tax liens that were held by the municipality prior to the sale.[13] In In re Princeton Office Park, L.P, however, the court held that the purchaser of a tax sale certificate “acquire[d] only a lien on the property owner’s real estate.”[14]  The Princeton court reasoned that because the taxes were paid in full as part of the sale to the purchaser there was no transfer of a tax claim.[15]  Accordingly, the Princeton court found that all that remained was a lien on the property in an amount equal to what the purchaser paid the township at the sale, plus interest.[16] 

As a result of Debenedetto, future creditors purchasing tax liens must consider if they will have substantially the same rights as the original holder of the debt and whether their purchase may extinguish the debt’s tax claim status.[17]  In order to get the protections of section 511, when negotiating for the purchase of a delinquent tax lien, a purchaser of a tax lien should now include a provision in its asset purchase agreement with the taxing authority that provides for all (or almost all) of the rights under the tax lien transfer from the taxing authority to the purchaser. Moreover, the asset purchase agreement should provide that the purchaser is merely buying the liens from the taxing authority and is not satisfying the underlying tax claim.  By taking these two steps, the purchaser of the tax liens should be able to enforce a higher interest rate on the liens if the debtor later files for bankruptcy and seeks to modify the interest rate on tax liens to more favorable rate. 

[17] Id.