The U.S. Court of Appeals for the Fifth Circuit recently held that a transfer of a tax lien to a tax buyer under Texas law does not constitute an extension of credit that is subject to the federal Truth in Lending Act (TILA).

A copy of the opinion is available at:  Link to Opinion.

In four consolidated cases, the plaintiffs were individuals who agreed to have the defendant property tax buyers pay their real estate taxes in exchange for the transfer of their tax liens pursuant to Sections 32.06 and 32.065 of the Texas Tax Code. The transactions were each evidenced by a promissory note executed by the plaintiff and payable to the tax buyer.

The plaintiffs each brought suit against the defendant tax buyers alleging that they committed TILA violations. The defendant tax buyers moved to dismiss, arguing that TILA did not apply because tax lien transfers are not “consumer credit transactions” under TILA.

In three of the four consolidated cases, the district court denied the defendants’ motions to dismiss, finding that TILA does not apply to the tax lien transfers. The district court certified the question for appeal.

In the fourth case, the district court held that because property taxes are not debt under Texas law, and the transfer of the tax lien to a private party does not change the nature of the obligation such that it becomes a debt, the transfer of a tax lien to a private entity is not a consumer credit transaction subject to TILA.

As you may recall, TILA’s disclosure protections apply to the offering of consumer credit by creditors, as defined by the statute. “Credit” is defined as “the right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment.” 15 U.S.C. §1602(f). “Debt” is not defined by TILA and thus takes on the definition under applicable state law.

The Consumer Financial Protection Bureau (CFPB) is charged with interpreting TILA. The CFPB commentary to the implementing regulations of TILA expressly excludes “tax liens and tax assessments” from the definition of credit, but states that third-party financing of such obligations is credit for purposes of the regulation.  See 12 C.F.R. pt. 1026, Supp. I, Subpart A, cmt. 2(a)(14)(1)(ii).

Texas imposes property taxes, which are secured by a tax lien that automatically attaches to taxable property each year in favor of each taxing unit having power to tax the property. Under Texas law, a tax lien may be transferred to the person who pays the taxes on behalf of the property owner. The tax code includes a number of protections for property owners who use a tax lien transfer to defer payment of their property taxes.

The Fifth Circuit followed their holding in In re Kizzee-Jordan in determining whether the transfer of a tax lien to the tax buyers and the resulting promissory note, executed by the plaintiffs and payable to the tax buyers, extinguishes the original tax obligation and creates a new debt that is subject to TILA.  In re Kizzee-Jordan held that tax lien transfers were not extensions of credit under TILA because the transactions were merely transfers of tax obligations and, thus, did not create any new debt that would be subject to TILA.

The Court in In re Kizzee-Jordan first looked to federal bankruptcy law and concluded that a tax claim is a broad claim for the payment of taxes that is protected from modification by 11 U.S.C. § 511 of the Bankruptcy Code, and that a private entity may seek the benefit of Bankruptcy Code § 511 in pursuing such a claim.  Under Texas’s real estate tax scheme, the transferee of the tax lien is subrogated to and is entitled to exercise any right or remedy possessed by the transferring taxing unit.

The Fifth Circuit explicitly held in In re Kizzee-Jordan that a tax claim is not extinguished when the transferee pays the property taxes to the taxing authority.  Instead, the Fifth Circuit held that “a tax lien transfer under Texas law preserves the existing tax claim, and 'changes only the entity to which the [property owners] are indebted for the taxes originally owed, not the nature of the underlying debt.'”

In applying the holding of In re Kizzee-Jordan to the instant case, the Fifth Circuit held that the payments made by the defendant tax buyers to the taxing authorities and the subsequent transfer of the tax liens did not extinguish the original tax obligations.  Stated differently, “when a lender pays a taxing authority and in exchange receives the tax lien along with an executed promissory note from the property owner under Section 32.06 of the Texas Tax Code, the lender holds the preexisting tax claim — not a new debt arising from the execution of the promissory note.”

Accordingly, the Court held, the transfers did not create new debts, but rather transferred existing tax obligations, which under Texas law are not “debts” and are therefore not subject to TILA.

The plaintiffs argued that In re Kizzee-Jordan is inapplicable due to its bankruptcy context. However, the Fifth Circuit found that In re Kizzee-Jordan interpreted the impact of a tax lien transfer under the same provision of the Texas Tax Code applicable as the instant case, and relied on interpreting the Texas Tax Code not the Bankruptcy Code.

Thus, the Fifth Circuit held that the transfer of a property tax lien is not an extension of credit subject to TILA, and accordingly affirmed one of the consolidated cases and reversed the remaining three consolidated cases.