The Seventh Circuit Court of Appeals recently held that a plan under chapter 13 of the Bankruptcy Code can modify the rights of a purchaser of delinquent real estate taxes on a debtor’s home by providing for payment of those taxes over time rather than in a lump sum. See In re LaMont (No. 13-1187, 7th Cir. January 7, 2014).

Bankruptcy Code section 1322(b)(2) prohibits modification of a claim secured only by a security interest in a debtor’s principal residence (i.e., a home mortgage). In LaMont, the Seventh Circuit observed, however, that a lien for unpaid real estate taxes on a debtor’s principal residence is a statutory lien, rather than a consensual security interest. As a result, the debtors’ chapter 13 plan could modify the tax lien without violating the Bankruptcy Code’s anti-modification provision. As discussed below, the decision will benefit home mortgage lenders whose liens have been primed by liens for delinquent real estate taxes that have been sold.

In Illinois, a tax sale purchaser receives a Certificate of Purchase which qualifies the purchaser for a tax deed to the property once the tax redemption period ends without the purchaser having received payment for the delinquent taxes (plus interest which can be as high as 1.5 percent per month for the two- to three-year redemption period). The tax deed extinguishes junior liens on the property, including mortgages. This situation creates a problem for the holder of a mortgage on the homeowner’s property. If the homeowner is unable or unwilling to redeem the delinquent real estate taxes, the mortgagee must either redeem those taxes itself (and hope for reimbursement from the homeowner) or face a total loss of its mortgage when a deed for the property is issued to the tax purchaser.

In LaMont, the debtors’ Grundy County, Illinois home became subject to a  tax lien for an unpaid special assessment. At an annual tax sale, Grundy County sold the property to an entity that assigned its rights to the appellant, Lyubomir Alexandrov.

Before the redemption period for paying the delinquent real estate tax expired, the LaMont debtors filed for bankruptcy and the court confirmed a chapter 13 plan that modified the lien for delinquent taxes to provide for payment of those taxes over time, without interest.

When the redemption period for the delinquent taxes expired, Alexandrov applied for an order to have a tax deed to the debtors’ home issued to him. Having apparently learned of the debtors' bankruptcy case, the state court refused to enter that order. As a result, Alexandrov filed a motion in the debtors’ bankruptcy case for relief from the automatic stay to permit entry of the foregoing order. The bankruptcy court denied Alexandrov’s motion on the grounds that the debtors’ plan had made adequate provision for Alexandrov’s claim against the debtors’ home.

The Seventh Circuit's Opinion 

In its affirming opinion, the Seventh Circuit held that Alexandrov’s interest in the debtors’ home was a non-recourse lien for delinquent real estate taxes, rather than a contingent real estate interest. Consequently, Alexandrov had a “claim” (as that term is defined in the Bankruptcy Code) that could be treated in, and paid through, the debtors’ chapter 13 plan. As mentioned above, the court held that the claim was not subject to the anti-modification provisions because the lien did not result from a consensual security interest.

The Seventh Circuit rejected Alexandrov’s assertion that the debtors’ plan must provide for payment of the redemption amount in a lump sum before expiration of the redemption period. The Seventh Circuit held that the debtors’ plan properly treated Alexandrov’s secured claim and that the debtors’ payments did not represent a formal redemption of delinquent real estate taxes. Furthermore, once the debtors successfully completed their plan payments, Alexandrov’s claim was satisfied, thereby eliminating Alexandrov’s right to obtain a tax deed. Expiration of the redemption period while the debtors were making their plan payments did not affect the plan’s treatment of Alexandrov’s secured claim. Alexandrov’s equitable remedy of obtaining a tax deed would have survived only if the debtors had failed to make all of their plan payments.

The debtors in LaMont  filed their bankruptcy case under chapter 13. However, the parallel language in chapter 11 suggests that the Seventh Circuit’s decision will also allow a debtor in an individual chapter 11 case to modify the rights of an entity that purchased delinquent taxes on the debtor’s principal residence.

LaMont's Implications for Mortgagees

A combination of the LaMont decision and the Bankruptcy Code provides the mortgagee with a solution to the foregoing problem. Instead of redeeming delinquent real estate taxes just before expiration of the redemption period if the mortgagor fails to do so (or losing its mortgage lien by failing to redeem those taxes), a mortgagee could declare a default based on the borrower’s failure to pay real estate taxes and suggest that the borrower file a chapter 11 or 13 bankruptcy case. In such a case, the borrower/debtor would propose a plan that pays the delinquent real estate taxes over time, while continuing to make payments on the mortgage. This course of action would provide an alternative to the borrower who would otherwise face either (1) the need to make a lump-sum payment to redeem the delinquent taxes or (2) lose his home through either the issuance of a deed to the tax purchaser or through a sale of the home following a judgment of foreclosure.

A bankruptcy filing does not toll the running of the statutory time period for redeeming delinquent real estate taxes. Consequently, a borrower who decides to pay delinquent taxes under a bankruptcy plan should file a bankruptcy case, and obtain confirmation of his chapter 11 or 13 plan, before expiration of the statutory redemption period. As noted, while the borrower’s chapter 11 or 13 plan can modify the rights of a purchaser of delinquent real estate taxes, the Bankruptcy Code prohibits plan modification of the rights of a mortgagee whose claim is secured only by a security interest in the debtor’s principal residence. As a result, the mortgagee will continue to receive regularly scheduled mortgage payments under the debtor’s chapter 11 or 13 plan.