Ignoring Its Own Precedent, Seventh Circuit Refuses to Allow Tax Lien to Ride Through Chapter 13 Case

Contributed by Katherine Doorley
Previously, we have examined the concept that liens may “ride through” a bankruptcy case where a creditor does not “participate” in the case, even where a secured creditor does not act to preserve its lien or where the secured creditor’s claim was disallowed for untimeliness.  Although we believe this concept to be a relic of the former Bankruptcy Act that should not be applicable under the Bankruptcy Code, both the Fifth Circuit and the Seventh Circuit recently embraced the principle.  Recently, however, the Seventh Circuit deviated from its own precedent and held in In re LaMont, No. 13-1187 (7th Cir. Jan. 7, 2014), that a tax sale purchaser’s tax lien could be treated in a chapter 13 plan, resulting in the lien being extinguished, even though the secured creditor did not participate in the case prior to the confirmation of the debtors’ chapter 13 plan.  Notably, the Seventh Circuit did not discuss or attempt to distinguish its “liens ride through” precedent in this most recent decision.
In Illinois, if the owner of real property fails to pay property taxes, the taxing authority may sell the property at an annual tax sale.  The tax sale purchaser pays the outstanding taxes, the taxing authority releases its lien, and the tax purchaser receives a “Certificate of Purchase.”  The taxpayer is given two and a half years to redeem the property by paying the tax purchaser all amounts due, including interest.  Six months before the redemption period expires, the tax purchaser is required to file a petition for a tax deed.  Once the redemption period has expired, the tax purchaser may apply for an order granting the petition for a tax deed and obtain title to the property.  Alternatively, the tax purchaser may apply for a declaration that the tax sale was a “sale-in-error” for one of several statutory reasons, including that the taxpayer filed for bankruptcy after the tax sale but before the tax deed was issued.  If the sale is deemed a sale-in-error, the taxing authority is required to reimburse the tax purchaser the purchase price plus interest.
The debtors owned a home in Grundy County, Illinois and failed to timely pay property taxes.  In November 2008, the property was sold at an annual tax sale, and the purchaser assigned its interest to Lyubomir Alexandrov.  The debtors filed a voluntary chapter 13 petition in December 2008.  It is unclear if Alexandrov received notice of the bankruptcy because the debtors listed the taxing authority as the creditor for the unpaid property taxes.  On August 2, 2011, Alexandrov filed a petition for a tax deed, and on January 13, 2012, after the redemption period had run, Alexandrov applied for an order directing the county clerk to issue a tax deed.  When the county court refused to enter an order while the bankruptcy case was pending, Alexandrov filed a motion in bankruptcy court seeking a declaration that the automatic stay did not prevent him from obtaining a tax deed.  At the time Alexandrov filed his motion, the debtors’ chapter 13 plan had been confirmed for nearly three years.  By the time the Seventh Circuit heard oral arguments, the debtors had made all of the required payments under their plan, which provided for payment of the delinquent property taxes directly to the taxing authority.
The bankruptcy court held that Alexandrov’s interest was properly classified as a secured claim treated under the debtors’ plan and that the automatic stay prevented Alexandrov from obtaining a tax deed.  Section 362(c)(2) of the Bankruptcy Code provides that the automatic stay applies to the debtor and any property of the debtor “until the earliest of (a) the time the case is closed; (b) the time the case is dismissed or (3) . . . the time a discharge is granted or denied.”  In a case under chapter 13, the debtor is only discharged after making all payments provided for under the debtor’s plan.  Here, the debtors had yet to receive their discharge, and accordingly the automatic stay remained in effect as to the debtors’ property, even though the debtors’ plan had been confirmed.  On appeal to the Seventh Circuit, Alexandrov argued that the lower courts had improperly characterized his interest as a claim and had erred in finding that the automatic stay applied.
Debtors’ attempts to provide treatment for claims under a plan generally are subject to constitutional due process, and a creditor that does not receive constitutionally adequate notice generally would not be bound by a plan.  For reasons that are unclear, Alexandrov first raised the question of notice in a motion for reconsideration of the bankruptcy court’s ruling on the automatic stay question.  The bankruptcy court characterized the inclusion of the notice argument in a motion for reconsideration as an inappropriate attempt to add an additional ground for appeal.  The Seventh Circuit found that the notice argument was waived because Alexandrov raised it for the first time on appeal.
The Seventh Circuit’s Decision:
Alexandrov asserted that his interest was a real property interest that automatically divested the debtors of title to their home upon the expiration of the redemption period and that he was entitled to a tax deed.  The Seventh Circuit noted two problems with Alexandrov’s position.  The first was that courts in Illinois consistently treat the tax purchaser’s interest as a tax lien rather than an executory interest in real property.  The second was that property sold at a tax sale still belongs to the debtor so long as the redemption period has not expired.  The debtor retains legal and equitable title, and the property becomes part of the bankruptcy estate.  A tax purchaser merely holds a lien for taxes.
Section 101(5) of the Bankruptcy Code defines a claim as a right to an equitable remedy or a right to payment.  The Seventh Circuit noted that although under state law Alexandrov did not have a right to payment, the Bankruptcy Code includes a right to payment from the debtor’s property within its definition of “claim,” and Alexandrov had a right to payment from the property.  In other words, if the debtors redeemed the property, Alexandrov had a right to payment from the money paid to redeem the property.  The Seventh Circuit further noted that Alexandrov had a right to an equitable remedy for breach of performance because Alexandrov had stepped into the shoes of the county.  When the debtors failed to timely pay their property taxes, that breach gave rise to certain equitable remedies, such as the right of the county to sell the property at a tax sale.  Alexandrov held a non-recourse tax lien that could be equitably enforced by obtaining a tax deed to the debtors’ home.  Accordingly, the Seventh Circuit held that Alexandrov held a right to payment or, in the alternative, a right to an equitable remedy against the debtors’ property, and therefore held a claim that could be treated in the debtors’ bankruptcy case.
The debtors’ chapter 13 plan treated Alexandrov’s secured claim by providing for payment in installments to the taxing authority.  Alexandrov disputed this treatment, arguing that this was not a proper redemption of the property and that once the redemption period expired, the debtors lost their ownership interest in the property.  The Seventh Circuit disagreed, noting that in chapter 13 (as in chapter 11), a plan may modify a secured claim and provide for its payment over time. Here, the debtors’ plan had been confirmed, and the debtors had completed making payments under the plan. The Seventh Circuit therefore found that Alexandrov’s claim had been satisfied, notwithstanding that the taxing authority, and not Alexandrov, received the payments.  Therefore, Alexandrov no longer had the right to a tax deed.  The Seventh Circuit held that because Alexandrov’s attempts to obtain a tax deed amounted to attempts to obtain possession of property of the debtors, the automatic stay properly applied.  The Seventh Circuit did note that if Alexandrov was dissatisfied with the debtors’ treatment of his claim he was entitled to seek a sale-in-error and obtain reimbursement from the taxing authority.
Interestingly, the Seventh Circuit neither addressed nor distinguished its prior “liens ride through” decisions.  There are several reasons why the Seventh Circuit may not have felt these prior decisions were relevant, or needed to be distinguished.  First, tax purchasers drawn into a bankruptcy case have an out of court alternative; they may apply for a sale-in-error and recoup their entire investment plus interest.  In fact, the Seventh Circuit noted that the sale-in-error provision indicates that the Illinois legislature specifically anticipated adverse treatment of a tax purchaser’s interest in bankruptcy.  Because Alexandrov could have been made whole through recourse to the taxing authority, it seems that the Seventh Circuit implicitly treated the taxing authority, and not Alexandrov, as the real party in interest.  Of course, extending such reasoning to other situations in which a creditor’s claim is guaranteed would upset established notions of what constitutes a “party in interest.”  Second, the Seventh Circuit noted several times that Alexandrov had only appealed from the lower court’s refusal to modify the automatic stay or declare it inapplicable and had not challenged the debtors’ chapter 13 plan or its treatment of his claim.  It is possible that any of these factors were deemed significant enough to differentiate this case from others where the Seventh Circuit has held that a lien rode through.