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Buyers of properties with active tax foreclosures CANNOT simply pay the tax lien at closing; they MUST file a Court motion first in time or else their property rights will be subsequently stripped!
This article is intended to AGAIN provide investors and buyers with knowledge of the NJ Supreme Court’s ruling and directive in Simon v. Cronecker, 189 N.J. 304 (2007) where the High Court condemned the practice of a buyer simply proceeding to a closing and paying off an active tax lien (currently in tax foreclosure) without first notifying the Court through an “intervention motion” and obtaining approval for the transaction. While this seminal and landmark case is now 7 years old, there are still active violations of this law on a daily basis. Buyers routinely fail to follow this mandatory procedure, and title companies routinely fail to require it. Yet when title rights are stripped for failure to follow the procedure, title companies deny coverage on the basis that the tax lien was not redeemed -- and they are correct. Thus, the Buyers are left defenseless -- and out of a whole lot of money! It is important to adhere to the policy and procedures to protect your property investment. Let’s start at the beginning:
In our example, let’s pretend you find a property that you want to buy and you learn that it is facing a tax foreclosure. This information is usually obtained either by the seller telling you that there is already a pending tax foreclosure, or through your title search when you are preparing for closing. Side note: having a tax lien against the property is not the same as having an active tax foreclosure case pending. In the first instance, a tax lien is sold for unpaid taxes. If this exists, but foreclosure has not yet been filed, you can generally proceed to closing and pay off the lien. But in the second instance, if the tax lien was not timely paid back and the tax lien holder waited the mandatory time period (usually 2 years but sometimes shorter if, for instance, the property is abandoned) then the tax lien holder files a tax foreclosure complaint and you now find yourself in the midst of an active foreclosure. Upon filing the complaint, the tax lien holder also files a lis pendens that is recorded in the county land records -- just like the tax lien itself, a deed, a mortgage, etc. It will show up on a county search and this indicates that there is a pending and active tax foreclosure.
The foreclosure process does not happen overnight. After the lis pendens is filed, the tax lien holder (also called the “Plaintiff” in the foreclosure case) has to serve the parties, obtain default, obtain a redemption order, etc., before they can apply for final judgment. In between this time and while the Plaintiff’s attorney is going through this process, the property owner facing tax foreclosure often seeks to either (1) pay off the lien, or (2) sell the property before final judgment occurs. It is this second instance where you come in as an investor. You want to buy the property. But you cannot. Not yet. And please do not let a title company or unknowing attorney tell you otherwise. Read on.
This is a specialized area of the law, and general real estate lawyers are notorious for getting it wrong. It is not difficult; it is just unknown and hence the need for this informational article -- even 7 years after the landmark decision of the NJ Supreme Court. The problem with simply going to a closing and paying of the tax lien -- just as you would pay off any open mortgages or judgments -- is that the Court considers the money being used to pay off the tax lien as the “buyer’s money”. The Court knows that the seller is redeeming at closing in order to be permitted to transfer clear title to the buyer. But since it is not the seller’s money independent of the entire transaction the Court considers the buyer the “indirect redeeming party”.
This is the problem, because the law requires that only certain persons are permitted to redeem a tax lien. Specifically, in order to redeem you must be “named in the action”. Your name must appear in the caption of the tax foreclosure case. The seller’s name obviously appears as the defendant and the property owner. But the buyer’s name does not. Thus, it must be added before redemption occurs or else the Court will find that the redemption is illegal. It does not matter that the transaction is an arms-length, bona-fide sale for true, market value dollars. It does not matter that title insurance was issued and all parties were given notice of the sale -- even if the tax lien holder was provided notice. It is the Court that must be given notice and must give its stamp of approval. Without it, the redemption is illegal. Period.
What does this mean? Well, let’s pretend in our example that you proceeded to closing without intervening in the Court action and you even used a lawyer and obtained title insurance. Let’s also pretend you bought a house valued at $250,000 for the bargain price of $200,000. Finally, let’s pretend you paid off the tax lien at closing long before the Plaintiff’s attorney even approached final judgment (but after the lis pendens was filed) and you took possession at closing and undertook a $20,000 rehab project on the property. Now, several months later (or even a year later) the tax lien holder files a Court action to declare the prior redemption of the tax lien illegal. He seeks to strip you of title and to obtain possession.
Your first knee-jerk reaction is to approach your title company and demand that they provide you a defense in Court, right? Wrong. The title company will deny the claim, and they will win. Why? Because in Schedule B of the title policy, they listed that you must redeem the tax lien as a requirement of title insurance. They didn’t spell out the procedures for doing so legally -- they just mandated that it be done. They do not have to tell you "how" to do it. It's enough that they required that it be done. It is your job (and your attorney’s job) to do it legally. So that now leaves you with the option of possibly suing your attorney for malpractice. But this doesn’t save your property, and even if you get a monetary judgment from your attorney’s malpractice insurance this is a long way off and likely a losing scenario, anyway. Why? Because attorneys do not like to sue other attorneys; and legal malpractice cases are usually complex, difficult, time consuming and expensive. So you’ll likely be paying for the mistake one way or another.
The question still remains - what happens to the property? In the Cronecker case, in which the author of this article Anthony L. Velasquez, Esq., was the lead attorney, the NJ Supreme Court ordered that the remedy of “constructive trust” is proper. This means that the tax lien holder succeeds to your bargain. They get to buy the property for the same price you paid. They get to step into your shoes. In essence they get the benefit of your bargain. You no longer made a $50,000 profit on the purchase; it is the tax lien holder who reaps this benefit. You get paid back your purchase price, but not your costs (attorney fees, closing costs, etc.) and you are held responsible for those costs. Also, based on another related NJ Appellate Court case the additional investment you made for rehab ($20,000 in our example) is also lost, and becomes a windfall to the lien holder -- because you proceeded to make those rehab changes at your own risk and in violation of the redemption law. Therefore, the tax lien holder gets to walk away with the property for $200,000 but gets a property valued at $250,000 plus $20,000 worth of additional rehab work that you invested (and lost). Also, some Courts award the tax lien holder attorney fees -- so you might even be charged with paying their attorney fees for them to receive this benefit!
Sounds heavy-handed, right? Nope. That’s the law. And in fact, the High Court has held in another case that this has always been the law and thus it is considered “retroactive” despite the fact that it was sparsely enforced.
You might think this is unfair. But the law exists not for the benefit of the tax lien holder. Instead it exists for the benefit of the distressed property owner facing tax foreclosure. The Court takes a high priority for protecting the vulnerable -- and it wants to see the transaction first, before it occurs and before redemption is made. In doing so, the Court can confirm that the sale is made for real, tangible, meaningful dollars -- not token money. Historically, unscrupulous investors have tried to take unfair advantage of distressed owners facing tax foreclosure and offered token or “nominal” value for the property. If the seller walks away with no true benefit (for example, the sale of $200,000 requires payment of $199,000 in tax liens and the seller receives a net gain of $1,000 or less from the closing) then the Court will not approve the transaction. So the Court mandates that it first have the opportunity to review the transaction and confirm that it exceeds “nominal” value. This is why the punishment is so harsh for failing to adhere -- because unmonitored transactions can be grossly unfair and harmful to the financially vulnerable seller. The Court not only frowns upon this -- it vehemently scorns it.
Now there is hope. The sale does not have to be true market value; in fact in Cronecker the Court said the $1.2 million property value that was sold for 21% ($250,000 sales price) with a net gain of 5% ($63,000 net dollars to the seller) was still sufficient and legal value (adequate) because that amount of money was true, actual, beneficial, meaningful, tangible dollars. But despite the $250,000 sales price and $63,000 net gain being above “nominal”, the Court still stripped the investor’s title rights in Cronecker because of the failure to first intervene. The monetary success did not stop, fix or excuse the procedural failure. The property rights will still get stripped.
It gets even worse if the investor obtains a mortgage. Let’s go back to our example and assume that after the sale the investor takes out a home equity mortgage based on the $50,000 equity that remained in the property. As above, let’s pretend a mortgage policy was obtained from a title company. But the title claim would again be denied because of the same standard exclusion noted above. Thus, the investor now find himself stripped of title, stripped of the benefit of the bargain, stripped of the rehab costs, possibly responsible for the other side’s attorney fees, and now responsible for the home equity loan amount he took out! Yes, the property is removed as “security” for the loan; but the lender could still seek recovery against the borrower as an unsecured loan - through a normal collection action.
As you can see, making of the mistake of not submitting a simple intervention motion prior to closing on a simple sale can have EXTREME consequences for an investor sometime down the road. So how do you avoid these pitfalls? My advice is to hire a competent attorney to file a quick motion to allow you as an investment buyer to proceed to closing and redeem the tax lien as part of the closing with the pending tax foreclosure then being dismissed (or do it yourself without an attorney if you can navigate the legal minefields).
As a final hint, it is advised that you do not try to take some easy way out and devise some plan or scheme to circumvent this mandatory intervention procedure. Many cases exist in New Jersey where a buyer “loaned” money to the seller so that the seller (named in the lawsuit) could redeem the tax lien prior to the sale, and then the buyer was “repaid” or “given a credit” at the closing for this loaned amount. This, too, has been struck down as illegal by the NJ Court -- along with a long list of variations on this scheme. It will result in the same thing -- stripped title, massive costs and a great big headache. It is amazing that 7 years after this case law was confirmed by the NJ Supreme Court (and repeatedly upheld and enforced in countless subsequent cases), real estate practitioners including attorneys, title companies and realtors still do not know of the mandatory requirements. But as always, ignorance of the law is no excuse. You are better served to play it safe, protect your investment and conduct a “legal” redemption of a tax lien in an active tax foreclosure when you seek to buy such an investment property.