Pitfalls in the Redemption of Property by Lenders
Real Estate Finance Newsletter
In Alabama, when a property owner fails to pay his ad valorem property taxes, his property may be sold at a public auction to the highest bidder (the “tax purchaser”). Statutory law in Alabama provides that the owner of the property who failed to pay the taxes, and certain other parties, such as a lender holding a mortgage on the property, have the subsequent right to redeem the property by paying the back taxes, the accrued interest and any excess bid paid by the tax purchaser at the tax sale . However, the Alabama Court of Civil Appeals recently addressed the rights of redemption by various parties and reached a decision that not only penalizes a lender for redeeming property in order to protect its interest but also provides a windfall to a property owner who failed to pay his property taxes and allowed his property to be sold at a tax sale.
In First United Security Bank v. McCollum, the Alabama Court of Civil Appeals addressed the rights of a lender that redeems property sold at a tax sale as a result of its borrower’s failure to pay his property taxes. In McCollum, the property owner executed a promissory note and a mortgage in favor of his lender. When the property owner failed to pay his 2009 property taxes, his property was sold at a tax sale. The tax purchaser not only paid the back taxes for 2009, but also paid an excess bid of $32,305.12. The lender subsequently foreclosed on the property and recorded its foreclosure deed in the county where the property was located. The lender, as the current owner of the property, then redeemed the property by paying the back taxes for 2009, interest and the excess bid of $32,305.12.
The lender then applied to the probate court for reimbursement of the excess bid it paid to redeem the property. The probate court refused, saying that the excess bid could only be claimed by the original property owner, that is, the individual who failed to pay the taxes on the property.
In rejecting the lender’s claim for reimbursement of the excess bid, the Court in McCollum stated that only the property owner was entitled to receive the excess bid even though such owner did not pay to redeem the property. The court based its ruling on Section 40-10-28 of the Alabama Code which provides, in pertinent part, as follows:
The excess arising from the sale of any real estate remaining after paying the amount of the decree of sale, and costs and expenses subsequently accruing, shall be paid over to the owner, or his agent, or to the person legally representing such owner, or into the county treasury, and it may be paid there from to such owner, agent or representative in the same manner as to the excess arising from the sale of personal property sold for taxes is paid.
The Court then ruled that even though the lender foreclosed on the property and was now the owner of the property, the lender still would not be entitled to receive the excess bid because the lender foreclosed after the tax sale took place. Therefore, the only person entitled to recover the excess bid was the owner of the property at the time of the tax sale, the person who failed to pay the property taxes. The Court reached its decision even though a party other than the property owner paid the excess bid as part of its redemption of the property.
In addressing who may recover an excess bid paid as part of the redemption process, the Alabama courts have reached a decision that:
1) penalizes a lender when such lender is forced to protect its interest by redeeming property when a borrower fails to pay his property taxes; and
2) awards a property owner with a financial windfall by allowing him to recover the excess bid despite his failure to pay his property taxes and the fact that a third party has repaid the excess bid as part of its redemption of the property.
So what can a lender do to protect its interests and recover any such excess bid paid as part of the redemption process? First, a lender can set up an escrow account from the borrower’s monthly payment to allow the lender to pay the property taxes. This would ensure the property is not sold for failure to pay property taxes. However, setting up an escrow account to pay the taxes may not always be practical. In this situation, a lender can require its borrower to execute a power of attorney or an assignment in the initial loan documents granting the lender the right to recover any such excess bid as part of any redemption process or, if the lender learns that property has already been sold for taxes, it can require the property owner to execute a power of attorney designating the lender as its representative before it redeems the property. Although these options may not be the perfect solution in every situation, they would allow the lender to fall under the definition of an owner’s representative and entitle the lender to seek to recover any excess bid paid as part of a redemption process.
1 The reason for paying an excess bid above the amount of taxes is that when the property is redeemed, the redemption payment includes not only the excess bid but interest earned on such excess bid.
2 The lender in McCollum foreclosed on the property before paying to redeem the property because the Alabama Supreme Court in a prior decision held that a lender that pays to redeem property as a mortgagee and NOT as the owner of the property is not entitled to receive the excess bid held by the county, as Alabama requires that any such excess funds are to be paid to the owner of the property NOT the party paying to redeem the property.