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In a case where private enterprise meets governmental finance, the Fifth Circuit has ruled that purchasers of Texas tax liens are protected from having their contractual interest rates modified in a plan. Tax Ease Funding, LP v. Thompson, et al, No. 09-20777 (5th Cir. 11/11/10). The opinion can be found here.

The case involved consolidated appeals regarding private parties who had purchased Texas property tax liens. In order to boost property tax collections, the State of Texas passed a law allowing property owners to enter into a transaction with a private lender to pay the taxes on their property. In return, the tax lien funder is subrogated to the lien of the taxing authority and takes an assignment of the tax lien. Under the law, the private party can charge any negotiated interest rate up to the usury limit of 18% as compared to the statutory rate of 12%. TEX. TAX CODE § 32.06(a-1).

One of the new sections created by BAPCPA was 11 U.S.C. Sec. 511, which provides that a "tax claim or on an administrative expense tax" shall be entitled to "the rate of interest shall be the rate determined under applicable nonbankruptcy law."

The cases before the court involved debtors who had financed their tax liens at high interest rates and then sought to reduce the rates under a plan. If the debtors had not engaged in the private party finance transactions, it appears clear that they would have been required to pay 12% interest to the original governmental creditor. However, by virtue of the private party transaction,the contract obligated the debtor to pay 14.8%.

The questions for the Fifth Circuit were whether the creditor held a "tax claim" and whether the creditor was entitled to the rate the original tax creditor would have received or the higher negotiated rate.

The court noted that the term "tax claim" is not defined under BAPCPA. The court began with the expansive definition of claim as right to payment. The court stated, "(i)n the simplest terms, a tax claim is a broad right to payment of taxes." The court found that private parties were entitled to "tax creditor" status because the court used the broader term of "tax creditor" as opposed to the more limited term "governmental unit."

The debtors argued that because the private party received only an assignment of the tax lien and not the taxes themselves that they were not entitled to protection of their negotiated interest rate. The court relied upon Johnson v. Home State Bank, 501 U.S. 78, 83, 111 S. Ct. 2150, 2154 (1991)to hold that a party with a lien held a "claim" against the debtor. Therefore, a tax lien equated to a tax claim.

The Fifth Circuit rejected the Bankruptcy Court's conclusion that the "tax claim" was extinguished when the private party paid the taxes. Under state law, the purchaser was subrogated to all the rights and remedies of the taxing authorities. The court found that contractual subrogation did not limit the subrogee to the exact same rights as the original creditor held.

Thus, a private party was entitled to non-modification of its higher contractual rate of interest.

Because the Fifth Circuit confined its analysis to a code to code connect the statutes approach, it did not look at the policies behind the statutes. However, there is an arguable case that local taxing authorities benefit from having their taxes paid from private parties now rather than having to pursue their own collection efforts. If the private party receives a greater reward for paying the taxes, that is simply the premium which must be paid to entice a private party into the market. Because the debtor's decision to refinance the tax lien is purely voluntary, the debtor has difficulty claiming that it was prejudiced.

There are two take aways here. The first is that Congress intended to protect local taxing authorities when it adopted Sec. 511. The second is that a party owing ad valorem taxes in Texas should seriously examine the wisdom of refinancing the tax lien. While it may provide short-term relief from the tax man, the debtor will be stuck with the burden of the bargain.

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