A lender’s dilemma: Redeeming property taxes during chapter 13 bankruptcies

When borrowers find themselves in significant arrears on their home mortgage and seek to restructure their debts in order to bring the loan current they will often file for chapter 13 bankruptcy protection. Under their bankruptcy plan they are given the opportunity to make monthly payments to the trustee over five years to pay off the arrearage, while at the same time making their current monthly payments directly to the lender.

Debtors also employ this tool to help them pay off sold property taxes through their bankruptcy plans to prevent the tax buyer from obtaining a tax deed to the mortgaged property once the redemption period expires. If the debtors make all of their bankruptcy plan payments, then all is well—the delinquent mortgage is brought current and the sold taxes are redeemed.

However, lenders can face significant peril if their debtors default on the bankruptcy plan and the trustee moves for dismissal of the bankruptcy case, especially if the deadline to redeem the sold property taxes already expired. This risk becomes apparent when looking at how bankruptcy courts have analyzed the interplay between chapter 13 bankruptcies and the redemption of property taxes under Illinois law.

Bankruptcy courts generally take one of three positions regarding how a chapter 13 bankruptcy filing affects the redemption of property taxes. First, some courts, like the one in Gan B, LLC v. Sims, find that the bankruptcy tolls the deadline to redeem taxes so long as the debtor is making payments towards the taxes through the plan. However, if the debtor stops making payments and the bankruptcy case is consequently dismissed, the deadline to redeem is no longer tolled. This would leave the mortgage lender without any time or right to redeem the taxes following the dismissal of the bankruptcy, and the tax buyer would be entitled to immediate issuance of a tax deed conveying the property free and clear of any mortgages or other liens.

Secondly, other courts, like the one in In re McKinney, have found that the bankruptcy does not toll the redemption period but rather that the automatic stay imposed by the bankruptcy filing bars the tax buyer from obtaining a tax deed so long as plan payments are being made. Again, once the bankruptcy case is dismissed, the deadline to redeem taxes would be expired, the automatic stay would no longer be in place and the tax purchaser would be entitled to a tax deed.

Finally, as illustrated in Jackson v. Midwest Partnership, yet other courts have held that a tax buyer can obtain a tax deed during the pendency of a bankruptcy case, even if the automatic stay is still in effect, so long as the deadline to redeem the taxes has expired.

As these cases show, although debtors may benefit from a chapter 13 bankruptcy by being able to effectively redeem their sold property taxes over the five-year plan period, lenders face significant risk of having their mortgage liens extinguished if the tax redemption period expires during the bankruptcy and the bankruptcy case is subsequently dismissed. Thus, lenders may want to consider redeeming the taxes prior to the redemption deadline and including the redemption amount in their respective proofs of claim.

Feel free to consult a Chuhak & Tecson Banking attorney to ensure that your mortgage liens are adequately protected during a chapter 13 bankruptcy.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Aaron D. White Jr., Associate

This alert originally appeared in the Spring 2018 Banking Focus newsletter.