US District Court Rules that Prior Recorded Condominium Lien takes Priority Over Federal Tax Lien to the Extent of the Amount Stated in the Lien Notice
In Yarmouth Commons Ass’n v Norwood, et al., 299 F. Supp.3d 862 (E.D. Mich., 2017), the United States District Court for the Eastern District of Michigan held that a prior recorded condominium lien had priority over a federal tax lien but only to the extent of the amount stated in the lien notice.
The case involves a condominium unit within the Yarmouth Commons Condominium project. Defendant Pamela Norwood (“Norwood”) bought a condominium unit in March 2015 in the Yarmouth Commons Condominium project (“Condominium Unit”). On January 28, 2016, Yarmouth Commons Association (“Association”) recorded a notice of lien with the Macomb County Register of Deeds in the amount of $1,490.00 for unpaid assessments, exclusive of interest, costs, attorney fees and any future assessments which may become due.
On April 6, 2015, the IRS made an assessment of past due income taxes against Norwood for the 2009 tax year she failed to pay but it was not until February 8, 2016 that the IRS recorded a Notice of Federal Tax Lien with the Macomb County Register of Deeds against Norwood’s property in Macomb County, which included the Condominium Unit. The Association advised the IRS that it had priority over its lien and the IRS countered that it had priority as the Association’s lien was not a security interest.
The Association, the IRS and the Macomb County Treasurer, to whom property taxes on the Condominium Unit were also owed, attempted to resolve the question of lien priorities amongst the three. However, no agreement was reached and the Association filed suit in the Macomb County Circuit Court against the IRS, the Macomb County Treasurer and Norwood. The IRS removed the case to the United States Eastern District of Michigan and filed a counterclaim against the Association and a crossclaim against Norwood for payment of the delinquent income taxes.
Norwood failed to respond to the Association’s complaint and the IRS was granted a default judgment on its crossclaim. Thereafter, the Association, the IRS and the Macomb County Treasurer stipulated that the County’s delinquent property taxes had priority over both of the Association’s and IRS’ liens and the County was dismissed from the case.
Thereafter, the Association and the IRS filed cross motions for summary judgment with the Association arguing that it had priority over the IRS tax lien pursuant to federal law.
Court Holds that Association’s Lien was a Perfected Security Interest
The District Court first examined the general rule of how a federal tax lien is perfected and its priority over other interests in property and if there are any exceptions to the general rule. The District Court found that the general rule is that a “federal tax lien need not be filed to gain priority over other interests; it is perfected at the time the lien is assessed.” In re Terwilliger’s Catering Plus, Inc., 911 F.2d 1168, 1176 (6th Cir. 1990) (citing 26 U.S.C. § 6322). The District Court then went on to state that the Internal Revenue Code (“IRC”) creates an exception to the general rule whereby a tax lien “shall not be valid as against any purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary.” Yarmouth, 299 F.Supp.3d at 866-67 (citing 26 U.S.C. § 6323 (a) (emphasis added)).
The District Court then examined the definition of a security interest under 26 U.S.C. § 6323 (h) and stated that Courts have agreed that a creditor relying on the security interest exception “must establish that its interest satisfies four conditions: (1) that the security interest was acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss; (2) that the property to which the security interest was to attach was in existence at the time the tax lien was filed; (3) that the security interest was, at the time of the tax lien filing, protected under state law against a judgment lien arising out of an unsecured obligation; and (4) that the holder of the security interest parted with money or money’s worth.” Yarmouth, 299 F.Supp.3d at 867 (citing Litton Indus. Automation Sys., Inc. v Nationwide Power Corp., 106 F.3d 366, 368 (11th Cir. 1997) (quoting Haas v. Internal Revenue Serv. (In re Haas), 31 F.3d 1081, 1085 (11th Cir. 1994)).
The IRS argued that the Association’s condominium lien was not a security interest because it was not a lien interest that was acquired by contract but instead a statutory lien that arose by operation of law and also because the lien was not any form of mortgage or other secured interest.
Although both the Association and the IRS cited to priority cases that arose under the Bankruptcy Code, the District Court stated that its analysis must focus on the language found in the IRC.
Thus, the Court began its analysis in determining whether the Association’s lien satisfied the security interest exception. The Court found that there was no dispute as to satisfying the second condition to establish a qualifying security interest – namely that the lien was in existence at the time that tax lien was filed.
The Court also found that the first condition that the security interest was acquired by contract for the purpose of securing payment or performance of an obligation was also satisfied. The Court found that the Association’s lien was obtained for the purpose of securing payment by Norwood of delinquent assessments. The Court further found that the security interest was acquired by contract in that the Association’s bylaws is a binding contract between co-owners and the Association. Yarmouth, 299 F.Supp.3d at 868-69 (citing Tuscany Grove Ass’n v Gasperoni, No. 314663, 2014 WL 2880292, at *3 (Mich. Ct. App. June 24, 2014)).
The Court further found Norwood accepted an obligation to abide to the terms of the Association’s Master Deed and Bylaws as the Association’s Bylaws stated that “[e]ach Co-owner, and every other person who from time to time has any interest in the Project, shall be deemed to have granted to the Association the unqualified right to elect to foreclose the lien securing payment of assessments either by judicial action or by advertisement.” Yarmouth, 299 F.Supp.3d at 869.
The IRS attempted to have the Court make a distinction between a “security interest” and a “statutory lien” and that the Association’s interest cannot be both. In doing so, the IRS cited to several bankruptcy and district court decisions that concluded that condominium assessments do not enjoy priority over the liens of other creditors in bankruptcy.
The Court stated that those cases were not applicable in the instant case as all of those cases addressed a narrow issue of statutory construction under the Bankruptcy Code, which was the scope of an exemption from the Code’s general ‘cram down’ provisions granted by 11 U.S.C. § 1322 (b)(2).
The Court examined IRC Section 6323 and found that it not only did not distinguish between a ‘security interest’ and a ‘statutory lien’. The court also found that nothing in Section 6323 (h)(1)’s definition of ‘security interest’ excludes interest that arise partly or wholly by operation of law but is instead the language is sweeping and inclusive.
The Court further found that the Bankruptcy Court in the Northern District of California implicitly held when construing section 6323 that a condominium association’s recorded lien was entitled to priority over the later filed federal tax lien but only to the extent of the amount specifically stated in the notice of the condominium lien and not including any indeterminate future assessments. Yarmouth, 299 F.Supp.3d at 872 (citing In re Guajardo¸ No. 15-31452, 2016 WL 943613, at *4 (Bankr. N.D. Cal. Mar. 11, 2016)).
Lastly, in addressing the IRS’s attempt to distinguish between a “security interest” and a “statutory lien”, the Court stated that although the Michigan Condominium Act lends support to the Association’s attempts to foreclose its lien, the statutory assist does not render the lien any less a product of a contract or disqualify it as security interest recognized by IRC section 6323(a).
Federal Law Determines Priority Disputes and Not State Law
Having determined that there was no distinction between a “security interest” and a “statutory lien”, the Court then examined the third condition for the Association to satisfy the security interest exception.
The Court examined MCL 559.208(1), which states that condominium assessment liens take priority over “other liens except tax liens on the condominium unit in favor of any state or federal taxing authority.” Yarmouth, 299 F.Supp.3d at 873 (emphasis added). The Court indicated that although the cited language would tend to suggest that a Michigan state court would not afford priority to prior recorded condominium lien over a federal tax lien, federal courts apply federal law in such prior disputes without regard to the effect of any state pronouncements on the question. Yarmouth, 299 F.Supp.3d at 873 (citing Blachy v Butcher, 221 F3d 896, 905 (6th Cir. 2000) (“The priority of a federal tax lien against competing claims is governed by federal law.”).
The Court further found that as against liens other than tax liens or a first mortgage, the Association’s interest is “protected under local law against a subsequent judgment lien arising out of an unsecured obligation,” by MCL 559.208(1) and MCL 559.208(1) explicitly offers the Association’s lien priority and offers a direct avenue for enforcing the lien by way of a foreclosure proceeding. Yarmouth, 299 F.Supp.3d at 873.
As to the fourth condition for the Association to satisfy the security interest exception, the Court found even though the parties had not briefed the issue that the Association had ‘part[ed] with money or money’s worth’ because it was evident from the record that the Association had incurred or paid expenses on behalf of Norwood that were necessary to maintain the common portions of the condominium project.
Thus, the Court found that the Association had satisfied the four conditions of the security interest exception. Having found that the Association had satisfied the four conditions of the security interest exception, the Court had to determine the amount to which the Association was entitled priority over the IRS lien.
The Court ruled that the Association was only entitled priority over the IRS in the amount set forth in the notice of lien. In coming to this conclusion, the Court first determined that the Association’s lien was choate and that the Association was entitled to enforce its line prior to the attachment of the federal lien. The Court found that the identity of the lienor (the Association), the property subject to the lien (Norwood’s condominium unit) and the amount of the lien ($1,490) were all plainly stated on the recorded notice of lien. It also found that there were no prerequisites under the Michigan Condominium Act about the Association’s immediate right to enforce its lien.
The Court however found that the Association was only entitled to priority in the amount set forth in the notice because the Association had not provided any evidence that any amounts beyond the $1,490 were rendered to a sum certain before the government filed its notice of tax lien.
Condominium associations are frequently faced with federal tax lien priorities when trying to determine whether to proceed with foreclosure of its lien. Yarmouth Commons Ass’n v Norwood, et al., 299 F. Supp.3d 862 (E.D. Mich., 2017) is important as it demonstrates the importance of timely recording liens on delinquent co-owners and having the correct amount possible in the lien by reviewing condominium documents with your association’s attorney to determine whether the line amount can include the acceleration of the annual assessments, the repair, replacement or maintenance costs that associations incur in bylaw infraction matters and the attorney fees and costs incurred in pursing bylaw infraction matters. If properly and timely done, it can be the difference between recouping most, if not all, of a co-owner’s delinquency to obtaining just the tip of the iceberg of the co-owner’s delinquency when facing a federal tax lien priority issue.
William Z. Kolobaric is an attorney with the law firm of Hirzel Law, PLC where he focuses his practice on community association law, construction law, real estate law, creditor’s rights in bankruptcy and probate and estate planning. He has extensive experience in state and federal courts involving a wide scope of real estate, commercial litigation and creditor’s rights matters. He can be reached at (248) 478-1800 or [email protected]. Please view The Michigan Community Association Law Blog at http://www.micondolaw.com for additional resources on Michigan Community Association Law.