Thursday, December 18, 2014

FYI: 4th Cir Rules in Favor of Lender in IRS Tax Lien Priority Dispute

The U.S. Court of Appeals for the Fourth Circuit recently held that a bank’s deed of trust was prior and superior to a recorded Internal Revenue Service (“IRS”) tax lien, where the deed of trust was executed prior to the IRS tax lien, but recorded after the tax lien had been filed.


Notably, the Court rejected the application of a Maryland relation back statute which provides that, for purposes of priority, the effective date of a recorded deed of trust relates back to the date of execution of the deed of trust.


Nevertheless, the Court still determined that the bank enjoyed priority over the IRS tax lien because it had an equitable security interest as of the deed of trust’s execution.


A copy of the opinion is available at:


This action arose in the context of an adversary proceeding filed by a lender (“Bank”) against the IRS in a debtor’s Chapter 11 bankruptcy case, in which the IRS filed a proof of claim for taxes, interest, and penalties owed. In the adversary proceeding, Bank sought a declaratory judgment as to the priority of its deed of trust as against the IRS’s tax lien.


The debtor had borrowed $1 million from Bank, which was secured by a deed of trust on real property. Six days after Debtor obtained the loan, the IRS recorded a notice of its federal tax lien for unpaid employment taxes. One month later, Debtor recorded the deed of trust.


Upon cross motions for summary judgment in the bankruptcy court, the bankruptcy court held that Bank held priority due to application of Md. Code, Real Property § 3-201 (the “Maryland Relation-Back Statute”) which provides that the priority of a recorded deed of trust relates back to the date of its execution.  


On appeal from the bankruptcy court, the District Court agreed, clarifying that the Maryland Relation Back Statute, made applicable by 26 U.S.C. § 6323(h)(1)(a), provided that “a recorded deed of trust is effective against any creditor of the person who granted the deed of trust as of the date the deed of trust was delivered (not the date it was recorded) regardless of whether the creditor did or did not have notice of the deed of trust at any time.” Op. at 7 (quoting Chicago Title Insurance Co. v. Mary B., 190 Md. App. 305, 316; 988 A.2d 1044, 1050 (2010). Consequently, the District Court held that “as of when the IRS’s lien was recorded, [Bank]’s [deed of trust] was already a ‘security interest’ that was entitled to priority under Maryland law and, hence, federal law.” Op. at 6.


In the alternative, the District Court held that Bank’s security interest would have taken priority under Maryland law even if the deed of trust were never recorded, because Maryland’s common law doctrine of equitable conversion entitles the holder of a deed of trust to the same protections as a bona fide purchaser for value, who takes title free and clear of all subsequent liens regardless of recordation. The District Court determined that an IRS tax lien has only those protections that local law would afford to “a subsequent judgment lien arising out of an unsecured obligation,” 26 U.S.C. § 6323(h)(1)(a), and concluded that Bank’s deed of trust took priority over the lien.


The IRS then appealed to the U.S. Court of Appeals for the Fourth Circuit.


As you may recall, the priority of a federal tax lien is governed by federal law. See Aquilino v. United States, 363 U.S. 509, 513-14 (1960). Under federal law, an IRS tax lien attaches to all property owned by a person who neglects to pay taxes for which he is liable after the IRS demands payment. 26 U.S.C. § 6321. The IRS lien arises at the time the tax assessment is made, 26 U.S.C. § 6322, and generally takes priority over a lien created after that date under the common law principle that “the first in time is the first in right,” United States v. City of New Britain, 347 U.S. 81, 85 (1954), even if the IRS lien is unrecorded.  See United States v. Snyder, 149 U.S. 210, 214 (1893).


However, an IRS tax lien is not “valid as against any . . . holder of a security interest . . . until notice thereof . . . has been filed by the Secretary [of the Treasury].” 26 U.S.C. § 6323(a). As used in § 6323(a), a “security interest” is defined as “any interest in property acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss or liability,” 26 U.S.C. § 6323(h)(1), and its existence at a particular moment depends on whether “the interest has become protected under local law against a subsequent judgment lien arising out of an unsecured obligation.”  26 U.S.C. § 6323(h)(1)(A).


The Fourth Circuit observed that, under Maryland law, a deed of trust becomes effective against subsequent judgment liens when it is both executed and recorded.  See Md. Code Ann., Real Prop. § 3-101(a). However, the Fourth Circuit ruled that the District Court failed to distinguish between Congress’s use of the present and present perfect tenses in § 6323(h)(1)(A) to determine the proper point in time to analyze whether Bank had a security interest protected under local law.


According to the Fourth Circuit, the issue was not whether Bank had a protected security interest against subsequent judgment liens on the deed’s recordation date, but whether Bank had a protected security interest on the earlier recordation date of the IRS tax lien. The Court held that the Maryland Relation-Back Statute could not be applied until the Bank had properly recorded its deed; one month after the IRS recorded its tax lien. Therefore, on the date the IRS lien was recorded, Bank had no protected security interest against the IRS’s tax lien under the Maryland Relation-Back Statute.


However, the Court also considered the Maryland doctrine of equitable conversion, under which Maryland courts have afforded priority to the purchaser of a property as against judgments subsequently obtained against the seller.  Under the Maryland doctrine of equitable conversion, a purchaser’s security interest is protected against other parties – except for bona fide purchasers – regardless of whether the purchaser has recorded his deed.  Under that doctrine, Maryland law is clear that “a judgment creditor is not in the position of a bona fide purchaser.” Kolker v. Gorn, 67 A.2d 258, 261 (Md. 1949). Thus, a judgment creditor’s claim “is subject to prior, undisclosed equities” and “must stand or fall by the real, and not the apparent rights of the defendant in the judgment.” Kolker, 67 A.2d at 261 (quoting Ahern v. White, 39 Md. 409, 421 (1874)) (internal quotation marks omitted).


Although Bank did not sign a contract to purchase Debtor’s property, it did receive a conditional deed to secure repayment of its loan via the deed of trust, and Maryland principles in equity “treat lenders who secure their interests with a mortgage or deed of trust as entitled to the protections available to bona fide purchasers for value,” so long as those lenders act in good faith. Was. Mut. Bank, 974 A.2d at 396.


Accordingly, the Court held that because Bank held equitable title to the property specified in the deed of trust as of the date the deed was executed, it was entitled to priority over all of Debtor’s subsequent judgment-creditor lienholders, which would include, pursuant to § 6323(a), the IRS tax lien.


Thus, the Fourth Circuit affirmed the District Court’s judgment determining that Bank’s deed of trust enjoyed priority over the IRS’s tax lien.





Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
(312) 551-9320
(312) 284-4751
(312) 493-0874


Admitted to practice law in Illinois





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