The state of New Jersey has gained a reputation as being a desirable state in which to purchase tax sale certificates, due in part to the 18% statutory interest rate that a certificate holder could obtain on his or her investment. A recent decision by the United States Bankruptcy Court for the District of New Jersey, however, casts significant doubt on a certificate holder's ability to claim such a rate of interest in the event the property owner files for bankruptcy protection. Specifically, in an opinion authored by Judge Michael Kaplan, the court held that the holder of a tax sale certificate is not the holder of a "tax claim" within the meaning of Section 511(a) of the Bankruptcy Code and, therefore, that the statutory interest rate applicable to the certificates may be modified. See In re Princeton Office Park, L.P., Case No. 08-27149 (MBK).
The sale of tax liens is a municipal financing option that provides a means to transform a non-performing asset into cash without raising taxes. In New Jersey, this financing option is governed by the Tax Sale Law, N.J.S.A. 54:5-1 et seq. Under the Tax Sale Law, when municipal taxes are delinquent for the statutorily proscribed period, a lien in favor of the municipality arises on the land on which the taxes are assessed, and the municipality may enforce the lien by selling a tax sale certificate. This mechanism is not an outright conveyance; rather, as a result of the sale, the municipality receives the tax monies from the certificate purchaser and the purchaser acquires the lien interest of the taxing authority. Thus, at the conclusion of the sale, the purchaser is vested with an "inchoate right or interest," which includes, inter alia, the right to foreclose the equity of redemption and to receive the sum paid for the certificate with a statutorily fixed 18% rate of interest.
In December 2005, Plymouth Park Tax Services, LLC ("Plymouth") purchased such a certificate relating to real property owned by Princeton Office Park, L.P. (the "Debtor") after the Debtor failed to pay taxes to the Township of Lawrenceville. Following the sale, Plymouth paid taxes on the Property for 2006, 2007, and the first two quarters of 2008, with the amount paid accruing interest at a rate of 18%.
In September of 2008, the Debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code. Plymouth subsequently filed a proof of claim against the Debtor, seeking to recover, among other amounts, post-petition interest at the statutory rate of 18%. The Debtor filed a Plan and Disclosure Statement, which provided for satisfaction of Plymouth's claim, but lowered the interest rate to 6% to reflect the market interest rate at the time. Plymouth objected to the Disclosure Statement, arguing that it was the holder of a "tax claim" and, as such, was entitled to the anti-modification protections of Section 511(a) of the Bankruptcy Code, which limits a debtor's ability to modify the interest rate applicable to those claims. The court disagreed.
Recognizing that the term "tax claim" is not defined in the Bankruptcy Code, the court characterized the determination of whether Plymouth's purchase of the tax sale certificate qualifies as a "tax claim" as a matter of New Jersey law, the law of the state that created the interest. The court explained that the New Jersey Tax Sale Law has been interpreted as simply conveying to the certificate holder a statutory lien on the underlying property and not a transfer of a tax claim (as is required for Section 511(a) to apply), as the taxes are paid in full at the conclusion of the tax sale.
The court acknowledged decisions from other jurisdictions finding that tax sale certificates were tax claims under Section 511(a). However, the court distinguished those decisions, noting that, under New Jersey law, the rights of a certificate holder were far more restricted than those of the municipality, and that the municipality did not assign or subrogate those rights to the certificate holder. Absent evidence of assignment or subrogation, the court concluded that it was constrained to find that, under New Jersey law, Plymouth acquired only a statutory lien claim, not a tax claim, and therefore, was not protected by Section 511(a). Rather, the court determined that the Debtor could modify the interest rate applicable to the certificate in accordance with the formula approach adopted by the Supreme Court in Till v. SCS Credit Corp.
We understand that Plymouth plans to appeal the Bankruptcy Court's decision.
This decision is likely to have significant ramifications for those who invest in tax certificates in the state of New Jersey and possibly the taxpayers as well. Because of its potential impact, we expect that the decision is merely the first salvo relating to this issue.
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