Bankruptcy and Property Tax Collection

By David R. Connell

As the weak economy persists, municipalities and tax collectors in particular, must deal with a surge in the bankruptcies of taxpayers. Bankruptcy law is federal law and therefore takes precedence when it conflicts with state law. Many people will recall the wave of bankruptcies and the Federal Deposit Insurance Corporation (FDIC) takeover of banks in the early 1990s that disrupted normal property tax collection procedures. Congress has amended the bankruptcy statute since then to make property tax collection easier, but there are still many unique procedures to comply with and some uncertainties to cope with.

Bankruptcy Law Overview
The United States Constitution grants Congress the authority to regulate bankruptcy by uniform national laws to deal with debtors unable to pay their obligations. The Bankruptcy Code is set forth in Title 11 of the United States Code, which is divided into 13 chapters. Bankruptcy law serves two main purposes: (1) It provides for reorganization or liquidation of the debtor's business and property and the orderly partial payment of creditors. (2) It discharges the debtor from personal liability for debts, thereby providing some economic hope and opportunity for the future.

There are three main components of the bankruptcy process: the automatic stay, the classification of claims and the discharge of debtors.

The Automatic Stay
The filing of a bankruptcy petition creates a debtor's estate comprising "all the legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. sec. 541(a)(1). The filing immediately creates an "automatic stay," an injunction, with certain exceptions, to prevent creditors from taking action against the debtor or the debtor's estate to recover any obligation existing on the date of the bankruptcy filing. 11 U.S.C. sec. 362(a). The automatic stay relieves the debtor of pressure and harassment from creditors and protects the debtor's property from piecemeal seizure. When a municipality or other creditor receives notice of bankruptcy filing, it is important to proceed with care, because violations of the automatic stay are subject to severe penalties, including actual money damages, punitive damages and attorney's fees. The automatic stay gives the bankruptcy court time to evaluate creditors' claims and to determine what assets of the debtor are available to pay claims.

Classification of Claims
Creditors notify the bankruptcy court of their right to payment by filing a "proof of claim," a written statement detailing the amount and nature of the alleged obligation. The proof of claim must conform substantially to the appropriate Official Form in the Bankruptcy Rules. The forms are available from the court. (See the list of resources at the end of this article.) There are three categories of claims for payment: (1) secured claims, (2) unsecured priority claims and (3) general unsecured claims. Secured claims are obligations that are secured by a lien or other interest in the debtor's property, such as a mortgage. Creditors are entitled to full payment of their allowed claims to the extent that there is enough value in the property subject to the lien. Priority claims are the types listed in Section 507 of the Code, which are entitled to payment from the debtor's assets before general unsecured claims, which have the lowest priority for payment.

Discharge of Debts
With some exceptions, the debtor's personal liability for debts will be discharged at the close of the bankruptcy case. The details depend on which of the three major types of bankruptcy is involved: Chapter 7 "Liquidation," Chapter 11 "Reorganization" or Chapter 13 "Adjustment of Debts."

Three Major Types of Bankruptcy
Chapter 7 "Liquidation." A debtor who files a bankruptcy petition under Chapter 7 of the Code surrenders all non-exempt assets in exchange for a discharge of debts. (Certain limited types of property are exempt from bankruptcy distribution.) A trustee is appointed to collect and sell all the nonexempt assets and to distribute the proceeds to creditors according to their status. Secured claims must be paid in full before unsecured claims can be paid from proceeds of property subject to liens. Often, there is no equity in property to satisfy unsecured claims. Sometimes there are no assets at all.

Chapter 11 "Reorganization." Chapter 11 is used by businesses that wish to continue operating a business while repaying creditors through a court-approved reorganization plan. Typically, the debtor remains in possession and fulfills the role of the trustee in bankruptcy, subject to administrative oversight by the office of the United States Trustee. The debtor's reorganization plan classifies claims and provides for payment in full or in part as available assets permit. An important criterion for evaluating a proposed plan is whether creditors would fare better under the plan than by liquidation under Chapter 7.

Chapter 13 "Adjustment of Debts." The "wage earner" chapter allows financially distressed individuals to repay creditors through a repayment plan extending over a period of three to five years. The plan must provide for payment in full of secured claims, including interest, or secured claims may be paid outside the plan. Unsecured creditors may lose some or all of their claims. A trustee collects plan payments by the debtor and disburses in accordance with the scheduled plan payments.

Property Tax Collection and Bankruptcy

Dealing with the Automatic Stay
Notice. Typically a municipality learns of a bankruptcy by a formal written notice from the bankruptcy court. However, the taxpayer's oral report to a tax collector has been held sufficient to put the municipality on notice of the automatic stay. Any municipal official who receives notice of a bankruptcy should share the information with other officials, who may or may not receive their own notice. Conceivably, the court might view notice to one town official as notice to all, thus exposing the town to liability for violating the automatic stay. For example, the tax collector should notify the board of selectmen in case some debt collection or other anticipated litigation against the debtor might violate the automatic stay.

What is barred by the automatic stay? Upon receipt of notice of bankruptcy, the tax collector must not attempt to collect property taxes from the debtor. This means no civil actions for tax collection under RSA 80:50 may be pursued. It also means that no tax deed or notice of tax-deeding may be issued.

Exceptions to the automatic stay. There are, of course, certain very important exceptions to the automatic stay available to the municipal tax collector. Assessing and billing property taxes is permitted. 11 U.S.C. sec. 362(b)(9). Perfection of a lien for taxes already billed as of the filing of the bankruptcy petition is permitted. 11 U.S.C. sec. 362(b)(3). Creation and perfection of property tax liens for taxes that are assessed and due postpetition is permitted. 11 U.S.C. sec. 362(b)(18). Thus, ordinary tax collection procedures are allowed to perfect a lien for delinquent taxes, but not to issue a tax deed, until the property is released from the automatic stay. Such routine tax collection procedures will include sending the debtor a notice of annual arrearage, RSA 76:11-b, and notice of impending lien. RSA 80:60. To fully inform taxpayers, these documents must explain the consequences of nonpayment. In some cases, debtors have attacked such documents as demands for payment of prepetition debts in violation of the automatic stay. In the case of In re Jennings, 304 B.R. 8 (Bankr. D. Me. 2004), the court held that property tax notices are protected by exceptions to the automatic stay so long as they are called for by statute and do not contain excessively strident, threatening or harassing language.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) amended the Code primarily to deal with the problems of fraudulent and serial bankruptcy filings. BAPCPA creates exceptions to the automatic stay in the event of repetitive, abusive bankruptcy filings, but these are quite complicated. Check with the town attorney if faced with a debtor who chronically files, withdraws and refiles.

Release of the automatic stay. The automatic stay that prevents tax-deeding is released in one of three ways:

  • The trustee formally "abandons" the property from the bankruptcy estate, which typically occurs when the total value of liens exceeds the value of the property.
  • The court grants a motion for relief from the automatic stay, which occurs in circumstances where the value of the property is declining or it is otherwise unfair to prevent a secured creditor from enforcing a lien.
  • The bankruptcy case is closed.

When the automatic stay is released, the tax-deeding remedy becomes available. But, if the debtor has been discharged, the debtor may not be pursued personally by collection efforts on the obligation.

Status of Property Taxes in Bankruptcy
Under New Hampshire law, property taxes are protected by an inchoate lien that arises as of April 1, the date as of which all taxes for the year are deemed to have been assessed. The lien continues for 18 months until one year from October 1 following the assessment and has priority over all other liens. RSA 80:19. For delinquent taxes, the statutory tax lien procedure extends the lien indefinitely. Thus, for purposes of the Bankruptcy Code, property taxes are "secured claims." Not all kinds of taxes, of course, are protected by statutory liens, and not all states protect their property taxes with statutory liens. Therefore, the Code provides that taxes in general are regarded as priority unsecured claims. 11 U.S.C. sec. 507(a)(8). This creates the potential for confusion on the part of those unfamiliar with either New Hampshire property tax statutes or the Code.

Proofs of Claim
Is it necessary to file a proof of claim? It is generally recommended to file a proof of claim in all cases except, possibly, when the notice from the court advises that proofs of claims need not be filed in a "no asset" Chapter 7 case. But accurate filing can do no harm. Timely filing of a proof of claim is important because late filing is allowed only at the discretion of the court. Collier on Bankruptcy (15th ed. rev.) sec. 501.02[4], p. 501-12.

Some commentators point out that because secured claims generally pass through bankruptcy unaffected, it is unnecessary to file proofs of claim. Collier sec. 501.01[3], p. 501-6. A New Hampshire case, In re MacKenzie, 314 B.R. 277 (Bankr. N.H. 2004), supports this view. However, the recent United States Supreme Court case of United Student Aid Funds, Inc. v. Espinosa, ___ U.S. ___ (March 23, 2010), indicates that this may be risky. In Espinosa, the bankruptcy court erroneously confirmed a Chapter 13 plan that called for payment of principal, but not interest, on a student loan. Student loans are not dischargeable without a specific finding of "undue hardship," which did not occur. The lender filed a proof of claim for the proper amount of principal and interest but then failed to object to the plan. Years later the lender tried to collect the interest, and litigation ensued. The U.S. Supreme Court held that, even though the plan should not have omitted payment of interest, the lender was bound by the terms of the confirmed plan because the lender had received notice of it and had failed to object. The Court focused on the lender's failure to object to the plan after receiving notice. The fact that the lender had submitted a proof of claim did not seem important in the analysis.

Espinosa dealt with peculiar provisions of the Code concerning dischargeability of student loans, so it is not clear whether the case applies to secured claims for property taxes under state law. But, if it does, it casts doubt on the strategy of ignoring the bankruptcy case and not filing a proof of claim. The most cautious approach is to file a proof of claim and monitor the case as discussed below.

Filling out the proof of claim form. The proof of claim form provides instructions for the critical information it requests:

  • the amount of the claim;
  • the basis of the claim;
  • amount of secured claim, interest rate and value of property subject to lien;
  • amount entitled to priority and type of priority; and
  • attached documents proving the claim and perfected lien.

What amount should be claimed? The instructions state that this is the total amount owed to the creditor on the date of bankruptcy filing. But what amount is that? Property taxes are deemed to be assessed as of April 1. Does that mean the entire amount billed in the June and December bills is deemed to be owed on any date following April 1? Or is the amount determined on a pro-rata per diem basis for the days between April 1 and the date of bankruptcy? Or, is the amount owed limited to what has actually been billed, semi-annually, plus interest? All three methods have been used by different bankruptcy courts in the past. Collier sec. 507.11[3], p. 507-64. Since the passage of BAPCPA, the third method is very probably correct because the ambiguous term "assessed" has been replaced with "incurred" to determine tax liability as of the date of bankruptcy. Collier sec. 503.07[2][b], p. 503-64. If bankruptcy is filed before the June bill, nothing is yet owed for that year. If bankruptcy is filed in October, the amount owed will be the first bill plus interest. After the date of bankruptcy the tax collector is free to bill taxes in the ordinary course, and the tax collector is free to perfect the lien if postpetition taxes become delinquent.

The amount claimed in the proof of claim will also include all arrearages from previous years, plus costs and all interest as of the date of bankruptcy.

The amount claimed in the proof of claim should also claim postpetition interest in the blank provided for the purpose. (See discussion of interest rate below.)

Secured claim, priority claim, or both? As mentioned above, all sorts of taxes are entitled to priority status, so property taxes are arguably qualified for priority status as a back-up in case of a defect in establishing secured claim status. However, to claim both secured and priority status on the same proof of claim form would be apt to cause confusion, so it is advisable to choose secured claim status and carefully document it.

What documents to attach? Attach a copy of the account as of the date of bankruptcy filing. Hopefully, software makes it a simple matter to print out a statement showing the debtor's property tax principal, costs and interest for all tax years involved. Attaching a proof of registry recording of the tax lien would help with the trustee's review of the claim's validity. It might also help, especially with cases in other jurisdictions, to attach copies of relevant statutes such as RSA 80:19, RSA 76:13 and the sections pertaining to the tax lien process.

Follow-up for proofs of claims. As discussed above, the Espinosa case seems to make it risky not to file a proof of claim at all. In a Chapter 7 case, typically the timely filing of a properly filled out and documented proof of claim will protect the town's interest. For Chapter 11 and 13 cases, it is generally recommended that the tax collector seek the assistance of the town attorney to monitor the cases in order to respond to improper treatment of a property tax claim in the debtor's plan. For example, in the case of In re Burrell, 346 B.R. 561 (U.S. Bankr. Appellate Panel 1st Cir. 2006), the town's proof of claim did not include a claim for postpetition interest on prepetition taxes. The confirmed Chapter 13 plan provided for 60 monthly payments of the amount in the proof of claim, but omitted any postpetition interest. The town was bound by the erroneous amount in the plan and could not collect its interest outside the plan. In many cases, this kind of outcome can be prevented relatively simply by a written objection by counsel that explains the error in the proposed plan.

What Is the Postpetition Interest Rate on the Amount Claimed?
Prior to BAPCPA, courts had determined the postpetition interest rate based on prevailing market rates. See In re DeMaggio, 175 B.R. 144 (Bankr. D.N.H. 1994). BAPCPA, however, enacted a new Code section 511, which provides that interest on a property tax claim shall be determined under "applicable nonbankruptcy law." Collier sec. 511.01, p. 511-2. At least one reported case has interpreted this favorably to the tax collector creditor. In the case of In re Bernbaum, 404 B.R. 39 (Bankr. D.Mass. 2009), the court held that Massachusetts state statutory interest rates applied postpetition to real estate and water and sewer charges. On this basis, the court should allow a postpetition interest rate of 12 percent for overdue taxes and 18 percent on taxes that go to lien under RSA 80:59 et seq.

Compliance with the Plan
Chapter 11 and 13 plans must provide for payment of postpetition property taxes as well as the scheduled payment of prepetition taxes. Postpetition taxes may be paid as administrative expenses or outside the plan. If plan payments or postpetition taxes are withheld improperly, town counsel may be able to move for dismissal of the plan or for relief from the stay to permit tax-deeding. For postpetition taxes, the statutory lien process, short of tax-deeding, is also available.

The Debtor's Interest in Redeeming Previously Tax-Deeded Property
In the case of In re Stevens, 374 B.R. 31 (Bankr. D.N.H. 2007), the court dealt with the status of property that the town had tax-deeded about three weeks before the filing of the debtor's Chapter 13 petition. The town claimed that the property was no longer in the debtor's estate in bankruptcy as a result of the tax deed, but the court held that the right to repurchase the property under RSA 80:89 entitled the debtor to exercise the right to repurchase by making payments through the Chapter 13 plan.

David Connell is legal services counsel with the New Hampshire Local Government Center Legal Services and Government Affairs Department. Contact LGC's legal services attorneys by phone at 800.852.3358, ext. 384, or e-mail

Basic explanation of bankruptcy system
Proof of claim and other forms
NH Bankruptcy Court: information, forms, rules, opinions
Case information and filing for certain large bankruptcies
DRA resources for tax collectors
NH Tax Collectors' Association