Foreclosure can be an effective but potentially harsh tax collection tool for local governments. A judicious, equitable, and consistent foreclosure program can get abandoned property into the hands of more responsible owners, spur delinquent property owners to pay old tax bills to avoid losing their properties, and improve a government’s collection rate.  Done poorly, tax foreclosures can lead to costly litigation and terrible headlines.

Tax foreclosures were back in the headlines earlier this year when the United States Supreme Court struck down the foreclosure procedures used by at least a dozen states.  Tyler v Hennepin County involved a 94-year-old Minnesota taxpayer whose home was foreclosed upon by the county for about $15,000 in delinquent taxes.  The county eventually sold the property for $40,000 and kept the $25,000 in surplus proceeds.

The taxpayer sued, claiming that the Minnesota law allowing a county to retain surplus foreclosure sale proceeds violated the “takings clause” of the Fifth Amendment of the United State Constitution.  That clause bars the taking of private property by the government without “just compensation.”  The Supreme Court agreed with the taxpayer.  It concluded that while the foreclosure itself was constitutional, the county’s refusal to turn over the surplus sale proceeds to the taxpayer violated the Fifth Amendment. In the words of the unanimous decision,

“The County had the power to sell Tyler’s home to recover the unpaid property taxes. But it could not use the toehold of the tax debt to confiscate more property than was due. . . . The Takings Clause “was designed to bar Government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.” Armstrong, 364 U. S., at 49. A taxpayer who loses her $40,000 house to the State to fulfill a $15,000 tax debt has made a far greater contribution to the public fisc than she owed. The taxpayer must render unto Caesar what is Caesar’s, but no more.”

While this decision is likely to cause great disruption for several states, its impact on North Carolina should be minimal.  Our property tax foreclosure procedures found in G.S. 105-374 and -375 already provide the opportunity for a property owner to benefit from any surplus proceeds from the sale of their property.

After a property tax foreclosure sale, the county or city is entitled to reimburse itself for all taxes, interest, fees, and costs included in the foreclosure.  Any remaining surplus must be turned over to the clerk of court “for the benefit of the persons entitled to it.”  See G.S. 105-374(q)(6)(for “mortgage-style” foreclosures) and G.S. 1-339.70(c)(for “in rem” foreclosures, per the reference to execution sales in G.S. 105-375(i)).  The party entitled to the surplus could be the original property owner or other creditors to whom that owner owes money. Happily, the responsibility of making that determination does not fall on the tax office.  It’s the job of the clerk of court to make that call and hold a special proceeding under G.S. 1-339.71 if necessary.

Given this process, I think it’s clear that North Carolina law already satisfies the standards mandated by the Tyler decision. Property owners must be informed of foreclosure proceedings and be given the opportunity to protect their property interests by either paying off the tax debt and terminating the foreclosure sale or bidding at the foreclosure auction.  If they choose not to act during the foreclosure process, the property owner can assert a claim on any surplus sale proceeds with the clerk of court. The local government that initiates a foreclosure is never permitted to retain surplus proceeds, even if they remain unclaimed.

While existing North Carolina tax foreclosure procedures satisfy the main concern of Tyler, there are two tangential issues that are potentially problematic.

The first issue involves notifying a former property owner of the existence of a foreclosure surplus.  While the property owner must receive advance notice of the foreclosure proceeding and the foreclosure sale, there is no statutory requirement that the (now former) property owner be informed that a surplus exists or of their opportunity to submit a claim for that surplus with clerk of court.  I assume that the clerk will automatically send the surplus to the former owner if no other party submits a claim for that money.  But I don’t know if all clerks follow that procedure; some clerks may deposit unclaimed surpluses with the state escheats fund for abandoned money (plug your name into this website to see if you are owed any money!).  As a result, a former property owner who is unfamiliar with the process may miss out on a surplus to which they are entitled.

I doubt this scenario would violate Tyler, because that case mandates only the opportunity under state law to claim a foreclosure surplus and not any specific notice or explanation from the local government to the property owner of how to take advantage of that opportunity. But, better safe than sorry. I recommend that local governments, if they are not already doing so, inform the former property owner in writing of the existence of a surplus and the fact that it is being submitted to the local clerk of court.  Such notice should effectively insulate the local government from claims that its foreclosure procedure fell short of the standards set by Tyler.

The second issue involves a subsequent sale of foreclosed property that is purchased by the county or city at the initial foreclosure sale.  As I described in two earlier posts (click here and here), a local government sometimes purchases a foreclosure property because they submit an initial bid in the amount they are owed. This initial bid guarantees that the local government will be paid in full if another party wishes to purchase the property at the foreclosure auction.  But if no other party submits a bid, the local government will be the high bidder and become obligated to purchase the property.

There is no surplus created by this initial sale to a local government because the bid matches the amount owed on the property.  But that local government may (and usually will) sell the property at a later date.  If that subsequent sale produces proceeds in surplus of what was originally owed to the government, North Carolina law does not require the local government to share any of the proceeds with the former owner.  Does this violate Tyler?

I don’t think so.  In this situation, the “taking” of private property occurred at the initial foreclosure sale. There were no surplus funds generated at this sale.  The government took from the taxpayer only the amount of property needed to satisfy the tax debt, which is permitted under Tyler.  When the government later sells that property, it is not selling the taxpayer’s property. It is selling its own property. Therefore, there is no “taking” of private property at the subsequent sale and the government is free to keep all of the sale proceeds.

Bottom line: with perhaps a few minor tweaks, local governments may continue to employ our state’s tax foreclosure procedures despite the Supreme Court’s ruling in Tyler.

For more on North Carolina’s tax foreclosure process, click here, here, or here.