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MSC: Unconstitutional For County To Keep Surplus Tax Sale Proceeds

Posted on Wednesday, July 29, 2020

Oakland County’s retention of surplus proceeds from tax-foreclosure sales was an unconstitutional taking without just compensation and violated Article 10, § 2 of the Michigan Constitution, the Michigan Supreme Court has ruled.

The plaintiffs in Rafaeli, LLC v Oakland County had unpaid property taxes dating back to 2011. They lost their properties through foreclosure proceedings under the General Property Tax Act (GPTA), MCL 211.1 et seq. Afterward, Oakland County sold the properties for more than the underlying tax debts and kept the surplus proceeds. One plaintiff lost about $76,000 in surplus proceeds arising from a tax delinquency of about $6,000, while another plaintiff lost about $24,500 in surplus proceeds arising from a tax delinquency of $8.41.

The plaintiffs then filed this lawsuit against the defendant, Oakland County, claiming it had violated the Takings Clauses of the Michigan Constitution (Const 1963, art 10, § 2) and U.S. Constitution (Const, Am V) by keeping the surplus proceeds.

The Oakland County Circuit Court granted summary disposition for the defendant, finding the plaintiffs did not have any property interests in the surplus proceeds. The Michigan Court of Appeals affirmed.

The Michigan Supreme Court reversed.

“We hold that plaintiffs, former property owners whose properties were foreclosed and sold to satisfy delinquent real-property taxes, have a cognizable, vested property right to the surplus proceeds resulting from the tax-foreclosure sale of their properties,” Justice Brian K. Zahra wrote for the Supreme Court.

“This right continued to exist even after fee simple title to plaintiffs’ properties vested with defendants, and therefore, defendants’ retention and subsequent transfer of those proceeds into the county general fund amounted to a taking of plaintiffs’ properties under Article 10, § 2 of our 1963 Constitution,” the Supreme Court said. “Therefore, plaintiffs are entitled to just compensation, which in the context of a tax-foreclosure sale is commonly understood as the surplus proceeds.”

Statutes & Case Law

The Supreme Court began its analysis by explaining the GPTA permits the recovery of unpaid real property taxes, penalties, interest and fees through the foreclosure and sale of the property for which there is a tax delinquency. The justices also noted the parties in this case acknowledged that sale proceeds are often insufficient to cover the full amount related to the foreclosure and sale of the property.

“But when there are excess proceeds from individual sales, such as the sale of plaintiffs’ properties in this case, those proceeds are used to subsidize the costs for all foreclosure proceedings and sales for the year of the tax delinquency, as well as any years prior or subsequent to the delinquency,” the Supreme Court wrote. “Then, after the required statutory disbursements are made, surplus proceeds may be transferred to the county general fund in cases in which the county is the foreclosing governmental unit.”

The GPTA does not provide for any disbursement of the surplus proceeds to the former property owner, the Supreme Court pointed out, nor does it provide former owners a right to make a claim for the surplus proceeds. “Michigan is one of nine states with a statutory scheme that requires the foreclosing governmental unit to disperse the surplus proceeds to someone other than the former owner.”

The Supreme Court then turned to the Michigan Court of Appeals reasoning, explaining why the panel improperly relied on Bennis v Michigan, 516 US 442 (1996), a case involving civil asset forfeiture, to conclude that no taking had occurred in this case.

Bennis is distinguishable and provides us little guidance as it relates to plaintiffs’ takings claim,” the Supreme Court observed. “The Court’s holding in Bennis focused narrowly on forfeited property that was used as an instrumentality for criminal activity and the government’s interest in deterring illegal activity. In this case, plaintiffs did not use their properties for illicit purposes. They simply failed to pay their property taxes, which is not a criminal offense. Accordingly, we conclude that the Court of Appeals improperly conflated the meaning of ‘forfeiture’ in an unrelated area of law with the meaning of ‘forfeiture’ as expressly described under the GPTA.”

Vested Right

Michigan’s Takings Clause has been interpreted to afford property owners greater protection than its federal counterpart when it comes to the state’s ability to take private property for a public use under the power of eminent domain, the Supreme Court explained.

“A ‘taking’ for purposes of inverse condemnation means that the government has permanently deprived the property owner of any possession or use of the property without the commencement of formalized condemnation proceedings,” the justices said. “When such a taking occurs, the property owner is entitled to just compensation for the value of the property taken.”

Next, the Supreme Court examined the history of claims for surplus proceeds after a tax-foreclosure sale. In reviewing the relevant case law, the justices observed that what the cases “do not tell us … is what occurs when the statutes governing foreclosure make no mention of, or expressly preclude, a divested property owner’s right to the surplus proceeds, but the divested property owner establishes a property right to the surplus proceeds through some other legal source, such as the common law.” As a result, the Supreme Court said it had to go one step further and determine whether the plaintiffs had a vested property right to the surplus proceeds through some other legal source, like the common law.

According to the Supreme Court, two fundamental principles – that the government shall not collect more taxes than are owed, nor shall it take more property than is necessary to serve the public – protect taxpayers and property owners from government overreach.

Further, the Supreme Court said that Dean v Dep’t of Natural Resources, 399 Mich 84 (1976), supports the proposition that a property owner has a recognized common-law right to the surplus proceeds from a tax foreclosure sale. “We conclude that our state’s common law recognizes a former property owner’s property right to collect the surplus proceeds that are realized from the tax-foreclosure sale of property.”

Taking & Just Compensation

As the foreclosing governmental unit under the GPTA, the defendant was entitled to seize the plaintiffs’ properties, the Supreme Court acknowledged. However, the defendant “could only collect the amount plaintiffs owed and nothing more,” the justices cautioned.

“Once defendants foreclosed on plaintiffs’ properties, obtained title to those properties, and sold them to satisfy plaintiffs’ unpaid taxes, interest, penalties, and fees related to the foreclosures, any surplus resulting from those sales belonged to plaintiffs,” the Supreme Court said. “That is, after the sale proceeds are distributed in accordance with the GPTA’s order of priority, any surplus that remains is the property of plaintiffs, and defendants were required to return that property to plaintiffs. Defendants’ retention of those surplus proceeds under the GPTA amounts to a taking of a vested property right requiring just compensation. To the extent the GPTA permits defendants to retain these surplus proceeds and transfer them into the county general fund, the GPTA is unconstitutional as applied to former property owners whose properties were sold at a tax-foreclosure sale for more than the amount owed in unpaid taxes, interest, penalties, and fees related to the forfeiture, foreclosure, and sale of their properties.”

The Supreme Court also rejected the defendant’s reliance on a line of Michigan cases to assert that the plaintiffs held no rights, titles or interests in their properties after foreclosure and that fee simple title had vested with the state. “None of these decisions … involved a claim for the surplus proceeds after a foreclosure sale,” the justices observed.

In the same way that foreclosure does not eliminate the former property owner’s interest in the personal property that sits on the foreclosed land, “the vesting of fee simple title to the real property does not extinguish the property owner’s right to collect the surplus proceeds of the sale,” the Supreme Court stated. “This is a separate property right that survives the foreclosure process. Accordingly, like any other creditor, defendants were required to return the surplus.”

The Supreme Court continued by saying it was not going to “recharacterize” the surplus proceeds as public money to be transferred into the county general fund. “While plaintiffs’ takings claim was not compensable until their properties sold for an amount in excess of their tax debts, that lack of an immediate right to collect the surplus proceeds does not mean that plaintiffs had no right to collect the surplus proceeds at all.”

Regarding the defendant’s argument that the county’s taxing power justified the keeping of the surplus proceeds, the Supreme Court said this argument was “an exceedingly poor attempt at disguising a physical taking of property requiring just compensation as an arbitrary and disproportionate tax.”

The Supreme Court then addressed what exactly is “just compensation” for the plaintiffs in this case. “[W]hen property is taken to satisfy an unpaid tax debt, just compensation requires the foreclosing governmental unit to return any proceeds from the tax-foreclosure sale in excess of the delinquent taxes, interest, penalties, and fees reasonably related to the foreclosure and sale of the property – no more, no less.”

In conclusion, property owners whose properties are foreclosed and sold to satisfy delinquent taxes have a vested property right to the surplus proceeds … a right that continues to exist after fee simple title to the properties vests with the county, the Supreme Court ruled. As a result, the justices held that defendant’s retention and transfer of the proceeds into the county’s general fund was an unconstitutional taking of the plaintiff’s properties under Article 10, § 2 of the Michigan Constitution.

Accordingly, the plaintiffs were entitled to just compensation – that is, the surplus proceeds, the Supreme Court ruled.

Concurrence

Justice David F. Viviano agreed with the overall result but disagreed with much of the reasoning.

“I would not define the constitutional term ‘property’ by merely citing an example of what the ratifiers might have thought would fall within the meaning of that term,” the justice said. “Instead, I would give the word its ordinary meaning at the time the Constitution was ratified and then apply that meaning to the case at hand.”

Furthermore, “I would examine the relevant property right: the taxpayers’ equity in the real property,” Viviano wrote. “Equity falls within the semantic scope of ‘property’ under our Constitution. And the Legislature did not purport to abrogate the taxpayer’s equity. Therefore, a taking occurred when title to plaintiffs’ property was vested in the government without any possibility of redemption. In this case, I agree with the majority that plaintiffs are owed the surplus proceeds from the tax-foreclosure sales.”

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