Implications of Leveraged Land

Acquiring tax liens is an investment with a general goal of foreclosing upon the lien and acquiring the underlying real property. To accomplish this goal, Arizona law requires that an investor go through the judicial foreclosure process; an investor must file a lawsuit to foreclose out the rights of all interested parties. Such a lawsuit naturally carries with it a number of hard costs, attorney fees, and the risk that a party will redeem the tax lien before the lawsuit can be completed.

Arizona’s tax lien foreclosure process allows counties to shift the burden of unpaid taxes to private parties willing to invest, as the counties receive their taxes and interest from investors, who then carry that financial burden, as well as the burden of foreclosing on the property, until the investor either obtains the property or it is redeemed. Of course, investors receive a return on the investment either through obtaining the property or being reimbursed the taxes paid by the investor plus interest. But the costs and fees in pursuing the foreclose action will many times exceed the return to an investor if the property is redeemed during the pendency of a lawsuit.

It is important to emphasize that while property owners have an opportunity to receive notice of the investor’s intent to file a foreclosure action, that is not the case for other parties with a redeemable interest, such as beneficiaries on a deed of trust or other lien holders. An investor must incur significant costs and attorney fees ascertaining the identity of other interested parties and providing them with notice through formal service of process as part of the foreclosure lawsuit. In many instances, it is only as a result of an investor’s efforts in pursuing a foreclosure action that a tax lien is redeemed.

To encourage investors to bear the financial burden of acquiring tax liens and pursuing foreclosure actions, given the high risk that the lien will be redeemed after the investor has incurred the time and expense of a foreclosure lawsuit, the Arizona legislature adopted A.R.S. §42-18206 to minimize the risks to an investor and make the investor whole if the tax lien is redeemed.

A.R.S. §42-18206 provides as follows:

Any person who is entitled to redeem under article 4 of this chapter may redeem at any time before judgment is entered, notwithstanding that an action to foreclose has been commenced, but if the person who redeems has been served personally or by publication in the action, or if the person became an owner after the action began and redeems after a notice is recorded pursuant to section 12-1191, judgment shall be entered in favor of the plaintiff against the person for the costs incurred by the plaintiff, including reasonable attorney fees to be determined by the court.

The language of Section 42-18206 seems clear on its face: if a party redeems after being served with process in the lawsuit, that party is responsible for the investor’s costs and reasonable attorney fees incurred in the matter. Inevitably, however, there has been dispute regarding precisely what attorney fees fall within the purview of Section 42-18206. This is of course a critical issue and was taken up by the Arizona Supreme Court in Leveraged Land Co., L.L.C. v. Hodges, 226 Ariz. 382, 249 P.3d 341 (2011).

In Leveraged Land, the plaintiff was awarded a default judgment foreclosing the defendant’s right to redeem the underlying tax lien after the defendant failed to appear in the matter. The defendant was ultimately successful in setting aside that judgment and subsequently redeemed the underlying tax lien. The plaintiff then filed an amended complaint, asserting a new claim challenging the validity of the redemption. The superior court granted the defendant’s motion for summary judgment as to the amended complaint and the court of appeals affirmed that decision. While the appeal from summary judgment was pending, the plaintiff filed a request for costs and attorney fees under Section 42-18206, seeking $153,182. The superior court awarded the plaintiff only $1,500, a decision which the court of appeals reversed. The defendant filed a petition for review with the Arizona Supreme Court, which disagreed with and vacated the decision by the court of appeals.

The language of Leverage Land has led to significant confusion regarding the issue of post-redemption fees. On the one hand, the Court frames the issue as “whether § 42-18206 permits recovery of attorney fees and costs for litigation that occurs after a taxpayer’s redemption.” The Court went on to state that “interpreting § 42-18206 to allow post-redemption fees and costs skews the statute to subsidize unsuccessful litigation.” These statements would lead to a conclusion that the Court’s decision means plaintiffs are unequivocally barred from recovering any costs and fees incurred after the date of redemption. On the other hand, the context of the case, other language by the Court, and policy reasons support the position that this decision should be limited in its application.

The Court considered the amended complaint to be the equivalent of a separate action from the pre-redemption lawsuit. The plaintiff was asserting a new claim for the first time after redemption, and the new form of relief being sought was more akin to that of a quiet title action than foreclosure.

In providing the rationale behind its ruling, the Court stated: “If a tax lien purchaser thinks the value of the land, coupled with the probability of success on the merits, justifies further litigation to challenge the redemption, the lien purchaser may pursue additional litigation; but neither the text of § 42-18206 nor sound policy supports requiring the landowner to subsidize that litigation.” The “sound policy” referred to by the Court is to prevent tax lien holders from engaging in protracted litigation challenging the validity of redemption at the property owner’s expense and using that threat to coerce the property owner into not redeeming. This concern makes sense in scenarios such as what occurred in Leveraged Land.

As a general matter, however, post-redemption litigation does not challenge the validity of redemption or seek to quiet title in the plaintiff’s favor. The post-redemption litigation is generally plaintiff’s attempt to simply recover what is owed by the redeeming party pursuant to §42-18206 and is part of the original complaint.

The complaint in a tax lien foreclosure lawsuit typically contains alternative forms of relief: (1) foreclosure of the rights of the defendants to redeem; and (2) recovery of costs and fees under §42-18206, if redemption occurs before final judgment.

In many cases, an interested party redeems the tax lien after being served but refuses to reimburse the plaintiff for its costs and fees incurred. The plaintiff then continues to pursue the same cause of action, seeking judgment for recovery of its costs and fees incurred based upon the alternative relief sought in the original complaint. This type of case does not fall within the rationale put forth by the Court in Leveraged Land, nor does it serve the applicable policy.

Unlike in Leveraged Land, where the plaintiff chose to initiate a separate action by challenging the validity of redemption, the plaintiff in the typical scenario is forced to continue the same litigation because the redeeming party failed to comply with Section 42-18206 upon redemption of the tax lien; had the redeeming party paid the costs and fees at the time of redemption in compliance with Section 42-18206, the post-redemption litigation would have been unnecessary and never occurred. Not only is this not a separate cause of action, it does not implicate the policy concerns of Leveraged Land since the plaintiff is not choosing to undertake the risk of new litigation at defendant’s expense – the plaintiff is merely trying to recover what defendant already owes but refuses to pay.

In fact, applying Leveraged Land to the typical scenario leads to adverse policy concerns. Not allowing a plaintiff to recover post-redemption fees incurred in an effort to collect under Section 42-18206 would nullify the purpose of that very statute. A defendant could refuse to make payment under A.R.S. §42-18206, continue to frivolously defend the lawsuit, file baseless motion after baseless motion, and drag out the litigation until the post-redemption fees incurred by the plaintiff exceed the pre-redemption fees. Not only would the tax lien holder not be made whole, it could be worse off than if it had just decided to forego any attempt to collect under Section 42-18206 in the first place.

The superior courts are divided on how they apply Leveraged Land. Some courts take a strict interpretation approach and say no post-redemption fees are recoverable. Other courts take the practical approach, looking at the context of the case, the Court’s rationale, and policy considerations by allowing plaintiffs to recover post-redemption costs and fees where those costs and fees are reasonable and part of the same action to recover under Section 42-18206. Unfortunately, until the Arizona Supreme Court addresses the issue again, this inconsistency will continue, and this is another factor that must be considered in weighing the risks and rewards of a foreclosure lawsuit.