In Kentucky, Third Party Tax Purchases (“TPTP”) allow third parties to purchase delinquent real property taxes. The TPTP industry operates under color of law as laid out by the Kentucky Court of Appeals in Flag Drilling Company Inc v. Erco Inc (2005). In Flag Drilling, the court held that purchasers are entitled to reasonable attorneys’ fees, administrative costs, and 12% annual interest on purchased delinquent property taxes. Crucially, purchasers of these delinquent property taxes are given a first priority lien on the property on which the delinquent taxes are owed over all other creditors. This first priority lien gives the purchaser the right to foreclose upon the property on which taxes are owed if the tax, fees, and expenses are not paid within a year of the purchase. Because this lien is given first priority, all other liens and secured parties are subordinate to the TPTP lien on the property. Thus, mortgagees are at a substantial disadvantage in recovering the balance of their loans. Because of this, members of the Kentucky Bankers Association should advocate for more strict regulation of TPTPs.
The first priority lien on third party purchased delinquent real property taxes presents a substantial risk to mortgagees of real property. If a delinquent property tax bill on real property is purchased by a third party, mortgagees or other secured creditors who would normally have first priority in a foreclosure action against the property are subordinated to the TPTP lien. Furthermore, because the TPTP lien includes attorney’s fees and administrative costs, as well as 12% annual interest, the TPTP lien is likely to amount to more than that which would otherwise have been owed on the property taxes in the first place. This is especially risky to mortgagees when a mortgagor is insolvent, because a foreclosure sale on the real property will, after paying out the TPTP expenses, fees, and principal, have less money left over to distribute to the property’s other creditors.
Because of the possibility of being subordinated to a TPTP lien holder, members of the KY Bankers Association are forced assume more risk than they otherwise would when originating real property mortgages. This additional risk results not only in higher overall mortgage costs for customers, but also in risk- averse lenders originating fewer overall mortgages than they would otherwise. This results in making it more difficult for small businesses to generate startup and operating capital, a social ill that all of Kentucky bears.
Additional risk to mortgagees exists in the functional impossibility of determining whether a real property owner is going to pay their property taxes on time, or at all. Businesses and real property owners are often delinquent in paying their property taxes for reasons that have nothing to do with insolvency. Some real property owners are forgetful, some fall on hard times, some address their checks incorrectly, and some choose to put off payment for family or personal reasons.
Not only do higher prices and fewer loan originations hurt Kentucky communities, but large investment firms whose business is buying delinquent real property taxes have little or no connection to the communities from which they purchase delinquent taxes. This lack of personal connection to the communities they are operating in can lead to ruthless treatment of home and small business owners, something that could be considered a moral grey area. Ideally, our Kentucky communities and community banks would work together to find a solution that benefits the state and local government, lenders, and their clients. This may not be the case with a large out-of- state corporation whose interests lie in charging fees to delinquent real property owners and then collecting those fees through the strong arm of foreclosure action.
However, state and local governments have a vested interest in the timely collection of property taxes. Property taxes are used to fund schools and local initiatives. Because delinquent or unpaid property taxes have a significant negative impact on the ability of state and local governments to meet their obligations, governments want property taxes to be paid as promptly as possible. According to the Lexington Herald-Leader, Third Party Tax Purchases (“TPTP”) in Kentucky have generated more than $72 million in collected delinquent taxes for state and local governments since 2009, of which nearly $40 million has been used to fund schools. 1 It is possible that the government would have collected these taxes in part or in whole without the use of TPTP. However, the budgetary constraints of local and state government and the time value of money suggest that having the taxes paid in full by third party purchasers and allowing those purchasers do the hard work of collecting outstanding debts offers significant value to the government.
Further, TPTPs are prevented from foreclosing on properties for one year after purchasing delinquent real property taxes, much more time than a mortgage lender would allow a borrower to be in delinquency under similar circumstances. There is little doubt that stricter regulation could help to alleviate some issues in the TPTP market. These regulations would need to be targeted so as to discourage abuse of TPTP and encourage community engagement. One way to accomplish this goal is by tying the third party purchasers more directly to the delinquent taxes that they purchase, and limiting the number of delinquent tax accounts that can be owned by any one person or corporation at the same time. A low limit, such as five loans, would effectively drive the largest industrial purchasers out of the market, and will lead to smaller, more local purchasers who will be less likely to see the small number of delinquent accounts they own as “just a number.” While there are many criticisms of the TPTP system as it exists in Kentucky,there is also significant value to state and local governments in collecting delinquent property taxes as soon as possible. This governmental interest, combined with the fact that TPTPs are forced to wait for one year of delinquency on 1 http://www.kentucky.com/news/local/education/shortchanging-our- schools/article44557302.html taxes, interest, and fees, suggests that the TPTP system does not need to be scrapped as a whole, but is in need of regulation such as limiting the number of delinquent property tax accounts an individual or corporation can own at the same time.