A recent district court case offers a cogent example: A scrap metals business in Alabama lost a battle with the IRS, which sought to enforce a federal tax lien against property acquired from a delinquent taxpayer; as in many of these cases, greater care on the part of the purchaser would have avoided the problem. United States v. Urioste, No. 4:15-CV-1787-VEH, 2017 U.S. Dist. LEXIS 4442 (N.D. Ala. Jan. 12, 2017).
Michael Urioste, the taxpayer, died leaving over $576,000 in delinquent income taxes and approximately $535,000 in delinquent employment taxes outstanding. Urioste, 2017 U.S. Dist. LEXIS 4442 at *14. The government filed suit against the taxpayer’s father and his son, as the executors of his estate, against the heirs of the estate and against Alabama Scrap, an LLC formed by the taxpayer’s son, Michael Urioste, Jr., seeking to foreclose its federal tax lien on certain real estate and to obtain an inventory of the estate. Id. at *3-*4. While the defendants agreed that the taxes were due, they challenged the government’s ability to foreclose on one of the parcels of land, known as the Forrest Avenue Parcels. Id. at *20.
The taxpayer had acquired the Forrest Avenue Parcels on April 21, 2006, and had granted a first mortgage to a bank at that time. Id. at *16-*17. On May 22, 2006, the IRS filed a notice of federal tax lien covering certain employment taxes. Id. at *19. Subsequently, the taxpayer conveyed the property to Alabama Scrap on November 13, 2006 in a warranty deed that expressly provided that the transfer was subject to the federal tax lien filed in May 2006. Id. at *17. In return, Alabama Scrap agreed to assume the existing mortgage loan, which had priority over the tax lien and an outstanding balance of approximately $60,000. Id. at *17-*18. Alabama Scrap ultimately paid the loan in full, and it was marked satisfied in May 2011. Id. at *18. The company also made significant improvements on the property to operate a scrap yard; it estimated the value of its improvements at $140,900. Id. at *18-*19. Apparently, Alabama Scrap paid off the mortgage and made the improvements without any knowledge of the pre-existing tax lien, as no one associated with Alabama Scrap ever saw the deed with its reference to the lien. Id. at *19-*20.
Having expended over $200,000 on the Forrest Avenue Parcels, Alabama Scrap opposed the government’s effort to foreclose, offering a series of equitable defenses, each of which proved unavailing.
First, it argued that it was equitably subrogated to the mortgage that it paid, asserting that it had paid off the superior lien and emphasizing that Michael Urioste, Jr., its principal, had no knowledge of the pre-existing tax lien. Id. at *22. The district court rejected this contention, noting that there was no evidence that Alabama Scrap had acted as a lender, a critical requirement for equitable subrogation. Instead, it had taken over the property and received the use of the land. Id. at *22-*23. The court also observed that a second requirement was lacking: In equitable subrogation cases, the succeeding lender must demonstrate that all parties intended that it have a similar lien position, but there was no evidence that the bank or the taxpayer had that expectation. Id. at *23. For good measure, the court noted that Alabama Scrap had offered no authority for equitable subrogation to be applied against the federal government in favor of someone who purchased property and paid off an existing loan. Id. at *23-*24. Having disposed of the issue on that basis, the court did not reach the question of whether Alabama Scrap’s negligence precluded it from asserting equitable subrogation as a defense. Id. at *23 n.7.
Second, Alabama Scrap argued that the federal government would be unjustly enriched by the value of the improvements it had made and requested an equitable lien on the property. Id. at *24. Despite some surface appeal, this effort failed as well. The district court noted that Alabama law required either wrongful conduct by the lienholder or some form of mistake or “misreliance” by Alabama Scrap, and concluded that there was no evidence of wrongdoing by the government. Id. at *26. The court also found Alabama’s Scrap argument that it had made a mistake unconvincing, noting that the mortgage loan was an obligation that Alabama Scrap had to pay to use the property and the improvements had allowed Alabama Scrap to operate its business for a number of years. Id. at *27. The only mistake that Alabama Scrap made was accepting the property, and it had offered no authority that this type of mistake should preclude the government from enforcing its rights. Id. at *27-*28. In addition, the court concluded that the lack of any contributing conduct by the federal government also made the unjust enrichment argument unavailing. Id. at *28-*29.
Third, Alabama Scrap turned to the equitable doctrine of marshaling of assets, arguing that the IRS should first execute its liens against the remaining parcels of property. The court readily rejected this argument, noting that marshaling is an equitable doctrine to be used between creditors, and Alabama Scrap was not a creditor. Id. at *29-*31. The court also noted a number of courts had held that marshaling was not available in an action to foreclose a federal tax lien. While declining to adopt a hard and fast rule, the district court observed that there had been no showing that the tax liens could be satisfied from the other parcels. Id. at *32-*33.
This is frankly a case where it is hard to muster much sympathy for the transferee, as Alabama Scrap and its owner were plainly negligent in their acquisition of the property without a title search or an examination of the proffered deed: “Distrust and caution are the parents of security.”1
1 Attributed to Benjamin Franklin.