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Supreme Court of Kentucky Holds That General Tax Liens Are Superior to Later Filed Mortgage Liens

05.25.2011

In Wells Fargo Bank, Minnesota, N.A. v. Dep’t of Revenue, No. 2008-SC-000419 (Ky. Apr. 21, 2011), on appeal from, No. 2007-CA-000009 (Ky. App. May 8, 2009) and Central Bank of Jefferson County, Inc., No. 2008-SC-000427 (Ky. Apr. 21, 2011), on appeal from, No. 2007-CA-000009 (Ky. App. May 8, 2009), the Supreme Court of Kentucky (“Court”) held, in a consolidated appeal, that general tax liens pursuant to KRS 131.515 [Delinquent taxes, penalties, interest, and other costs constitute liens in favor of Commonwealth; duration; notice] (formerly, KRS 134.420) take priority over later filed mortgage liens.

Central Bank arises out of the refinancing of a mortgage. On August 17, 1998, Shannon and Steve Foster executed a promissory note and mortgage in favor of Commonwealth Bank & Trust Company (“CB&T”) as security for the purchase of real property (“Property”). On July 11, 2001, the Kentucky Department of Revenue (“Department”) filed a tax lien against Steve Foster pursuant to KRS 134.420(2).

On July 26, 2001, the Fosters executed a promissory note (“Note 1”) in favor of Central Bank of Jefferson County, Inc. (“Central Bank”), secured by a mortgage (“Mortgage 1”) on the Property. The Fosters used the proceeds from Note 1 to satisfy the mortgage on the Property held by CB&T and to extinguish certain ad valorem tax liens on the Property, but not to pay the Department’s lien against the Property under KRS 134.420(2).

The Fosters also executed a second note (“Note 2”) evidencing a line of credit by Central Bank. Note 2 was secured by a mortgage (“Mortgage 2”) on the Property. The proceeds from Note 2 were used to satisfy debt to various credit card companies. On September 6, 2001, the Department filed a general state tax lien against Shannon Foster.

Wells Fargo arises from the initial purchase and financing of a home by Janet and Joseph Clark on November 16, 2001. Several years before purchasing their home, on June 14, 1996, the Department filed a general tax lien against Joseph Clark pursuant to KRS 134.420(2). At the time of purchase, the Clarks executed a mortgage in favor of The Provident Bank, which later assigned the mortgage to Wells Fargo Bank (“Wells Fargo”) on February 14, 2003. The Department later filed two additional liens against Joseph Clark on August 24, 2004 and October 20, 2004.

At issue in this consolidated appeal to the Court is whether: (1) general tax liens pursuant to KRS 134.420(2) are superior to later filed mortgage liens; and (2) equitable subrogation acts to displace the priority of an earlier recorded general tax lien.

The Court, affirming the decision of the Kentucky Court of Appeals, held that the priority created by KRS 134.420 must be taken into consideration in re-ordering the lien priorities. The Court held that “the Kentucky General Assembly is empowered to create statutory liens and establish their priorities; but absent a statute giving precedence to a statutory lien, its rank is determined under the principle of first in time, first in right.” The Court also declined to apply the doctrine of equitable subrogation to relieve the professional lenders where the liens “could have easily been discovered with due diligence.” The Court stated, “[t]he Commonwealth’s liens would rarely be satisfied if a lender were allowed to overlook the lien – either by inadvertence, negligence or incompetence….a professional lender who has actual or constructive knowledge of an earlier recorded general lien may not benefit from an equitable reordering of the liens.”

Accordingly, the Court remanded the matters to the respective Circuit Courts for entry of an Order applying KRS 134.420.

If you have questions about this topic or any other legal issue, please contact any member of the firm's State and Local Tax Team.

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