Due Process and Due Diligence: Claiming Surplus in New York’s In Rem Tax Foreclosures

By Kelsey R. Ruszkowski

Due Process and Due Diligence: Claiming Surplus in New York’s In Rem Tax Foreclosures

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Introduction

New York’s COVID-19 Emergency Eviction and Foreclosure Prevention Act of 2020 prevents local governments from engaging in tax foreclosures of residential property owners and small businesses with COVID-19-related financial hardships, amongst other protections. In May 2021, these protections were extended until August 31, 2021. Eventually these protections will end, and the proverbial foreclosure floodgates will open. Even though this day has not yet come, it would behoove all practitioners to be aware of the laws and rights that affect property interests in tax foreclosure proceedings as soon as practicable. Not only because claims to the surplus from tax foreclosures that occurred prior to the moratorium persist, but because even if an attorney does not represent a lienholder, property owner or other interested party as part of his or her regular practice, he or she may be appointed as a referee to determine the veracity and priority of each party’s claim, in addition to the sufficiency of notice, in a surplus proceeding or a foreclosure action.

The scope of this article will center on claims to surplus in tax lien foreclosures, an area of tax foreclosure law that is severely underexplored. When a property is foreclosed and sold for an amount beyond what was necessary to cover the foreclosing party’s interest, an excess amount, or surplus, is created. It seems intuitive that if the foreclosing party has already been paid what it is owed, the remainder would be distributed to other parties with a claim to the property. Under mortgage foreclosure law, this is the case. The surplus is distributed in the order of priority of all those with a claim to the property, generally following the “first in time, first in right” rule, before going to the equity of redemption holder.[1] Tax lien foreclosures, on the other hand, operate differently. Under Article 11 of New York’s Real Property Tax Law (RPTL), interested parties must either redeem the property or file an answer and reach a payment agreement with the tax district prior to the tax sale.[2] All interested parties that did not file an answer or redeem the property in the foreclosure proceeding are forever “barred and foreclosed of all right, title, and interest and equity of redemption in and to the parcel in which the person has an interest.”[3] A default judgment is entered and the tax district is granted the property in fee simple absolute.[4] This effectively means that when a default judgment is entered, the foreclosing tax district is permitted to keep the entire surplus, even if it far exceeds the debt owed to the tax district. This surplus routinely amounts to thousands of dollars and even hundreds of thousands of dollars. This arrangement has been upheld repeatedly by the New York Appellate Departments and by the Court of Appeals.[5]

Unfortunately, the landscape is unclear when it comes to the procedures surrounding tax lien foreclosures, particularly where surplus results from a sale. The scope of this article centers on claims to surplus funds in tax lien foreclosures, starting with an overview of the types of parties who may have a claim to surplus funds, followed by a discussion of notice requirements and the due process rights of parties. The article concludes by noting additional problems with the RPTL and proposes some possible solutions to balance the need for judicial efficiency in tax foreclosure proceedings with the due process rights of interested parties.

  1. Identifying Interested Parties

Inherent in the problem of providing notice is identifying to whom to provide notice. Unfortunately, identifying interested parties can be more complex than it may seem. Although separate from the foreclosure proceeding, a surplus proceeding is in essence connected to the foreclosure action itself.[6] Due to this, a party that had an interest in the foreclosed property will also have an interest in the surplus. An interested party includes the owner of the foreclosed property and “any other person whose right, title, or interest . . . [would have been] affected by the termination of the redemption period.” [7] This means that beyond the property owner, interested parties can include mortgagees, other tax districts, the IRS, lienholders and others. The lienholder category in particular can be expansive and difficult to determine for many reasons. One of those reasons is that judgments entered by a New York Supreme Court automatically attach as a lien to the property of the judgment debtor within that county. Another reason is that judgments entered elsewhere can be recorded at a county clerk’s office, where they become a lien on the debtor’s property in that county for a 10-year period, renewable for up to an additional 10 years.[8] A third reason why judgment liens can be particularly difficult is that they can attach to property the debtor acquires an interest in after the judgment is entered or recorded.[9] Unlike other interested parties whose interests are based on the “first in time, first in right” rule, liens on after-acquired property all attach at the time the property is acquired. Due to this, the after-acquired liens have equal priority to each other and take their share of the surplus, if any, pro rata.[10]

Because the surplus effectively takes the place of the foreclosed property, a property lien or claim that was valid at the time of the sale of the subject premises remains valid at the time of a surplus proceeding.[11] In a proceeding for surplus money, the court has jurisdiction to determine “the rights of all lienors who were such at the time of the commencement of the foreclosure proceedings . . . and all questions that could be raised in an independent action may then be raised and determined with like effect.”[12] Therefore, “[a] lien that lapses after the sale nevertheless shifts to a surplus (even if it lapses before the surplus proceedings), whereas a lien that lapses before the sale (albeit still within the 20-year period of the judgment itself) cannot support a claim to a surplus.”[13]

To further complicate matters, judgment liens against, or mortgages obtained by, the foreclosed property owner may not be the only interests relevant in a surplus proceeding. How exactly the foreclosed-upon owner was transferred the property may open the door to additional interested parties. There are a variety of deeds that can be used to transfer ownership of property: bargain and sale, warranty, and quitclaim, amongst others. Of these deed types, the bargain and sale and quitclaim deeds do not guarantee that the property is free and clear of encumbrances, such as a lien or mortgage. Because no such guarantee exists, recorded liens and mortgages against the prior property owner may still be attached to the foreclosed property and resulting surplus.[14]

There are several other complex issues that may arise while identifying parties with a potential interest in a surplus. For example, scenarios which may involve veil piercing and/or fraudulent conveyances. If the premises owner is a business entity or business owner, it may be appropriate to consider creditors of both parties as potentially interested parties in case a veil piercing argument for equitable relief is relevant.[15] If the business is merely the alter ego of the property owner, and the owner used that control to harm the creditor, then that creditor may have a claim to the surplus under the theory of respondeat superior.[16] Indeed, such an attempt was recently made in a foreclosure proceeding, but ultimately failed, in the Supreme Court of Bronx County.[17] Another possibility is that a creditor may make the at times related argument that the premises was fraudulently conveyed to the foreclosed-upon owner in order to avoid paying the previous owner’s debts.[18] What remedies that may be available to the creditor, including making a claim to the surplus, depend in large part on whether “reasonably equivalent value” was paid for the transfer, the purchaser’s knowledge of the fraud, and whether the transferor was insolvent, among other considerations that are outside the scope of this article.[19] Like the statute of limitations for the debts themselves, claims that a property was wrongfully conveyed that could have been brought at the foreclosure stage are also timely at the surplus action.

To identify these interested parties at the foreclosure stage, New York’s Real Property Tax Law only requires the enforcing officer to search the county clerk’s public records for interested parties and send notice to those with a name and address on file.[20] Because of the potential interest from debts associated with prior owners as well as debts that attach to after-acquired property, this search should at least encompass a 10-year period prior to the notice of pendency being filed. Likewise, a title search later conducted to identify interested parties to provide notice of a surplus claim should also include a search of that period. Note that these searches should not be limited to interests that specifically reference the at-issue premises, as they should include judgments obtained against the foreclosed owner, and in some cases, against prior owners and business entities. Although these steps should be taken, this does not mean that they are.

What initially seems like an easy task can become extremely complex, and where there is complexity, there is abundant room for error. In the case of foreclosure and surplus proceedings, the most detrimental errors involve violations of due process.

2. Addressing Procedural Due Process Challenges to Notice

Whether an interested party can lay claim to any surplus depends in large part on the proceedings at the foreclosure stage. If an interested party failed to answer or redeem at the initial foreclosure, then the only question that remains is whether they were deprived of property without due process of law.[21] Due process requires that notice be reasonably calculated, under the circumstances, to apprise interested parties of the pendency of an action and give them opportunity to present their claims and objections.[22] Actual notice is not required.[23] To address this issue, the real property tax law requires that notice be mailed to the owner and any other interested parties via first class and certified mail when a foreclosure proceeding is commenced.[24] When sending notice, New York’s law only requires the enforcing officer to send notice to interested parties with a name and address on file in the county clerk’s public records.[25] Because due process does not require the tax district to go to extraordinary lengths to send notice, in most instances these mailings are sufficient to satisfy due process notice requirements as to a particular party.[26] However, there are exceptions – the primary being that if all mailings sent by a tax district are returned undeliverable.[27] In these circumstances, a tax district would have to take additional steps to ensure due process is met.[28] What additional measures are required is dependent on the circumstances of a case; for example, such measures may include affixing notice to the premises.[29] With the rapidly expanding technological landscape, steps that might have seemed extraordinary in the past can now be simply undertaken. However, the merits of notice via social media are best left for another article. Regardless of whether personal notice is appropriately sent, due process is satisfied if the interested party nonetheless receives actual notice of the foreclosure.[30] This may be the case if the interested party learns of the pending foreclosure from a newspaper publication.[31] Notwithstanding this, without actual notice, publication in a newspaper is otherwise insufficient to satisfy due process requirements.[32] New York law provides that proof of such postings and mailings by way of affidavit be filed in the office of the county clerk and become part of the judgment roll of the foreclosure action.[33]

Enforcement proceedings for tax liens are presumed valid under the RPTL, and the party challenging a deed issued as a result of those procedures has the burden of affirmatively establishing a defect in the proceeding.[34] Further, if a tax district can show that the procedures they used to deliver notice were those used in the regular course of business, such as an affidavit stating that a letter was properly addressed and mailed to an interested party, then it is presumed that notice was received.[35] Because of these presumptions, due process violations are extraordinarily difficult to prove.

Due process claims are typically seen where a foreclosed-on homeowner claims to have never received notice of the tax foreclosure in an attempt to recover ownership of the home itself. In those scenarios, a homeowner is not simply trying to recover the excess value from the foreclosed property –⁠ he or she is trying to recover real property from a bona fide purchaser. This is likely why there is a two-year statute of limitations to set aside a referee’s deed and why referee’s deeds act as presumptive evidence that all procedures were followed, including those for notice, which becomes conclusive after two years.[36] Comparatively, scenarios where an interested party is simply claiming a share of the surplus do not affect the interests of a bona fide purchaser. The foreclosing tax district had already been made whole; after all, surplus, by its very nature, is in excess to the debt owed the foreclosing party.

Perhaps in consideration of this reality, New York courts have held that the statute of limitations does not apply when a party alleges that they did not receive actual timely notice of a pending foreclosure and asserts a due process violation.[37] Unfortunately, practically speaking, it is still difficult for an interested party to prove that their due process rights were violated. In the case of tax foreclosures, the apparent strategies available to a party are to highlight their unique circumstances that resulted in a district failing to take or attempt to take reasonable steps to send notice, or to challenge the notice requirements in the law itself, either as an as applied or facial challenge.

As discussed previously, there are many scenarios where it can be difficult to identify which parties may have an interest in the pending foreclosure. Nevertheless, legal complexity does not excuse the tax district’s duty to notify these parties when their judgments and/or mortgages, names and addresses are available in the public record. These complexities may leave room for error when providing notice to interested parties, as tax districts may fail to search for judgments against property owners entered prior to their ownership of the at issue premises, judgment liens against anterior owners, etc., in their standard search of the public records conducted in the regular course of business.

As to challenges to the law itself, it is paramount to note that many tax districts have opted out of New York’s Real Property Tax Law and have instead created their own law for tax foreclosures.[38] Also, even if a county tax district opts out of the RPTL, a city or town may apply RPTL, even if they are located in that county, and vice versa. Although the tax foreclosure laws of many of those districts that did not adopt RPTL largely mirror the New York Law, some of their notice requirements depart from those enumerated in the RPTL and may pose their own due process concerns.[39] For example, like RPTL § 1126, the tax foreclosure laws for the County of Erie require notice of a pending foreclosure be sent to parties who recorded their interests in the property with the tax district.[40] However, unlike New York’s law, the laws of Erie County attempt to eliminate the tax district’s burden of notifying lienholders of a pending foreclosure unless that interested party had previously notified the county of their interest in the property.[41]

Although this process saves the county the time and expense of determining interested parties by placing the onus of notice on those parties claiming an interest, such a procedure clearly raises due process concerns. In fact, the Fourth Department has already held that this notice provision in the Erie County Tax Act does not comport with due process, even if the unnoticed parties were sophisticated.[42] Notably, the U.S. Supreme Court has held that, at a minimum, interested parties must be mailed notice, as the State may not forgo “even the relatively modest administrative burden of providing notice by mail to parties who are particularly resourceful” if their name and address are reasonably ascertainable.[43] Further, “a party’s ability to take steps to safeguard its interests does not relieve the State of its constitutional obligation.”[44] However, this analysis can be very case-specific. When the Court of Appeals reviewed New York City’s “notice-by-request” procedure for in rem tax foreclosures, where notice would be sent to those parties who registered their interest in the property, they found that the law satisfied due process notice requirements, as applied to the owners of real property, where the city also required actual notice to be mailed to the last known address of the owners in the tax assessment rolls if no notice of interest was received from the owner.[45] Based on the limitations of this ruling and standards set by the U.S. Supreme Court, this case likely would have been decided differently if there were no procedures in place for mailing notice to interested parties that did not submit a notice card.

3. Additional Considerations and Conclusion

It cannot be denied that a tax district’s retention of the excess sale proceeds beyond what debt is owed to them is an unsettling practice. Indeed, the Western District of New York has referred to the RPTL as “draconian” and held that tax foreclosure sales under that scheme may amount to fraudulent conveyances and result in improper windfalls for the tax district.[46] This is because tax foreclosure sales commonly start bidding at the amount of the tax debt owed without regard to market values, which often results in the foreclosed property being sold for far below its actual value, even when considering the risks involved in purchasing foreclosed property. This practice results in an overall devaluation of the property and less surplus available to interested parties. While this practice encourages interested parties to redeem the property before a foreclosure sale can take place, if they were even made aware of the pending foreclosure, this diminution in value only heightens the due process concerns inherent in tax foreclosures.

Although tax districts had the ability to opt out of the RPTL, and even those who apply it may in practice choose to distribute the surplus rather than retain it, in lieu of amending RPTL to allow distribution of the surplus to match the procedures for mortgage foreclosures, changes in how due process claims are evaluated can provide an opportune middle ground while still allowing the tax district to keep the surplus in some circumstances. Namely, shifting the burden to the tax district to show what steps were taken to send notice would provide an additional safeguard for due process by allowing easier recovery for interested parties at the surplus stage or when seeking to overturn a default judgment or deed. Such a requirement is not entirely inconsistent with New York’s law, given that RPTL §1128 already requires that an affidavit of mailing, publication and posting be filed with the application for judgment, presumably in part to demonstrate that a tax district complied with notice requirements. However, note that it is not clear whether this filing requirement is merely directory or mandatory, or whether noncompliance would constitute a jurisdictional defect.[47]

An additional problem touched on previously is that there is no apparent statute of limitations for asserting claims to a surplus, specifically when alleging due process violations. This is concerning given that lienholders essentially have unlimited time to bring claims to a surplus if they were not sent proper notice of a foreclosure, even if the statute of limitations had already lapsed on the lienholder’s underlying lien. The lack of a statute of limitations allows debtors and equity of redemption holders to sit on their claims indefinitely. This presents some practical detriments, namely that tax districts may be discouraged from putting the surplus granted to them towards public use in favor of letting it sit idle and unutilized in an account indefinitely for fear that a party may later claim the surplus based on a due process violation. Additionally, record retention policies and the passage of time in general may effectively limit or prevent a fair and accurate evaluation of due process claims and the subsequent determination of the priority of claims if there is a significant delay in bringing claims to surplus. These problems can at least be remedied in part by notifying the equity of redemption holder of the surplus, which is typically not required, so that they can then start a surplus claim if they so choose, which would eventually result in the distribution of the surplus and the ultimate closing of the foreclosure matter.

Note that due process considerations are not limited to simply notifying interested parties of a pending foreclosure or a surplus proceeding. COVID-19 and the rapid transition into virtual courtrooms has prompted additional considerations regarding a party’s access to foreclosure proceedings, most recently when held virtually. Individuals without reliable access to the internet, computers or an email address, or simply those who lack technological proficiency, may find it difficult or practically impossible to attend hearings and other proceedings. Likewise, those same considerations that make that party’s attendance difficult may also merit additional steps to ensure that accommodations are made and that they are properly notified of those proceedings. Due process may even require that the foreclosure proceeding be postponed until in-person proceedings can be held in such circumstances.

Overall, this is an area of law that has very little guidance despite having a multitude of complexities and serious constitutional consequences. Of further concern is that attorneys who are unfamiliar with the intricacies of tax foreclosure law are routinely appointed as referees to determine the interested parties and to evaluate their claims before making a recommendation to the judge concerning claims at both the initial foreclosure and surplus stages. Because of these considerations and the importance of upholding a party’s constitutional rights to due process, clear guidance and procedures from the courts and legislature is needed to help practitioners, referees and interested parties navigate the intricacies of foreclosure proceedings.

Kelsey R. Ruszkowski is a litigation associate at Gibson, McAskill & Crosby in Buffalo, New York, and a former fellow of William & Mary’s Center for Legal and Court Technology, an affiliate of the National Center for State Courts. Her legal scholarship focuses on constitutional issues as well as on the impact of advances in science and technology on the legal system. With a background in psycholegal research, her analysis routinely intertwines the fields of law and psychology.


[1]. Article 13 of the Real Property Actions and Procedures Law (RPAPL), § 1361; RPTL, Article 9, Title 3, § 926 also allows a tax debtor to retain the surplus.

[2]. RPTL § 1150.

[3]. RPTL § 1131.

[4]. RPTL § 1136. This section grants courts the full power to determine and enforce all rights, claims and the like regarding the properties to be foreclosed pursuant to Title 3 of Article 11.

[5]. Kennedy v. Mossafa, 100 N.Y.2d 1 (2003); Hoge v. Chautauqua County, 173 A.D.3d 1731 (4th Dep’t 2019); Sendel v. Diskin, 277      A.D.2d 757, 761 (3d Dep’t 2000) (citing Key Bank of Cent. New York v. Broome County, 116 A.D.2d 90, 92 (3d Dep’t 1986)).

[6]. See Diamond v. Kimberly Construction Co., 88 N.Y.S.2d 26, 27 (Sup.Ct., N.Y. Co. 1949); see generally, 38 N.Y. Jur. Mortgages and Deeds of Trust § 317, at 615–16 (1964) (“A foreclosure suit is not terminated until there has been a disposition of the surplus money realized on the foreclosure sale”).

[7]. RPTL § 1125. Notice must also be provided to parties who filed an unexpired declaration of interest under RPTL § 1126 and the enforcing officers from other tax districts with an interest.

[8]. CPLR 5203.

[9]. CPLR 5201(b); CPLR 5203(a); Hulbert v. Hulbert, 216 N.Y. 430 (1916).

[10]. Hulbert, 216 N.Y. 430.

[11]. CPLR 203(c); Dime Sav. Bank of New York v. Boklan, CV 86-2664, 1989 WL 35946 (E.D.N.Y. Apr. 3, 1989) (citing Colichio v. Bailey, 77 A.D.2d 694 (3d Dep’t 1980) and Nutt v. Cuming, 155 N.Y. 309, 312–13 (1898) (“Only liens in existence at the time of the sale and conveyance in a foreclosure action are transferred to the surplus moneys arising therefrom; and if at that time no lien exists, there is nothing which can be transferred to the fund”)).

[12]. Dime Sav. Bank of New York, 1989 WL 35946 (quoting 15 Carmody and Wait 2d Cyclopedia of New York Practice, Foreclosure of Mortgages on Real Estate § 92:460, at 414).

[13] § 23:2.Claimants to surplus, 35 N.Y. Prac., Mortgage Liens in New York § 23:2 (2d Ed.) (citing Island Holding, LLC v. O’Brien, 775 N.Y.S.2d 72 (2d Dep’t 2004) (claim to surplus moneys timely when made within the 20-year statute of limitations as a judgment creditor) and Federal Land Bank of Springfield v. U.S., 250 N.Y.S.2d 999 (3d Dep’t 1964)).

[14]. See CPLR 5203.

[15]. CPLR 5225; Walkovszky v. Carlton, 18 N.Y.2d 414, 417 (1966) (veil piercing permitted when a person uses their control of a company to further their own business).

[16]. See Conason v. Megan Holding, LLC, 25 N.Y.3d 1, 18 (2015).

[17]. NYCTL 2016-A Tr. v. 3254 Cambridge Realty, LLC, 2021 N.Y. Misc. LEXIS 1507, 2021 N.Y. Slip Op. 50286(U) (Sup. Ct., Bronx Co. April 6, 2021).

[18]. Dime Sav. Bank of New York, 1989 WL 35946.

[19]. N.Y. Debt. & Cred. Law §§ 270–281 (2019) (the New York Uniform Voidable Transactions Act).

[20]. RPTL § 1125.

[21]. In re Ellis v. City of Rochester, 227 A.D.2d 904, 904 (4th Dep’t 1996) (where a party did not answer or redeem “[t]he only issue . . . is whether the [interested party] received proper notice.”); U.S. Constit. amend. XIV; N.Y. Const. art. I, § 7.

[22]. Jones v. Flowers, 547 U.S. 220, 226 (2006).

[23]. Id.; but see In re McCann v. Scaduto, 71 N.Y.2d 164, 177 (1987) (“Actual notice is therefore required”); see also In re Foreclosure of Tax Liens by Proceeding in Rem Pursuant to Art. 11 of Real Prop. Tax Law by the County of Ontario, 169 A.D.3d 1508 (4th Dep’t 2019).

[24]. RPTL §§ 1124-1125. Notice must also be provided to parties who filed an unexpired declaration of interest under RPTL § 1126 and the enforcing officers from other tax districts with an interest.

[25]. RPTL § 1125.

[26]. Jones, 547 U.S. at 242; Kennedy v. Mossafa, 100 N.Y.2d 1 (2003) (due process satisfied where owner’s current address was not reasonably ascertainable, the Town attempted personal notice, and both posted and published notice).

[27]. RPTL §1125(1)(b); Wilczak v. City of Niagara Falls, 174 A.D.3d 1446 (4th Dep’t 2019) (citing Lin v. County of Sullivan, 100 A.D.3d 1076, 1078 (3d Dep’t 2012)).

[28]. Jones, 547 U.S. at 242.

[29]. Id. at 234–35.

[30]. Id. at 226.

[31]. RPTL §§ 1124–1125.

[32]. Jones, 547 US 220 (citing Mullane v. Cent. Hanover Bank & Tr. Co., 339 U.S. 306, 317 (1950)).

[33]. RPTL § 1128.

[34]. RPTL § 1134; Kennedy v. Mossafa, 100 N.Y.2d 1 (2003); Sendel v. Diskin, 277 A.D.2d 757, 758 (3d Dep’t 2000).

[35]. Sendel, 277 A.D.2d at 758–59.

[36]. RPTL § 1125(3); RPTL § 1128; RPTL § 1137.

[37]. In re ISCA Enterprises v. City of New York, 77 N.Y.2d 688, 698 (1991); McCauley v. Holser, 136 A.D.3d 1256, 1258 (3d Dep’t 2016); Bridgehampton Dev. Corp. v. County of Suffolk, 26 A.D.3d 308, 309 (2d Dep’t 2006).

[38] RPTL § 1104. A list of tax districts that opted out of the tax enforcement program can be found at https://www.tax.ny.gov/research/property/legal/localop/1104.htm.

[39]. Id.

[40]. Compare RPTL § 1126 with Erie County Tax Act § 11-14.0.

[41]. Id.

[42]. In re Foreclosure of Tax Liens, 103 A.D.2d 636, 639–40 (4th Dep’t 1984).

[43]. Mennonite Bd. of Missions v. Adams, 462 U.S. 791, 799–800 (1983).

[44]. Id. at 799.

[45]. ISCA Enterprises v. City of New York, 77 N.Y.2d 688, 698, 700–01 (1991).

[46]. Hampton v. Ontario Cty., New York, 2018 WL 3454688 (W.D.N.Y. 2018).

[47]. City of Yonkers v. G.H. Clark & Son, Inc., 159 A.D.2d 535, 537 (2d Dep’t 1990).

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