Federal Court Holds That Bank’s Deed of Trust Primes IRS Tax Lien Despite Its Subsequent Recordation

By: Matthew G. DiMeglio; Lerch, Early & Brewer (Maryland, USA - TAGLaw)

A federal court of appeals held that a bank’s deed of trust had priority over an IRS tax lien, even though, the IRS filed notice of the tax lien more than a month before the bank recorded the deed of trust. On January 4, 2005, Restivo Auto Body, Inc. borrowed $1 million from Susquehanna Bank. The bank secured the $1 million loan with a deed of trust on two pieces of property executed and dated on January 4, 2005. On January 10, 2005, the IRS filed notice of a federal tax lien against Restivo for unpaid employment taxes. On February 11, 2005, the bank recorded the deed of trust from Restivo.

Restivo filed Chapter 11 bankruptcy in 2011, and the bank sought a declaratory judgment stating that its security interest had priority over the tax lien. The bank argued that the deed of trust’s effective date relates back “to the date when the deed of trust was executed” and that, based on the Maryland common law doctrine of equitable conversion, the bank had an equitable interest in the property that was prior to the IRS’ lien. The bankruptcy court ruled in favor of the bank, and the federal district court affirmed both the relation-back and equitable conversion arguments.

The Court of Appeals for the Fourth Circuit rejected the district court’s holding regarding the relation-back argument but affirmed the court’s holding regarding doctrine of equitable conversion.

Court Turns to Local Law to Determine Which Came First: Bank’s Security Interest or IRS’ Tax Lien

In its analysis of the priority of the competing interests, the court first determined that federal law governs the priority of an IRS lien law. Under federal law, an IRS lien is not valid against a holder of a security interest who did not have notice or knowledge of the IRS lien (Internal Revenue Code § 6323 (b)). The Internal Revenue Code (IRC) states that a security interest exists at any time, “if, at such time, the property is in existence and the interest has become protected under local law against a subsequent judgment lien..." (IRC § 6323 (h) (1) (A)). To determine if the bank’s security interest existed when the IRS lien was filed, the court reviewed Maryland local law.

Bank Fails to Record Deed of Trust Before IRS Files Notice of Tax Lien

First the court reviewed Maryland statutory law and, in particular, the relation-back statute, (Md. Real Property Code § 3-201). This statute protects security interests from judgment liens that may be recorded after the security interest is executed, but before the security interest is recorded. The statute states, in part, that “[e]very deed, when recorded, takes effect from its effective date” (which is the date when executed and delivered) “as against the grantor, his personal representatives, every purchaser with notice of the deed, and every creditor of the grantor with or without notice.” The court found that although Maryland’s relation-back law will retroactively validate Susquehanna Bank’s security interest when the deed of trust is ultimately recorded, on the date when the IRS recorded its tax lien, the relation-back protection had not been triggered because the bank had not yet recorded the deed of trust. Consequently, the court held the bank’s security interest did not “exist” (as required by IRC § 6323) when the IRS filed its notice on January 10, 2005.

Does Bank’s Security Interest Have Priority?

The court then turned its attention to Maryland common law and the doctrine of equitable conversion. The court found that, “under the doctrine of equitable conversion, the holder of an equitable title or interest in property, by virtue of an unrecorded contract of sale, has a claim superior to that of a creditor obtaining a judgment subsequent to the execution of the contract” and that the doctrine “protects the security interest of a purchaser regardless of the purchaser’s compliance with the recordation statutes.” Noting that the doctrine also applies “to Lenders whose interests are secured by mortgages or deeds of trust,” the court reasoned that because the bank’s “equitable interest in secured property arose prior to the IRS’ lien, the IRS was a subsequent judgment lienholder, and its lien did not have priority over the lender’s security interest."

Even though the court ruled in favor of the bank, a best practice for a lender is to record its security interests before or immediately after the disbursement of funds, and to always follow up with the settlement company to ensure its security interests are recorded.

This case is cited as In re Restivo Auto Body, Inc. v. Susquehanna Bank, 772 F.3d 168 (4th Cir. 2014).

Matt DiMeglio is a real estate and lending attorney who helps national, regional and local banks, credit unions and SBA lenders close loans. For more information on deeds of trust, contact Matt at (301) 657-0721 or This email address is being protected from spambots. You need JavaScript enabled to view it..

This article was originally featured in the Lerch Early Commercial Lending Bulletin. To subscribe, visit http://www.lerchearly.com/publications/408-subscribe-now.