Recent Baylake Bank Case Questions a City’s Ability to Enforce Development Agreement Penalties as Taxes

The priority of special assessments is hardly a sexy topic. But the decision in the recent Baylake Bank case can dramatically affect the value of a development property in foreclosure, and can have just as dramatic an effect on the finances of a municipality or TIF district that provided improvements to the development, relying on those liens. The impact continues to Counties who paid for those delinquent taxes, and to parties holding tax certificates.

In Baylake Bank, as is typical in real estate development projects in TIF districts, the Bank placed a first mortgage lien on the project, to secure the Bank’s loan, and the developer entered into a development agreement with the City, which provided that if the developer did not produce a certain amount of assessed value on the property by a particular date, the developer was liable for a “make up” payment, equal to the value of the taxes lost by the lack of sufficient assessment. The development agreement provided that this penalty was a “special charge” which was to be entered into the tax roll against the property and collected in the same manner as real estate taxes, as a first lien against the property.  

When the project was delayed, the Bank foreclosed, and the City entered these damages onto the tax roll, presuming the “lien” of the damages would “jump” the priority of the mortgage and be the first lien, like taxes. The Court of Appeals ruled in this case that this “make up” payment was just a contract right and not a tax, and therefore could not “jump” the priority of the mortgage.   

The impact of such an interpretation of amounts due under a development agreement could be broad. If the development agreement language does not allow its penalties to “jump” to the top priority as taxes, then a first mortgage holder can foreclose, or wipe out those fees, cleaning up title to the property and allowing sale or resale to a new buyer with little or no concern of paying off the development agreement obligations. This case will likely impact whether Banks will be willing to accept property back in a deed in lieu of foreclosure, and may impact how foreclosures are negotiated.

This case may also affect cities which either built improvements for the development, or committed to pay money to the developer, relying on the priority liens in their development agreements. Cities will need to review their existing development agreements to see if their language is strong enough to withstand the analysis and “lien subordination” effect of this case, and if not, look at whatever powers they have under these agreements to negotiate priority with the lender. Counties who have paid a municipality for delinquent “taxes” which include this type of lien will need to evaluate the validity of that lien.

The Baylake Bank case can be found at:  Baylake Bank v. Fairway Properties of Wisconsin, LLC, (No. 10-2632, 2011 WL 4089566) (Wis. Ct. App. Sept. 15, 2011) (unpublished opinion).  Technically, as an unpublished opinion, the case does not have the weight of judicial precedent, but these issues will surely be raised in other cases, and in negotiations between developers, lenders and cities.