When Tax Foreclosures Become a Taking

The government’s power to take private property is limited by a fundamental constitutional requirement: property owners must receive just compensation when their property is taken for public use.  Although this principle is most commonly associated with eminent domain proceedings, it can also apply when municipalities acquire properties through tax foreclosures and retain proceeds beyond what they are owed.

The New Jersey Supreme Court is now considering this issue in Lynette Johnson v. City of East Orange, a case that could determine whether municipalities must compensate former property owners for surplus equity retained through tax foreclosures.  We have previously written about this case before, FYI – see this post about Ms. Johnson’s appellate court victory, and this original post when her lawsuit was first filed.

The Dispute Over Surplus Equity

In March 2014, Lynette Johnson purchased a fire-damaged commercial property in East Orange for $55,000, intending to renovate it for her children to operate a business.  After Johnson failed to pay property taxes, the City of East Orange acquired a tax lien in 2015 and initiated foreclosure proceedings in 2017.

In February 2018, the Superior Court entered a final foreclosure judgment, terminating Johnson’s right to reclaim the property by paying the outstanding debt.  Four months later, East Orange sold the property for $101,000 and retained the proceeds.

The amount Johnson actually owed remains disputed.  Johnson maintains that her outstanding debt was approximately $25,000, while the City claims that the total was approximately $56,000 when additional taxes, water charges, and property registration fees are included.

In December 2021, Johnson filed a lawsuit alleging that the City’s retention of the property’s surplus equity constituted an unconstitutional taking without just compensation.  Importantly, Johnson did not seek to overturn the foreclosure itself.  Instead, she sought compensation for the value retained by the City beyond her outstanding obligations.

The Constitutional Right to Just Compensation

Johnson’s claim gained significant support from the United States Supreme Court’s May 2023 decision in Tyler v. Hennepin County, Minnesota.  In Tyler, a Minnesota county seized a condominium to satisfy approximately $15,000 in unpaid taxes, interest, and penalties.  The county subsequently sold the property for $40,000 but retained the entire amount, including the $25,000 exceeding the owner’s debt.

The Supreme Court held that the property owner had stated a viable claim under the Fifth Amendment’s Takings Clause.  Although the government could recover unpaid taxes through foreclosure, it could not retain property value exceeding the amount legally owed without providing just compensation.

The decision established an important distinction between the government’s authority to collect unpaid taxes and its constitutional obligation to compensate property owners when the government retains equity exceeding those obligations.

The Issue Before the New Jersey Supreme Court

The central issue in Johnson is whether a former property owner may pursue a separate claim for just compensation after the underlying tax foreclosure judgment has become final.

The City of East Orange and the New Jersey Attorney General’s Office argue that Johnson should have raised her constitutional claim during the original foreclosure proceedings.  Relying on New Jersey’s entire controversy doctrine, which generally requires related claims to be addressed in a single proceeding, they contend that Johnson should not be permitted to bring a separate lawsuit years later.

During oral arguments, however, several justices questioned whether Johnson could reasonably have been expected to challenge the taking of the surplus equity before the foreclosure even occurred.  Chief Justice Stuart Rabner emphasized the importance of fairness, asking how a municipality could justify retaining surplus equity that rightfully belonged to the former property owner.  Justice Rachel Wainer Apter also questioned why Tyler should not control, noting similarities between the timing of the two property owners’ lawsuits.

The court’s decision will therefore address whether procedural rules can prevent property owners from pursuing compensation for surplus equity allegedly taken in violation of their constitutional rights.

Potential Implications for New Jersey Municipalities

A decision favoring Johnson could have substantial financial consequences for municipalities throughout New Jersey.

East Orange and the Attorney General’s Office argue that municipalities followed the law as it existed when these foreclosures occurred and should not face liability for conduct they could not reasonably have anticipated would later be declared unconstitutional.  They also warn that allowing similar claims could expose municipalities to millions of dollars in judgments and legal expenses while creating additional disputes involving private tax lienholders.

Conversely, Johnson’s position, advanced by her attorneys and our colleagues at the Pacific Legal Foundation, emphasizes a fundamental principle of condemnation law: the government’s lawful authority to acquire private property does not eliminate its constitutional obligation to provide just compensation.