Government Claim Vs. Prior Perfected Mortgage Lien: Who Wins Under The Federal Priority Statute?

The Federal Priority Statute, as it is presently codified at 31 U.S.C. § 3713 or one of its predecessors, has been in effect since 1797.1 Despite its long history, the statute is not very well known.2 The Federal Priority Statute grants the government priority over all other claims in certain situations when an insolvent debtor's property is held by an assignee, including in state court receiverships. While this priority appears absolute from the language of the statute,3 courts have implied limited exceptions. One such exception applies to prior perfected mortgage liens and security interests. In addition to this implied exception, a secured creditor may argue that allowing the government to destroy the value of the creditor's mortgage lien also violates the Takings Clause of the Fifth Amendment.

Implied "Specific and Perfected Lien" Exception

The United States Supreme Court has established that the Federal Priority Statute creates a priority only for payment and does not create a lien in favor of the government. See United States v. Fischer, 6 U.S. 358, 390 (1805) ("On this subject it is to be remarked, that no Lien is created by this law"). In other words, the United States remains an unsecured creditor with a right to prior payment. As a result, courts imply an exception to the Federal Priority Statute for prior liens that are "specific and perfected." See Straus v. United States, 196 F.3d 862, 864 (7th Cir. 1999) ("Although the Federal [Priority] Statute, on its face and taken alone, is absolute ... the Supreme Court has recognized several exceptions to the general priority rule the statute dictates. The first exception is for a specific and perfected lien."). In United States v. City of New Britain, 347 U.S. 81, 84 (1954), the Supreme Court discussed that a mortgage, by its nature, is a specific lien. When properly perfected, a mortgage lien should defeat the government's priority under the Federal Priority Statute.

Some confusion can arise when reconciling the specific and perfected lien exception with the Supreme Court's ruling in Thelusson v. Smith, 15 U.S. 396 (1817). In that case, Thelusson obtained a judgment that constituted a lien on the debtor's real property. After the debtor made an assignment for the benefit of creditors, the United States obtained judgments against the debtor and levied on his real property. Thelusson brought an action to recover proceeds of the sale to satisfy his judgment. The Court determined that the...