Foreclosed: A Play on Tax Liens By Wall Street Types Blows Up in Their Face
Judge in New Jersey Backs Property Owners in Suit Against the Financiers
Damages for a Lost House

By Paul Beckett, 11/30/2000, The Wall Street Journal, Page A1

JERSEY CITY, N.J. -- Wall Street has created securities based on everything from hurricane risk to the future royalties of rock star David Bowie. J. Douglas Breen had an idea, too: tax liens.

He devised a plan seven years ago to issue bonds to buy the rights to delinquent property taxes in Jersey City, a gritty city on the Hudson River that was then in dire financial straits. Both sides would win: The city would instantly get millions of dollars from back taxes that were otherwise difficult to collect. Mr. Breen's investment firm, while paying off bondholders with collected taxes, would reap plump fees, then duplicate its feat in other cities. "Our business plan at that time was: `The world's our oyster if we can get the Jersey City deal done,' " he says.

Instead, the plan sank into a mire of recrimination and litigation involving his firm, his investment-bank partners, the Jersey City mayor (himself a former broker and analyst), and property owners. Now, thanks to the latest lawsuit, Mr. Breen's bright idea threatens to put the small firm he owns with two others out of business. Damages loom as well for Bankers Trust, one of the small firm's partners in the deal. And lawyers for the property owners are targeting others who followed in the path Mr. Breen blazed, casting a shadow over a new form of business that seemed a natural extension of Wall Street finance.

At the heart of the problem is a legal issue the plan's architects never anticipated. A state judge ruled that installment plans offered to delinquent taxpayers weren't legal, because New Jersey law authorizes only municipalities to set up such plans. Municipalities do so routinely, and charge property owners up to the legal limit of 18% interest. But the judge said the private group's use of such plans, and other infractions such as effectively charging 18 1/4% interest instead of 18%, were such serious abuses of state tax-lien law that they amounted to consumer fraud.

He cited plaintiff Ruth Fails, a postal worker who accepted an installment plan to pay her overdue property taxes, didn't meet its terms and lost her house to foreclosure. Ms. Fails "was solicited by defendants at a time of great vulnerability when her economic world was collapsing around her," Judge Jose Fuentes wrote. "Defendants seized this opportunity to extract from her the last financial breath." For her and some others, Judge Fuentes is expected to order the defendants not only to return all the back taxes collected but also to pay damages equal to the value of the foreclosed house.

The damages he assesses could run as high as $80 million against Breen Capital Services Corp. and as much as $35 million against Breen partner Bankers Trust, lawyers on both sides estimate. Mr. Breen says this would be ruinous, and is unjustified because his firm essentially treated delinquent taxpayers no differently than municipalities do. Lawyers for Bankers Trust say that actual damages to the plaintiffs were minimal and provide no basis for such an award. They say the installment plans were in fact helpful to property owners, because without them the owners' only options would have been to pay all the back taxes in a lump sum or face foreclosure.

Both Breen and Bankers Trust, now owned by Deutsche Bank AG, plan an appeal. But looking back on the deal, Mr. Breen observes: "People rushed into it without realizing the implications or really understanding the characteristics of tax liens. This is a blot on any Wall Streeter's career."

Tax liens, imposed when property owners don't pay their real-estate taxes, have long been something that people invested in. But it is usually just individuals who do so. They often buy "tax-sale certificates" relating to a few properties they are familiar with, knowing the properties have sufficient value that their owners will pay the taxes rather than lose them -- or that, if it does come to foreclosure, the investor will end up with something valuable. But liens purchased in bulk are a far trickier game, as Mr. Breen found out.

Mr. Breen, 54 years old, was a latecomer to Wall Street, selling industrial insulation and dabbling in real estate before giving securities a try. He became a government-bond salesman for PaineWebber in 1977, and a dozen years later launched Breen Capital Partners Inc. with two friends in his hometown of Princeton, N.J. He never quite hit the Wall Street big time; he wears black Gucci loafers and speaks fondly of his Porsche, but says he acquired both back around 1985.

Mr. Breen long had the idea of applying Wall Street financial techniques to tax liens, and in late 1992 he got his chance: Jersey City chose as mayor Bret Schundler, formerly of Salomon Brothers and C.J. Lawrence. The first Republican mayor in 75 years, he took over a city that was facing a financial crunch, and collecting just 78% of property taxes owed. That put it close to the threshold where the state might take over tax collection and impose fiscal constraints.

Soon, Mr. Schundler and Mr. Breen were talking about a solution. Advisers went to work on details, and in mid-1993, a trust vehicle issued $31 million of bonds to be paid off from the collection of overdue Jersey City property taxes. Proceeds were used to buy about 2,520 tax liens, with a face value of $43.7 million. In return, Jersey City received $25 million in cash and a note for as much as $19 million more, depending on how much more Breen Capital could collect after the bonds were paid off. Breen would make its profits through fees for collecting the taxes.

The deal involved some financial heavyweights. Bankers Trust was "master servicer" for the trust that issued the bonds. First Boston, now part of Credit Suisse Group, underwrote them. Advising the mayor was W.R. Lazard & Co., which is now defunct. With the city's financial crisis stanched, the deal makers celebrated at Felidia Ristorante in Manhattan over veal chops and Macanudo cigars.

Their euphoria didn't last long. Breen Capital was ill-equipped to handle payments, say some property owners. During the 1993 Christmas season, auto mechanic John Varsalona got a letter from Breen at the shop his family has owned for 35 years. In it, Breen officials said they "strongly recommend" that he sign up for an installment plan to pay off a tax lien on the property.

He did. "The impression I had was they could have pulled the place from me in a New York second," says Mr. Varsalona, 47 years old. "I just wanted to get that note off my back and pray Momma didn't find out."

But as he was paying the full amount of $5,419 (including interest) over the next three years, he received no monthly statements. Personal checks were returned, because Breen accepted only money orders. And, he and some other property owners say, they got no notice when Breen Capital moved its offices.

Mr. Breen says property owners certainly knew where to send payments: "We wanted their money. It wasn't like we were trying to hide from them." He agrees that the firm had some administrative problems but says they have been exaggerated.

Others say the glitches were signs of bigger trouble brewing: Payments were starting to fizzle out. By mid-June 1995, two years into the deal, only $11.9 million of the $44 million in back taxes had been repaid, far less than projected. One thing the forecasts hadn't taken fully into account: These were the liens left after individual investors had picked over the most attractive offerings.

Mayor Schundler contends that, because Breen Capital's fees were based partly on the amount of liens outstanding, the firm dragged its feet in collections. Mr. Breen denies that. He claims the collection delay had to do with politics: The mayor, to allay criticism of the deal, wanted Breen to avoid foreclosing on anybody for a year. Mr. Breen says he agreed to this in a "handshake deal" that deprived his firm of its main leverage with property owners for a while. Mayor Schundler denies any such deal.

Later, Breen Capital started bulk foreclosures, filing more than 500 in early 1996. But this caused so much paperwork that dozens of file boxes piled up in the Office of Foreclosure in the state capital. As the delays mounted, another problem arose: Each year that owners continued not paying their taxes generated a new tax lien. It, too, could be bought by an individual investor, who would also have the right to foreclose. To protect its interests, Breen Capital had to buy out such investors, ultimately spending $5.2 million to do so.

This was money it intended to use in repaying the bonds issued to do the deal. Another Breen firm, Breen Capital Investment Corp., eventually stepped in and spent about $18 million to buy back the bonds at par ahead of their 7 1/2-year maturity.

Meanwhile, the slow collections dashed Jersey City's hope of collecting more money than the initial $25 million it received. Unfortunately, city officials had begun counting on the additional money to plug budgetary gaps.

Frustrated and facing criticism from a restive city council, the mayor's office turned to Bankers Trust, hoping it would whip Breen into shape. Bankers Trust had been given the role of ensuring proper handling of the tax payments, partly so bond-rating agencies would see that a big-name firm was involved. But Bankers Trust had subcontracted many of its duties to Breen. City officials soon concluded, based on meetings they scheduled, that Bankers Trust had little interest in playing an active part.

Mr. Breen and Mayor Schundler struggled to salvage the transaction but grew increasingly mistrustful, until in mid-1997 they stopped talking. The city filed a breach-of-contract and fraud suit in New Jersey Superior Court in Trenton. In an eventual settlement, with no party admitting wrongdoing, the city received about $6.25 million, $1.25 million of which came from Bankers Trust, according to people familiar with the matter. Bankers Trust won't comment on that or on the size of its fee for being in the deal at all, which others estimate at $2 million.

By that time, Jersey City's fortunes had recovered. The tax-collection rate is now up around 99%. But for Breen Capital and Bankers Trust, the worst was yet to come.

Next on the attack: lawyers representing hundreds of property owners who had used installment plans offered by Breen. State law explicitly says municipalities may offer such plans to people behind on their property taxes. It says nothing about other owners of tax liens. The many lawyers who vetted the deal in 1993 say there was nothing to indicate the installment plans weren't allowed.

"There was no case law on it, so what are you supposed to do -- not do the deal or make an assumption?" says James Moyer, a partner at the New York law firm of Sullivan & Donovan, which was the city's bond counsel. The plans were regarded as such a nonissue that they weren't mentioned in any of the legal opinions rendered by the bond counsel, by the city's own lawyer or by "deal counsel" Mudge Rose Guthrie Alexander & Ferdon, a once-prominent New York firm that is now defunct.

But others note that a 1969 state supreme court decision, while not addressing installment plans, had stated that parties have rights under New Jersey tax-sale law only if specifically permitted by statute.

Once property owners sued -- over this deal and one other that Breen Capital was involved in -- Judge Fuentes of Superior Court in Jersey City ruled that not only had the defendants set up an illegal payment plan, they also had levied excessive fees. And because of the way they calculated interest, it ended up totaling a quarter-point above the state limit. All this meant, he said, that they should return to the property owners not just the overcharges but all the money paid under the plans, and also forfeit the tax liens, effectively forgiving owners their back taxes.

Judge Fuentes also ruled that the defendants had violated the state's consumer-fraud law, which can lead to a trebling of damages. Breen letters such as the one sent to Mr. Varsalona, the judge said, put property owners in an "unfair bargaining position" where they could "either enter into an installment payment agreement, terms and conditions to be set by Breen, or lose their home."

He also cited Ms. Fails, whose job with the U.S. Postal Service pays her $38,000 a year. Breen set up a plan under which she would pay $676 a month for three years to pay off her overdue taxes plus interest. She says she fell behind in part because she lost one of the money orders she had bought. Breen foreclosed. Judge Fuentes said the fact that Ms. Fails got no credit in the foreclosure for the $3,740 she had paid on her back taxes up to that point was an "unconscionable outcome" that left her "homeless and deeper in debt."

Ms. Fails says she "realized my house was at stake and I was trying to do something about it, but there was nothing I could really do." She still lives in the house but now rents it. At 59, Ms. Fails says her plans to retire soon are now in jeopardy.

Mr. Breen argues that Ms. Fails and the others were no worse off than they would have been had the city retained their tax liens.

The judge, who had found for the plaintiffs in a summary judgment, ordered plaintiffs' lawyers two weeks ago to submit a proposed level of damages, the first step toward returning money to the property owners.

As news of the litigation spreads, it has put a chill on the business of applying Wall Street finance to tax liens. Even before the suit, some big financial firms that initially followed Mr. Breen's lead had dropped out. Of about $8 billion in delinquent property taxes nationwide, Wall Street has taken on about $2.2 billion, in just a handful of deals. Many of them have had problems.

New York City alone has handled about 40% of the total, in a series of deals. It is one of the few cities to have figured out how to do it successfully.

Meanwhile, flush with victory in Jersey City, the class-action lawyers have filed several similar tax-lien cases in New Jersey courts. "Everybody is spooked now because the litigation was very nasty," Mr. Breen says. "What seemed to be a wonderful product for the initial round of people has turned into a nightmare."


  1. "Wall Street has created securities based on everything from hurricane risk to the future royalties of rock star David Bowie. J. Douglas Breen had an idea, too: tax liens."  Research these two previous securitizations.  Were they more or less complex than the current one?
  2. In describing the value of the idea, the article says: "The city would instantly get millions of dollars from back taxes that were otherwise difficult to collect. Mr. Breen's investment firm, while paying off bondholders with collected taxes, would reap plump fees."  Why would an investment firm find it easier to collect back taxes that the city found difficult to collect?  What is the value added in this securitization?  What is the value added in securitizations, in general?
  3. The article says: "Municipalities do so routinely, and charge property owners up to the legal limit of 18% interest. But the judge said the private group's use of such plans, and other infractions such as effectively charging 18 1/4% interest instead of 18%." And later, it goes on to say: "not only had the defendants set up an illegal payment plan, they also had levied excessive fees. And because of the way they calculated interest, it ended up totaling a quarter-point above the state limit."  What is this method of calculating interest?
  4. What is the difference between individuals buying tax liens and buying tax liens in bulk?  Is it what the article implies?  Are there other differences?  Discuss.