Equitable Subrogation: “Complete and Perfect Justice” Requires Party To Be Without Fault

Ocwen Loan Servicing LLC v. Summit Bank, N.A. (In re Francis), 750 F.3d 754 (8th Cir. 2014) –

A lender that attached the wrong legal description to its recorded mortgage sought equitable subrogation and/or reformation of the mortgage in order to obtain a first priority lien on the intended property.

A lender (GMAC) refinanced a mortgage loan on a home and surrounding land. Unfortunately, the recorded mortgage described adjacent property as the mortgaged property. The borrower made several attempts to have the error corrected:

  • The borrower brought the error to GMAC’s attention. It did not respond.
  • He ordered a survey so that a correct legal description could be prepared. GMAC’s answer was that it only worked from tax parcel numbers.
  • The borrower then obtained new tax parcel numbers. GMAC still did not correct the error. At that point the borrower apparently gave up.

He disclosed to two subsequent lenders that he intended to give GMAC a first lien on his property, although that did not occur due to the incorrect legal description. He also noted to one of the lenders that GMAC apparently had no intention of correcting its error.  Thus, at the time the borrower filed bankruptcy, the two subsequent lenders had first and second priority liens on the debtor’s property, and GMAC did not have any lien on the property.

Under state law “subrogation is an equitable remedy that rests upon principles of unjust enrichment and attempts to accomplish complete and perfect justice among the parties.”

A common instance of equitable subrogation involves a lender that refinances an existing first priority mortgage based on the expectation it will have a first priority lien, but for some reason the new lien ends up junior to liens that had been junior to the refinanced mortgage. Under these circumstances, “if not chargeable with culpable and inexcusable neglect” the refinancing lender will be subrogated to the rights of the refinanced lender.

However, the 8th Circuit distinguished this case from the typical circumstance because (1) GMAC did not have any lien on the property, as opposed to an inadvertent junior lien, and (2) the outstanding senior lenders obtained liens after the original mortgage was discharged, so this was not a case of unfairly allowing a junior lender to improve its position.

GMAC further contended that it should be given a senior lien because both of the new lenders had actual knowledge of the intent to grant it a first priority lien – arguing that an unrecorded deed is not valid against a subsequent purchaser unless it has inquiry notice.

The 8th Circuit rejected this approach because (1) the equities did not favor GMAC’s position – it knew of its error for many months and failed to correct it, (2) the court doubted that this principle applied to mortgages, since by statute a mortgage is a lien on property from the time it is filed for recording and not before, and (3) the blame lay entirely on GMAC. It made a mistake and failed to correct it even when the error was brought to its attention. In seeking equitable subrogation, a party “must be without fault.”

Legal descriptions often contain mistakes. It is puzzling that GMAC was so recalcitrant and did not take advantage of the opportunities to correct its mortgage. Regardless, obvious lessons to be learned are (1) if possible, don’t make mistakes in legal descriptions, and (2) correct any mistakes as quickly as you can once they are identified.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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