Chapter 13 debtors sought a determination of the priority of two mortgages. A successor to the first mortgagee argued that the entire balance owed to it should be subrogated to the priority position of the first mortgage.
The timeline of events was as follows:
- 1982: Debtors granted a mortgage to secure advances under an equity loan plan. The mortgage included a provision that future advances would be secured by the mortgage “when evidenced by promissory notes stating that said notes are secured hereby.”
- 1989: A bank became the successor mortgagee under the 1982 mortgage as a result of a series of bank acquisitions.
- 1993: Debtors borrowed money and granted a mortgage to a second lender to secure the loan. The mortgage was recorded and included a reference recognizing that it was subordinate to the 1982 mortgage. The outstanding balance at the time the debtors filed bankruptcy was $221,000.
2000: The successor bank made a loan to refinance the outstanding balance under the 1982 equity loan plan of ~$6,000. The debtors granted a new mortgage to secure advances under the 2000 equity loan plan which was recorded.
- Neither the new 2000 equity loan plan nor the 2000 mortgage referenced the 1982 mortgage.
- The bank received a credit report and borrowers’ affidavit that did not disclose the 1993 mortgage. The bank did not obtain any title report.
- The bank recorded a satisfaction of the 1982 mortgage stating that it was “fully paid and satisfied.”
2001: The bank modified the 2000 equity loan plan to increase the credit line to $21,000.
- Again there was no reference to the 1982 mortgage.
- Again the bank obtained a credit report and borrowers’ affidavit that did not disclose the 1993 mortgage, but did not obtain any title report.
- 2015: The debtors filed bankruptcy.
The outcome turned on whether the bank was entitled to be subrogated to the first lien position of the 1982 mortgage. Under state law: “Subrogation is an equitable doctrine intended to ‘avoid unjust enrichment, and may properly be applied whenever a person other than a mere volunteer pays a debt and equity in good conscience should be satisfied by another.'”
To be entitled to equitable subrogation, the lender had to show that (1) it was secondarily liable, (2) it loaned money to protect its own interests, or (3) there was an agreement that the lender was to have security for its debt.
Under conventional subrogation, money must have been advanced “in reliance upon a justifiable expectation that the lender will have security equivalent to that which its advances have discharged, provided that no innocent third parties will suffer.” Conventional subrogation requires a definite agreement of the parties and will be granted only after a balancing of the equities.
In this case the court had no trouble determining that the ~$6,000 used to refinance the 1982 mortgage balance was entitled to priority based on conventional subrogation. The court concluded that it was evident that the parties intended that the 2000 mortgage continued to have first priority, and the second lender knew about the 1982 loan, so was not an innocent third party.
However, the additional advances that did not discharge pre-existing debt were a different story. Two critical facts were (1) the 1982 mortgage was discharged as fully paid, so that it could not be argued that the subsequent advances were secured under the terms of the mortgage, and (2) even if the 1982 mortgage had not been discharged, none of the 2000 or 2001 loan documents stated that the debt was secured by the 1982 mortgage (as required by that mortgage).
This was not necessarily the end of the matter because subrogation is an equitable doctrine. To be equitable, the new lender is required to have a “justifiable expectation” of receiving equivalent security. In this case the bank never ordered a title report. Arguably this means that it’s expectation of a first priority position is not justifiable. However, negligence is not necessarily a bar to subrogation if the equities favor it.
Some states require actual or constructive notice of intervening liens to defeat equitable subrogation. However the law applicable in this case “gives courts freedom in weighing the equitable concerns in each individual case.” As the court put it “equitable concerns reign supreme.”
In going through its analysis the court kept coming back to the fact that the additional advances would not have been entitled priority under the 1982 mortgage even if it had not been discharged. Since (1) the 1982 mortgage secured future advances only if they were evidenced by a note that stated it was secured by the mortgage, and (2) no such statements were included, the advances were not secure by the mortgage. Giving the bank priority for the additional advances would have put it in a better position than it would have been in if 1982 mortgage was still in effect, which would give the bank a windfall.
Thus, the court held that the bank was entitled to subrogation in the amount of ~$6, 000 (i.e. the amount of the original debt that was refinanced), but denied subrogation for the additional amounts.
Subrogation and the priority of future advances secured by a mortgage over intervening liens can vary significantly state-by-state. However, it is a good bet that a senior lender is going to have a hard time obtaining priority for an amount that is significantly higher than would be reasonably anticipated at the time the intervening lien arose.
Vicki R Harding, Esq.