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Fair is Fair for Competing Lien Holders

Mortgage & Lending Law and Real Estate Contracts & Transactions

On September 27, 2011, the California Court of Appeal held that a holder of a second deed of trust was entitled be a first position lien holder over the bank that recorded its deed of trust first on the property in question.  This is an exception to California’s “first in time, first in right” rule that provides whoever records a deed of trust first on property, has priority over competing lien holders.  This was made possible through the Court’s invocation of “equitable subrogation”, a theory that allows for a court to make a senior lien holder a junior lien holder when the fairness of the case requires that result.  Equitable subrogation allows a party who stands behind one or more lienholders under California’s “first in time, first in right” recording statutes to claim priority over the senior lien holder.  (Equitable subrogation is similar to the more common remedy of “equitable subordination” which applies in California and most other states.)

Facts

JP Morgan Chase, N.A. (“Chase”) made a residential loan to borrowers Jon and Julie Siems in order to pay off the two preexisting liens in first and second position.  Chase’s refinance loan was intended to be secured by a new first deed of trust (replacing the first and second liens) and the escrow instructions provided that the loan funds could not be paid if Chase’s lien was not in first position.  Meanwhile, Jon Siems also sought a business loan from Sky Bank, Banc of America Practice Solutions, Inc.’s (Banc) at the same time.  When the Banc loan was funded, Banc recorded a deed of trust against the property before Chase recorded its deed of trust.  Chase’s preliminary title report and title insurance did not contain any reference to Banc’s deed of trust and thus Chase did not have actual notice of Banc’s preexisting lien on the property.  After Chase discovered its deed of trust was in second position to Banc, Chase sought and obtained an order to have the Banc loan made junior to Chase’s loan through the theory of equitable subrogation.  Banc appealed.

Holding

Under the present facts, the “equities” or “what’s fair is fair” mandates that Banc’s deed of trust be junior to Chase’s lien.  This result is appropriate as Banc always intended its lien to be junior and behind two other liens.  The Court’s invocation of “equitable subrogation” provides both Chase and Banc with the result they bargained for: Chase received a first deed of trust for the amount it used to pay off the preexisting first and second deeds of trust and Banc’s deed of trust was junior to the first two deeds of trust.  Application of “equitable subrogation” was appropriate in this case as it gave the parties exactly what they intended with Banc receiving a deed of trust second to the two existing liens.

Takeaway

A court may use equitable subrogation to give the parties what they intended if “equity” or “fairness” dictates that result.  The holding of a case involving “equities”, “fairness” and an “exception” to the general rule should be taken with caution.  Even though the case does provide some protection for a lender that does not record its deed of trust before another creditor, given a small variation of the facts, the fairness of the case could have mandated a different result.  Here, the fact that Banc had never bargained for a 1st position loan was a factor in this case and the court’s result did not prejudice Banc.  A secured creditor should make sure to have an updated title report prior to funding any loan, regardless of the escrow contingencies.

If you have a matter related to this article, or anything else relating to real estate law, please contact Brewer Offord & Pedersen LLP at (650) 327-2900, or visit our website at www.BrewerFirm.com.

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