Daily Development for Tuesday, August 11, 2009
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

MORTGAGES; SUBROGATION; FRAUD: Junior mortgage holder entitled to equitable subrogation to the rights of prior construction mortgagee where it advanced funds to pay off prior encumbrances with the express understanding that it would be secured by a senior lien on the property, even when there is no actionable fraud by the party against whom subrogation operated and even when the entire amount of the construction mortgage was not paid off. .

 Byers v. McGuire Properties, Inc., 2009 Ga. Lexis 243 (Ga. 2009).

Manager of homebuilder assisted homebuilder in obtaining construction loan from bank ("Construction Lender") for development of subdivision secured by a security deed on the propeerty. Manager of homebuilder later took note for payment of management fees secured by security deed on same property.

Lot purchaser then entered into contract with homebuilder to purchase lot and financed purchase with loan from second bank ("Purchaser Money Lender") who put security deed on property. At the time of closing on lot purchase, neither the closing law firm nor independent title examiner discovered the security deed of the manager, and neither the purchasers nor the Purchaser Money Lender had any knowledge of its existence. After homebuilder filed for bankruptcy, manager tried to foreclose on the lot pursuant to its security deed. The purchasers and the Purchase Money Lender sued the manager and others for cancellation of the manager's security deed based on alleged fraud, a decree to quiet title, and equitable subrogation. On cross-motions for summary judgment, the trial court entered an order granting summary judgment to the manager regarding the complaint and in favor of the manager on its quiet title counterclaim. The purchasers appealed that decision to the Court of Appeals which
 transferred to the Georgia Supreme Court.

The purchasers and the Purchaser Money Lender argued that the manager intentionally waited until shortly before the lot sale closing to file its security deed, knowing the delay in indexing would make it impossible for the security deed to be discovered in a title examination, which "silence" was fraudulent. The Court, however, noted that, under Georgia law, one is not bound on all occasions to give warnings to incautious people. No duty to speak arises from the mere fact that a man is aware that another may take a prejudicial action against him if the real facts are not disclosed. Furthermore, to sustain a claim for fraud, the plaintiff must show he relied on the words or conduct of the defendant to his detriment. The Court found no evidence of fraud or constructive fraud on the part of the manager that would have required denial of its motion for summary judgment.

The Purchaser Money Lender further argued, as an independent grounds for subrogation, that, at the time of  the closing on the lot, the homebuilder and the Purchase Money Lender had an understanding that the funds advanced were to be secured by a senior encumbrance on the property.   The court accepted this argument.

The court noted that the fact that the advance didn't fully satisfy the construction loan secured by a first security deed didn't violate the rule that when less than the total amount of the debt is tendered, subrogation isn't permitted. The rationale behind that rule is that equitable subrogation shouldn't prejudice the senior lienholder's attempt to collect the entire indebtedness secured by the senior lien. In this case, the Construction Lender's rights weren't prejudiced by the Purchase Money Lender's subrogation because the Construction Lender agreed to release its entire lien on the lot in exchange for partial payment of the debt. As a junior lienholder, the manager had no standing to complain that the Purchase Money Lender hadn't paid the entire indebtedness. Furthermore, the Court found that since the manager was a junior lienholder anyway (second to the Construction Lender), the Purchase Money Lender's right of subrogation wouldn't prejudice the manager's rights because i
ts security deed would remain in second priority position. Based on that analysis, the Supreme Court reversed the trial court's award of summary judgment in favor of the manager and ruled that the Purchase Money Lender was entitled to summary judgment on its claim for equitable subrogation.

Comment 1: This is an interesting case not only because subrogation was permitted for less than the senior debt.  Although the purchase money lender was innocent, so was, apparently, the construction manager.  The Restatement and some courts have ruled that there is no need to “balance the equities.”  The only “equity” necessary is that the party seeking subrogation paid off a senior debt and the party fighting subrogation cannot prove reliance on an record apparently clean of the senior debt.  The Georgia court didn’t have to reach that question here.  The purchase money lender had an “equity.” 

Comment 2: Compare:  Casstevens v. Smith, 2008 WESTLAW 4660152 (Tex. App. 10/23/08) The DIRT DD for 11/11/08) Victim of fraud who advances money to pay senior mortgage may not acquire subrogation as against subsequent purchaser of property at foreclosure of junior mortgage. [Here - the foreclosure purchaser could argue reliance.] Also compare:  Lawson v. Brian Homes, Inc.,   6 So..3d 7, (Ala, Jul. 18, 2008)  (purchase money mortgagee cannot be subrogated to construction lender so as to obtain priority over mechanic’s liens attaching as of commencement of construction, even though construction lien did have priority, having been recorded prior to construction.

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