Daily Development for Thursday, January 11, 2001

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; PRIORITY; PURCHASE MONEY MORTGAGES: Vendor's purchase money mortgage primes a simultaneous third party purchase money mortgage, even when the third party mortgage is first recorded, where the third party mortgagee is aware of the existence of the vendor's lien and there is no agreement to subordinate that lien. ALH Holding Co. v. Bank of Telluride, 2000 WL 1770035 (Colo. 12/4/00) (case not yet approved for final publication)

Seller sold property to buyer and took back a $110,000 purchase money mortgage to secure a part of the price. Buyer also gave a $55,000 mortgage to a bank to secure another part of the price. Seller and the bank were each aware of the financing arrangements with the other party. Although the parties did not enter into any agreement reflecting the relative priority of the two mortgages, the closing officer, apparently arbitrarily, recorded the bank's mortgage before it recorded the seller's mortgage.

Later, a dispute arose as to priority. The Colorado Court of Appeals held that the order of recording controlled, citing authority indicating that purchase money mortgage priority is subject to the recording acts.

On appeal to the Colorado Supreme Court: Held, Reversed. Although purchase money mortgages are subject to the recording acts, the bank in this case knew of the vendor's purchase money mortgage, and consequently was not a bona fide purchaser without notice. Therefore common law, and not the recording acts, control here. Under common law, the vendee's title necessarily passes to the vendee already encumbered by the agreed upon purchase money mortgage in the vendor, and there is no possibility that a third party purchase money mortgage can acquire priority over it without separate agreement.

The court cited Colorado authority supporting the notion that the execution of the deed and vendor's mortgage are considered simultaneous acts, such that the title never rests in the buyer unencumbered by the mortgage. "The purchaser is therefore never in a position to assign rights in the property without them being subject to the preexisting encumbrance, even to a party loaning him money for the purchase."

The court went on to discuss with approval the policy analysis of the Restatement (Third) of Property on the issue, although it cautions that "Colorado has never expressly adopted [this restatement]. The Restatement, in Section 7.2, would uphold the priority of the vendor's purchase money mortgage in this situation. The court quotes from that comment:

"[T]he equities favor the vendor. Not only does the vendor part with specific real estate rather than money, but the vendor would never relinquish it at all except on the understanding that the vendor will be able to use it to satisfy the obligation to pay the price. This is the case even though the vendor may know that the mortgagor is going to fiancne the transaction in part by borrowing from a third party and giving a mortgage to secure that obligation. In the final analysis, the law is more sympathetic to the vendor's hazard of losing real estate previouisly owned than to the third party lender's risk of being unable to collect from an interest in real estate that never previously belonged to it."

Comment 1: Note that in this case each side knew of the other. The Colorado court does not suggest what might happen if that were not the case, but it's analysis suggests that things might be different. The Restatement authors also are of that view.

Under Restatement comment 7.2, if neither knows of the other, then the vendor purchase money lender will prevail. Neither lender is a "subsequent purchaser" under the recording acts. "Here neither mortgage can meaningfully be said to be subsequent to the other, since both mortgages arise in the same transaction." Therefore, the policies favoring the vendor, discussed above, should apply.

If only one of the parties has notice of the other, according to the author's of the Restatement, the recording acts should apply, and the party lacking notice should prevail. "Even though delivery of the mortgage is essentially simultaneous, the party lacking notice must in fairness be treated as the subsequent taker and thus eligible for the protection of the recording acts. Thus, in a jurisdiction having a notice type recording act, the lender who takes its mortgage without notice of the other's mortgage prevails. * * * In a race notice type jurisdiction, the lender who takes without notice must also record first in order to prevail." [note that Colorado is a race notice jurisdiction.]

Comment 2: The editor has always felt that we should look for policy reasons to reach results here, rather than to look at real estate relationships as just a species of plumbing. The traditional approach to vendor's purchase money, voiced by the Colorado court, says simply that the vendor's mortgage comes first because it's attached to the title when it passes to the buyer. It's not physically attached, of course this is all an abstract construct to begin with. So why not look for reasons for our rules, instead of just pretending that ideas have real substance?

Fortunately, the Restatement supplies a rationale for the rule as applied by the Colorado court here. The editor also agrees with the extension of the Restatement's analysis to the case in which neither party knows of the other.

Note that where only one party knows of the other, Nelson and Whitman would conclude that the equities favor the party without knowledge, presumably on the theory that the party with knowledge is in the best position to insure full understanding and clarity. This is consistent with the position taken by the editor in yesterday's DD, dealing with a conflict between vendee's lienholder and a construction lender with knowledge of the vendee's contract.

But the editor feels that, again, the decision here should be based upon policy, and not upon recording acts. The Restatement would have it that the party lacking knowledge of the other mortgage would not obtain priority in a race notice jurisdiction if it failed to record first. Of course, in a case such as the one at hand, if a party did not know that there was a competing mortgage, it would not be in a position to give instructions to the closing officer to record its mortgage first. The competing mortgagee, having notice of the other mortgage, would have both the ability and incentive to instruct that its mortgage be recorded first. Thus, viewing the problem as subject to the "first recorded" rule of a race notice jurisdiction would reverse the policy result for no good reason. In the editor's view, the mortgages should be regarded as recorded simultaneously, and the "first recorded" rule ought not to apply. The Restatement begins with this position when it discusses the competing mortgagees problem at the outset, and its failure to adhere to the position in the case where only one competing mortgagee is aware of the other is an inconsistency.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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