Daily Development for Thursday, June 28, 2001

Daily Development for Wednesday, June 20, 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 MORTGAGE:

Mortgage that refinances buyer's obligation under a preexisting installment land contract is a purchase money mortgage, even when given to a third party lender, and has priority over prior recorded liens against contract vendee.

Graves v. American Acceptance Corp., LC No. 96511648, 20010515_c215141(45)_215141.opn.pdf (Mich. App.5/15/01)

Mortgagor and his wife had an existing vendee's interest under an installment land contract at the time of a divorce settlement through which mortgagor obtained the sole right to the equitable interest existing under that contract subject to a lien in favor of mortgagor's divorced spouse for child support in arrears, rent for the property (apparently relating to the mortgagor's period of sole occupancy during the divorce proceedings) and for arrearages on the installment contract itself as they existed at the time the lien was ordered.

The court lien was recorded about a month later. On that same day, mortgagor entered into a mortgage with a lender to refinance the balance due under the installment land contract, including, apparently, those arrearages which were mentioned in the earlier lien. Subsequently, the mortgage lender assigned the mortgage to Assignee..

The Court of Appeals, citing the new Restatement of Property, Third (Mortgages), held that the mortgage had priority over the lien.

Priority arose not because Assignee claimed bona fide purchaser status under the recording acts (indeed, the deed to the mortgagor from the contract vendor conveyed title subject to "acts or admissions of grantee since

8/25/87 being the date of a certain land contract in fulfillment of which this deed is given)." Rather, the Assignee had priority due to the application of the traditional common law rule giving priority to purchase money lenders over any preexisting liens against vendee, whether recorded or not.

The court noted that this was a case of first impression in Michigan (where installment land contracts are more prevalent than in most other states), and the court noted a split in the authority on the point in other states. Cases in Illinois and Indiana found in favor of the purchase money mortgagee's priority, while cases in New Mexico and Oregon did not.

The court noted that Michigan did have authority finding that third party lenders enjoyed the same status as vendor purchase moneylenders. It referred to the rationale for the purchase money priority rule discussed in the Illinois case that parties providing purchase money financing ought to be encouraged to do so by providing priority in these cases, where the lien of their mortgage necessarily covers only that portion of the value of the property that does not, at the time of the mortgage, represent any "equity" in the property held by the mortgagor. Any preexisting liens against the mortgagor's interest, although subordinated to the purchase money mortgage, still enjoy attachment to the extent of the mortgagor's preexisting equity in the property, and consequently suffer no diminution in their security rights. That part of the value in the property covered by the purchase money mortgage is essentially value made possible by the mortgage itself.

Comment 1: The rule is a sensible one, and the editor concurs with the Restatement that it ought to apply in these circumstances. Of course, it is true that the prior lien against the vendor now is junior to an additional lien, and this may create difficulty for the lienholder as a practical matter in realizing upon its security interest. But the rule nevertheless makes sense in order to encourage lenders to finance the acquisition of the title by the buyer, which in fact may make it more likely that the prior lienholder's interest will have some value. In this case, for instance, the installment land contract was in default, and the contract vendor, had the contract not been refinanced, might have forfeited the vendee's interest, leaving nothing for the lienholder at all.

Comment 2: The rule usually is applied against judgment lienholders of the contract vendee, and their interests, of course, might also attach to other property held by the judgment debtor. But it also has been applied against property tax liens and other liens unique to the property in question.

Comment 3: This decision has raised some questions in the Michigan Bar, and the editor notes these comments that have been posted regarding the decision in Michigan:

(First Commentator) I agree with the Court of Appeal's reasoning. But for the purchase money mortgage the wife would have only had a lien on the vendee's interest not the fee title that was foreclosed by the purchase moneylender. Just as she would have had to clear the default to avoid foreclosure of the senior vendor's interest to save her lien position she need to cure the default on the mortgage or redeem from the foreclosure.

I don't think this decision affects the land contract mortgage statue.

Had the wife been a mortgagee under a land contract mortgage perhaps she would have received notice of the foreclosure of the purchase money mortgage and cured the default or redeemed the property.

(Second Commentator) At first blush, it seems to me that a Land Contract Mortgage on the vendee's interest, and a judgment lien on the vendee's interest, would enjoy the same position visavis a mortgage, the proceeds of which are used to payoff the land contract balance and acquire "title" in the vendee. So, the impact of this case would be the same on a Land Contract Mortgagee of the vendee's interest. And, here we go, again, on the issue of a vendee's "equitable title" vs legal title. I am not sure I agree with (Comment 1) what if the mortgage, in this set of facts, is in an amount greater than the land contract balance? It would appear that this is a case of first impression, and I would like to see us "debate" it, and see if we collectively agree or disagree with the Court of Appeals decision, then if we do, we ask to intervene.

[In response to the concern raised by the second commentator, the editor responds that if the mortgage is indeed in an amount greater than the outstanding balance of the installment land contract, then, to that extent, it is not financing the purchase price under the contract and should not be afforded the special priority available to purchase money lenders. The editor notes, however, a few decisions that have afforded purchase money status to purchase money/improvement loan mortgages, where the proceeds have been used to improve the value of the property. The editor, lacking research facilities on the road, is not certain that such cases have involved the question of priority, but they do raise a nice question if indeed the proceeds of the mortgage have been used to improve the value of the property.]

Comment 4: Note that one complexity this concept introduces is the problem of circular priorities. Prior judgment liens against the buyer's interest may be senior to other interests attaching to the property after it has been financed by the purchase money mortgage. If the purchase money mortgage is not recorded,, however, it itself might be subordinate to these subsequent interests, although remaining prior to the judgment liens.

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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