Daily Development for Monday, March 21, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

MORTGAGES; PRIORITY; SUBORDINATION: First lienholder’s agreement to subordinate its interest to a junior lienholder is not an agreement to subordinate to future advances subsequently made pursuant to a future advance clause in the junior lien.

NAB Asset Venture III, L.P. v. Brokton Credit Union, 815 N.E. 2d 606 (Mass. App. 2004)

In the 1960's Borrowers gave a mortgage to  BCU securing a $10,000 indebtedness.  In 1980, Borrowers gave a second mortgage to MBTC securing  $180,000 note and certain obligations under a guarantee of another mortgage loan.

In 1984, Borrowers desired to increase their mortgage indebtendness to BCU, and apparently MBTC had an interest in cooperating by subordinating the MBTC mortgage to a new BCU mortgage.  MBTC subordinated its 1980 mortgage to BCU’s 1984 mortgage.

The 1984 BCU mortgage secured a note for $66,000 and “all other direct and contingent liabilities of the Mortgagor hereof to [BCU] whether now existing or hereafter contracted.”  The court describes this clause as a “dragnet” clause.  Although, two decades later, an MBTC loan officer testified in deposition that it was not MBTC’s intention to subordinate to the “dragnet” clause, it produced nothing in writing documenting that claim.  (The case was decided on summary judgment, so we have no record to speak of).

Later, another lender, Shawmut, also took a mortgage from Borrowers, and thereafter, in 1989, Borrowers also gave an additional mortgage to BCU, securing a revolving credit agreement, and Shawmut subordinated to that.  (Such cooperative lenders!!!)

Guess, what?  Borrower eventually defaulted, MBTC foreclosed, obtained title at the sale, and then sought declaratory relief that its lien was subordinate only to the face amount of the $66,000 note secured by the 1984 BCU mortgage, and not to advances made by BCU thereafter.

The court agreed - on summary judgment no less.

The court began by saying that Massachusetts law generally favors the borrower’s position on dragnet loans, refusing to grant secured status to subsequent advances unless those advances are “generally related” to the original debt or the intent of the debtor otherwise is clear  that these advances are secured by the original mortgage.  This is consistent with common law in many jurisdictions.

Here, however, the question before the court was not the protection of the debtor from overreaching by the lender, but a priority dispute between two lenders.  The court acknowledged that, as against other lenders, advances made pursuant to a “dragnet” or “future advances” clause are generally held validly secured with priority  when they occur before  the attachment of the other lenders’ liens.  But where a lender or another party obtains an interest in the security before  the making  of an advance by the original “dragnet” lender, Massachusetts courts are more circumspect, apparently even where it is clear that the borrower intends that the earlier mortgage will secure the new advance.

The court says that the future advances clause will not provide priority to the original lender as to advances made after another party has obtained an interest in the property.  The subsequent interest will “prime” the lien for the later additional advances.   Interestingly, the court does not say whether the rule is true both for optional advances made by the first lender and “obligatory” advances - those made pursuant to a binding commitment to lend (such as lines of credit or many construction loans.)  The distinction is not significant here, since the new loan made by BCU in 1989 appears to have been “optional.”

The general common law rule (now disputed by the Restatement of Mortgages) is that optional advances do not enjoy the original priority of the future advance mortgage as against known subsequently arising interests attaching prior to the optional advance, but that “obligatory” advances do enjoy that original priority.  The editor suspects that the Massachusetts is just acknowledging that rule here, although it doesn’t mention the “optional/obligatory” distinction.

But the application of the traditional common law rule to the instant case is still a little problematic, because MBTC’s lien was not “subsequently arising,” but rather arose prior to the original future advances clause and became a junior priority interest pursuant to a subordination agreement.

The court, however, concluded that the narrow reach typically given to future advance clauses as against junior interests mandated that the intent of any attempt to subordinate by a future advance loan be read very narrowly.  Unless the parties clearly indicate their intent that the subordination is valid as to the “dragnet” feature of the prime loan, the court will not infer an intent to subordinate.

Comment: The purpose of the “optional/obligatory” distinction usually is said to be to preserve the “mortgageability” and transferability of the property for the debtor by preventing the original dragnet lender from tying up the property with a monopoly on the security value in the property

But is that purpose served by protecting MBTC here?  Note that any other lender, buyer, lessee, or dogcatcher was free to obtain an interest in the property that would prime the lien of any advances made by BCU.  There really was no concern that the Borrowers’ property was tied up in any significant way by honoring the priority of the BCU lien.

MBTC and BCU were commercial parties engaged in complex and technical arrangements.  They deserved to have their agreements given the meaning expressed by their language.  There is no supervening policy here that should outweigh commercial predictability.  The logical meaning of its subordination to the BCU mortgage was that MBTC was subordinating to all the rights of that mortgage.  Unless contemporaneous documentation or similar evidence indicated that the parties placed a different meaning on the subordination agreement to which they openly agreed, what benefit is served by denying to BCU its legitimate expectation that future advances it made primed the MBTC lien?

The case is wrongly decided.  We’re not dealing with widows and orphans here.  If MBTC had a different intent than that expressed in the subordination agreement, it should have had the burden of clarifying that intent.

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