Daily Development for Wednesday, October 24, 2001
By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu
MORTGAGES; MODIFICATION: Modification agreements to senior lien loan that
increase interest rate, cross collateralize with other loans, or increase costs
secured by mortgage in event of default will be disallowed versus interest of
subordinate mortgagee. Extensions of
time for payment of the senior lien note, however, will not automatically lead
to loss of priority.
Burney v. McLaughlin, 2001 WL
1143226 (Mo.App. S.D. 9/28/01)
Burneys owned two adjacent parcels.
They constructed a motel on Parcel One, and sold that parcel to
C&J. In this deal, C&J paid $1
million cash, to Burneys, paid off Burneys' $1 million construction loan,
replacing it with a new loan from Bank, secured by Parcel One, and gave a note
to Burneys for another $1 million, also secured by Parcel One.
Burneys executed an express subordination of the priority of their purchase
money deed of trust to Bank's deed of trust on Parcel One.
Subsequently, C&J acquired Parcel Two from Burneys with money borrowed
from Bank, and constructed an addition to the motel on Parcel Two. The acquisition and construction loans were
at first secured only by Parcel Two.
Later, however, C&J gave Bank a new deed of trust on Parcel One
securing this loan. This new deed of
trust, everyone agreed, was subordinate to both the Bank's original deed of
trust on Parcel One and to Burneys' deed of trust on Parcel One.
Soon thereafter, the project got into trouble, and there ensued a series of
modifications and extensions of the C&J loans as the parties attempted to
accomplish a workout of the project's difficulties. These modifications at first were simply extensions of the
payment structure of the C&J structure.
Later they included increases in the interest rate, and, in the last few
adjustments, the Bank also added a cross collateralization clause, linking the
Parcel One and Parcel Two loans, and provisions adding additional "closing
fees, appraisal fees and provisions relating to bankruptcy [unspecified]."
Ultimately, C&J just surrendered and notified Bank that it would not
reopen the motel following the traditional winter closing. The Bank filed for foreclosure, intending to
sell Parcel One and Parcel Two at foreclosure together as a single
operation. Burneys obtained a temporary
restraining order enjoining the foreclosure pending resolution of priority. Burneys
claimed that Bank had lost its priority over the Burney lien through its
frequent modifications of the secured loan on Parcel One.
The trial court granted the injunction and found that the Bank lien was
subordinate to Burneys'. The Court of
Appeals here reversed, at least in part, holding that the foreclosure could
proceed as to Parcel One. The Bank did
not lose its priority merely because it had extended the date of payments under
its Parcel One secured loan. But the court held that the modification
agreements that altered the interest rate and other terms (aside from payment
date) would not be effective as against Burneys.
The court virtually incorporated the provision of the Restatement of
Mortgages Section 7.3(b), which establishes that, even absent any language in
the instruments, the parties to a mortgage loan may modify the terms in ways
that do not injury interest of junior lienholders and retain the priority of
the original secured position. The Restatement
indicates, as does the weight of authority, that a simple extension in terms of
payment will not normally do injury to the interests of juniors, but does allow
for the possibility that this might not be true in a particular case. The Restatement is quite clear that cross
collateralization, increase in the interest rate, or increase in the secured
amount are all changes that would detract from the status of junior lenders,
and will not enjoy priority.
Comment 1: The case is correct, and consistent with authority. The editor's only caveat is that there may
in fact be a case in which an alteration in a payment schedule would work to
the disadvantage of the junior interest.
Further, the editor believes that a junior lender who is interested in
restricting the mortgagee from making any changes in the terms of the senior
lien could easily do that. The editor
hasn't seen the case in which this has been done. Certainly any such changes could be made an event of
default. The bigger question might be
whether such an agreement really could inhibit the ability of the senior to
make a deal with the mortgagor anyway, retaining priority. The junior might not find out about such a
deal until it is too late (of course, in theory, if the junior can show injury,
then it will not be subordinate, but this may not solve every problem -
especially in cross collateralized loans and interdependent projects). Perhaps a better approach would be for the
junior to notify the senior of its contractual inhibitions and rely upon a
potential tort claim for interference with contractual relations as a deterrent
to the senior's proceeding to make any changes.
Comment 2: Needless to say, the
senior can dodge all these problems by placing a provision in its mortgage
permitting it to modify the senior lien.
The Restatement Section 7.3(c) validates such provisions as preserving
priority, but the editor notes that the discussion in the Restatement
acknowledges that there may be some policy argument running contrary to this
position in jurisdictions that attempt to preserve the junior's ability to deal
with its equity in the case of, say, the future advance mortgage. A jurisdiction that follows the
"optional/obligatory" test in that area may feel it appropriate to
place some inhibitions on the ability of the senior lender to completely tie up
the property by authorizing unlimited modifications.
The instant case specifically refused to consider or approve Restatement Section 7.3(c), since there was no contract provision in the senior Bank note or deed of trust here that authorized modifications.
Readers are urged to respond, comment, and
argue with the daily development or the editor's comments about it.
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