Daily Development for Thursday, October 19, 2006
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; EQUITABLE SUBROGATION: Another precinct reports - Minnesota finds that institutional lenders have a special duty of care to check records, and denies equitable subrogation where lender failed to double check land records and missed a late recorded mortgage that went unpaid at closing.

Ripley v. Piehl, 700 N.W. 2d 540 (Minn. App. 2005)(rev. denied 10/18/05)

Although it seems that we have reported on this issue ad nauseum, new cases are always coming down and jurisdictions are taking distinctly different positions on the basic questions of the availability of equitable subrogation to refinancing lenders.  So it is useful to note the new decisions. 

Here, Hewitt was purchasing property under a contract for deed, had some federal tax liens, and owned Ripley $250,000.  Hewitt applied for a loan from Bank to acquire the title to the property from the contract seller.  The Bank checked title at the time of the application.  Thereafter, Hewitt gave a recorded mortgage to Riply to secure the $250,000.  More than a month later, the bank closed on the refinancing loan without it or its title insurer checking the records again.  Hewitt provided an affidavit that there were no other liens that would remain unpaid following the closing and the court commented that there was absolutely no doubt that the lender expect to receive a mortgage on an unencumbered title. 

There followed some interesting shenanigans by Ripley that apparently the court concluded had no bearing on the subrogation issue. 

Hewitt quickly fell into default on both the Riply mortgage ($255,000) and Bank mortgage ($330,000) and Ripley brought a foreclosure action.  Bank responded by asking to be subrogated to the installment land contract and tax liens that its loan proceeds had paid off.  The court rejected the claim.  It acknowledged that there are three prevailing approaches now being followed on the question of whether subrogation is available: (1) Actual knowledge of prior liens at time of the second mortgage will preclude an subrogation to earlier liens retired from the second mortgage proceeds; (2) actual or constructive knowledge will block subrogation; (3) knowledge is generally irrelevant - all that matters is whether the proceeds were in fact used to retire the prior liens and other equities are appropriate (the Restatement approach).

The court concluded that Minnesota, for reasons that the court seemed to support, followed the second rule - even constructive knowledge will bar subrogation, at least for a junior lender who should have and could have checked the record and discovered the prior liens.  The court quoted from Eighth Circuit authority discussing the Minnesota approach, and specifically targeting institutional lenders and their title insurers: 

[T[he Eighth Circuit Court of Appeals, applying Minnesota law, held that a title insurer's failure to perform a title search--which would have disclosed the existence of prior federal tax liens against the subject property--was not an excusable mistake of fact warranting application of its subrogation rights as against the government. . . .

. The court wrote:

We believe that . . . the Minnesota courts impose stricter standards on professionals than lay persons in assessing whether mistakes are "excusable" for purposes of the doctrine of [equitable] subrogation, especially when the professional relationship arises out of a commercial transaction involving consideration. It is unreasonable to believe that the Minnesota Supreme Court would distinguish a title insurer from a bank; both are professional enterprises experienced in the area of secured transactions involving real property.

The court also stated:

[Appellant title insurer ] Universal is a professional enterprise, which is in the business of insuring marketable title to real property. Although Universal contends that it exercised prudent business practices in investigating the title to the ... property, it fails to explain what precautions it took or why it failed to discover the properly recorded federal tax lien. Its claim that it sought and received assurances from the seller that there were no liens, other than those discharged at closing, is patently insufficient.... Universal's inability to explain its failure to find the properly recorded federal tax lien is significant, because Universal had the burden of persuasion at trial of demonstrating its entitlement to subrogation.... Universal's failure to detect the federal tax lien resulted from negligence, and therefore, it is not entitled to be legally subrogated to the rights of the prior senior lienholders. (citations omitted).

Comment 1:   The editor has always been of the view that equitable remedies cannot be ordered off a menu.  There must be “good equities” to support this special form of relief, and the editor, like the Minnesota courts, has always wondered why a Bank that ought to be in the business of lending money against confirmed value in security, should get a “free pass” when it is negligently in checking the security, as it appears was the case here. 

Maybe things would be different where a document is treated as recorded and prior but, as a practical matter, is unindexed and undiscoverable.  Then the bank may have an equitable excuse, but it does not appear that was the case here.

As the reporter in the Minnesota current developments report noted: Practice tip: Update title prior to closing.  (Well, duh!!!)

Comment 2: As indicated above, there were some shenanigans not mentioned by the court except in the statement of facts.  After Hewitt gave the mortgage to Ripley, he gave Ripley a quitclaim deed to the property, which Ripley didn’t record until after the Bank mortgage.  As the Bank lacked constructive or actual notice of the deed to Ripley, the Bank would have priority over the deed.  But that fact is neither here nor there, since Ripley’s earlier recorded mortgage was in the record.

But why didn’t the deed to Ripley extinguish the mortgage by merger?  No comment from the court.  Interesting.

Readers are encouraged to respond to or criticize this posting.

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