Daily Development for Wednesday, September 5, 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; SUBORDINATION; CIRCULAR PRIORITY:

Subordination agreement may operate to subordinate only to specifically identified junior liens, and will operate to transfer to beneficiary of subordination available senior status up to amount of subordinating liens as against intervening lienholder.

Bratcher v. Buckner, 109 Cal. Rptr. 2d 534 (Cal. App. 2001)

Looking behind the reported facts, it appears that Bratcher was engaged in litigation with Buckner and was about to obtain a successful judgment.

To stave off collection, Buckner established his property as a homestead, which in California results in protection of $20,000 in value. Buckner then executed a mortgage to his attorneys in the amount of $160,000 and then a mortgage to his own parents in the amount of $23,000. Bratcher, apparently stymied by these defenses, never did collect on the $18,000 judgment that he eventually received in his lawsuit. All of this happened in 1976.

In 1979, apparently without Bratcher's knowledge, Buckner borrowed $46,000 from the Small Business Administration and secured the debt with a mortgage on the same property. Both his attorneys and the his parents executed subordination agreements expressly subordinating their liens specifically to the SBA mortgage. The subordination agreements said nothing about the Bratcher lien.

Bratcher duly renewed his judgment in 1986 and 1996, as permitted by California law. By 1999, Bratcher's judgment had accrued interest and had grown to $94,500.

Apparently, over the intervening 23 years, Buckner had made no payments on the mortgages to either his attorneys or his parents, and the attorneys' lien, with accrued interest, had grown to $169,000. No interest accrued on the $23,000 mortgage debt held by Buckner's parents.

The property in question, however, had also increased in value. Buckner claimed that the value was $175,000, but Bratcher claimed that it was $275,000. Bratcher sought an order of sale to satisfy his lien claim. The trial court concluded that the result of the subordination was that Bratcher was junior to the SBA liens as well as to the liens held by the attorneys and the parents. As the court concluded that this would leave no value for Bratcher to reach, the court refused to order a sale, Bratcher appealed.

Under California law, property that is a homestead cannot be sold at foreclosure of a junior lien if the bids received would be insufficient to cover the homestead and all liens prior to the foreclosing lien. Buckner and Bratcher argued as to the meaning of this statute, but the appeals court, following precedent, concluded that the lower court should offer the property for sale and in order to ascertain what the actual final bid would be, and then determine whether there would be any amount available to Bratcher. If there was something that Bratcher could take from the sale, the court should confirm the sale and use the proceeds to satisfy the liens senior to Bratcher, paying the balance to him.

But the real question remained to be resolved whether in fact there would be any surplus for Bratcher. The answer to this question apparently depended upon resolution of the priority dispute among the parties. Bratcher contested the finding of the trial court that he was "last in line." He argued that the effect of the subordination was to put him first in line. The California Court of Appeals agreed with Bratcher, but only in part.

The court found that the subordination agreement was valid under its terms. It was effective to subordinate the attorneys' and parents' liens to the SBA loan, and did not subordinate those liens to Bratcher's lien. The result, however, was not to leave Bratcher in last place, but rather to create a circular priority. Bratcher was senior to SBA and junior to the attorneys and parents. But SBA was senior to the attorneys and parents.

The court cited extensive precedent from California and elsewhere to study how the circular priority muddle has been resolved. It noted that one authority acknowledged that no resolution has been completely satisfactory, but adopted an approach that it concluded would best serve the interests of fairness here. It awarded the SBA priority to the extent of the liens subordinated to it. These liens were senior to Bratcher, and Bratcher could have no complaint that his situation was changed. The SBA lien did not exhaust the available priority senior to Bratcher, so the parents and attorneys enjoyed the balance of their priority (one would assume that the attorneys continued to have priority to the parents with respect to this balance). After the balance of the original amount of priority for the attorneys and parents was applied, then Bratcher's claim would be satisfied. The attorneys and parents would have any balance.

The court noted that it didn't matter whose estimate of the value of the property was accurate, since in any event the trial court ought to order the sale to ascertain what the high bid would be. Obviously it is likely that Bratcher will be bidding at the sale, and if he concludes that the property is worth more than $175,000, he can "put his money where his mouth is" by bidding higher. Once the "priority allowance" established by the homestead and amount of the attorneys' and parents' liens is paid, Bratcher's bid will simply be a credit bid of his own lien.

Comment 1: The court notes that, for purposes of this appeal, Bratcher did not contest the validity of the attorney's and parent's liens. The astonishing generosity of the attorneys in this case deserves note, however. They did not seek to collect on the secured note for their fees even though there was a substantial amount of equity available to pay that note. Makes one wonder about the bona fides of that note to begin with.

Comment 2: Did Bratcher have the option of throwing Buckner into bankruptcy and challenging those prior liens in the bankruptcy court? Sometimes bankruptcy courts have more flexible rules for avoiding liens. Well, all those liens happened back in 1976 to begin with. Makes proof problems, at least, a lot more difficult. But, even if it all happened last week, Bratcher would have been better off using state court remedies. If a trustee in bankruptcy "strongarms" aside a real estate lien, junior liens don't slide up. Rather, under Bankruptcy Code Section 551, the "financial space" occupied by the avoided lien is available to the estate. If, on the other hand, Bratcher had been able to set aside the liens under state fraudulent conveyance statutes, then Bratcher would have been able to move up the food chain.

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

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