Readers who have suffered through massive traffic on title insurance issues over the last two weeks may be critical of my starting another firestorm here. But this case is just too juicy (and too important) to ignore. Have at it, folks!!

Daily Development for Wednesday, September 26, 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; PRIORITY; SUBROGATION: Equitable subrogation to refinanced senior lien not available to a title company defending an insured refinancing lender as against a judgment lien recorded after the original mortgage but after the refinancing mortgage.

Kim v. Yakima County Title Co. 2001 WL 1095731 (Wash.9/20/01)

Changs desired to assist Lees, their daughter and son in law, to obtain a house. In 1995 they obtained a house in Yakima County, Washington and executed a note to a Sterling Trust. The note was for a six year term and carried an interest rate of 10.5%. The Lees moved into the house and made the payments on the Chang note.

In 1997, Kim obtained a judgment against the Lees in another county, and later that year recorded the judgment in Yakima County. At that time, Changs, and not Lees, were legal owners of the Lees residence, but, later in 1997, Changs quitclaimed a one half interest in the house to the Lees.

In April of 1998, apparently oblivious to the effect of the outstanding judgment, the Changs and Lees decided to arrange for the Lees to take full title to the property and to refinance the Sterling loan. Changs deeded the other half of the property to Lees by quitclaim deed, and Lees executed a 30 year, 6.75% note to Pioneer, together with a deed of trust.

The entire proceeds of this loan were used to pay off the Sterling note and Sterling released its deed of trust.

Yakima Title Company insured the lien of the Pioneer deed of trust.

Yakima apparently missed the properly recorded Kim judgment lien, and neither disclosed its existence nor included it as an exception to coverage in the policy. Soon thereafter, Pioneer assigned the note to Countrywide, and Countrywide, apparently, assigned to PHH. PHH recorded an assignment of the mortgage (there is no indication who took possession of the note.)

At the same time these assignments were going on, Kim's lawyer contacted Yakima Title to inform it of the existence of Kim's mortgage lien, which Kim's lawyer now assumed was in first position . A few days later, Yakima Title, with actual knowledge of Kim's lien claims, issued a new ALTA mortgagee's policy to PHH, the assignee of the loan.

The court does not explain why it was necessary to issue a new policy to Pioneer's assignee. Perhaps the earlier policy had not been an ALTA policy and such a policy was required by the secondary market in which PHH was participating.

There ensued a little procedural chess game as Kim's lawyer attempted to execute on the judgment lien and Yakima attempted to block the execution, at least to the extent that the execution sale would wipe out the PHH interest. (The court doesn't mention Lee's interest in all of this either the Lee's didn't get a policy or had some kind of homestead protection of their equity, if any). Yakima Title appeared to be the real party in interest in this case, although the court does not indicate whether Yakima Title actually paid PHH and formally invoked its subrogation rights under its policy. The dispute eventually wound up in the Washington Court of Appeals, which found that the PHH deed of trust was subrogated to the position of the Sterling deed of trust and that Yakima Title was entitled to benefit from that subrogated position.

Hence, the Kim lien was junior to the deed of trust.

The Supreme Court of Washington reversed, concluding that, although Washington (on an issue of first impression), would recognize the doctrine of equitable subrogation of mortgages, it was inappropriate to apply that doctrine in this case, since the title company had constructive notice of the judgment lien when it insured Pioneer and actual knowledge when it insured PHH.

The court, cited Nelson & Whitman's treatise on Real Estate Finance Law, concluded first that equitable subrogation would be available only to a refinancing lender. The court further determined that it would "adopt the principle of subrogation in the mortgage loan context as set forth in the Restatement (Third) of Prop. : Mortgages sec. 7.3: "(a) If a senior mortgage is released of record and, as part of the same transaction, is replaced with a new mortgage, the latter mortgage retains the same priority as its predecessor, except (1) to the extent that any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest in the real estate, or (2) to the extent that one who is protected by the recording act acquires an interest in the real estate at a time that the senior mortgage is not of record."

The court dealt with two issues. The first was whether the PHH lien would qualify for under the Restatement test as a "replacement mortgage." The court concluded that the fact that the new loan was for a different interest rate and a different term, and with different mortgagors, would not preclude it from being treated as a refinancing loan.

After concluding that the PHH loan was a refinancing loan, despite the differences from the loan it paid off, the court went on to analyze whether this was a situation in which equitable subrogation ought to apply. It noted that the Restatement of Mortgages would grant subrogation to a refinancing mortgagee even in the situation in which the mortgagee had actual knowledge of an intervening lien. Dealing with the issue as a matter of first impression in Washington, the court rejected that notion, at least insofar as title insurers were concerned.

The court concluded that when the refinancing lender's position was that of a title company, equitable subrogation would not apply because it was inequitable to the intervening lienholder. It cited a 1966 case in which the court had granted subrogation to some parties, but had denied it to a title insurer. In that case, the court had set forth the notion that "it was not the province of the court to relieve a title insurance company of its contractual obligation," to insure title."

The Lee court here, went on to reason that title companies occupy a unique place in real estate transactions:

The role of the title insurer is to insure title; "either they insure or they don't." . . . Generally, the role of the title insurer is relied upon by the lender, judgment creditor, and other lienors. Just as a lender relies on the title insurer to commit that title is vested in its borrower, subject only to known exclusions, judgment creditors and other lienors rely on title insurers to prevent a debtor from conveying real property without first satisfying a perfected lien.

"I the instant case, legal remedies and equity suggest that the loss should fall on the title company rather than the innocent judgment creditor."

Comment 1: This is a perfectly awful opinion apparently misconstruing the treatise and Restatement authority upon which it relies, and then twisting to a rule of law that sticks losses to title companies in a way that is not only unreasonable but impractical. In the manner of the blind pig that finds the occasional acorn, however, the opinion actually meanders to what the editor concludes is the correct outcome.

Comment 2: For openers, at common law, the benefit of granting equitable subrogation to the position of a cancelled senior lien normally is not limited exclusively to refinancing lenders. Although, indeed, lenders who pay off earlier loans are frequent beneficiaries of the doctrine, it also has been used to protect foreclosure purchasers as against junior lienholders omitted at the sale or others with sufficient equities to justify the result.

Comment 3: Further the "doctrine of equitable subrogation" that the court characterizes as embraced by the Restatement of Mortgages in Section 7.3 is not a doctrine of subrogation at all. Other sections of the Restatement deal with subrogation. Section 7.3 deals with the question of whether an existing senior lienholder can continue to enjoy that status as against junior parties when, through an agreement with the mortgagor, it replaces or modifies its own senior lien. In that context, it is relevant to ask whether the modifications will adversely affect the junior lienholder.

In classic equitable subrogation, the party seeking subrogation is not granted the priority for its own lien, but rather is substituted to the rights represented by the lien to which subrogation is sought. Indeed, it is the very fact that the junior lienholder is not typically injured in any way that has led many courts to provide subrogation quite liberally.

Of course, if, following subrogation, the party enjoying that status seeks to make changes in the senior debt or security rights, its right to make those changes ought to be determined according Section 7.3. But that is quite a different question as to whether subrogation will be available in the first instance.

Comment 4: It is perhaps because of the conflation of equitable subrogation principles and modification principles that the court falls into an analysis that leads it to protect "innocent" junior judgment holders from the subrogation claims of title insurers. In most subrogation cases, the junior party is "innocent," but the question is somewhat moot, since the real justification for subrogation is that the junior party's position remains essentially unchanged.

Comment 5: The above analysis, however, does not explain the court's total misunderstanding of the role of title insurance companies. It suggests that junior judgment lienholders rely upon title companies to see to it that they are paid off when real estate closing occur. This would be news to most title insurers and, the editor suspects, to most judgment lienholders. Although title insurers do play an important role in bringing about clear understanding of title issues and making it possible for many parties to take risks based upon their insurance, there is no process in the title insurance operation designed to confer any benefit upon record judgment lienholders. It may be true that, as a byproduct of clearing title in preparation for a first lien mortgagee to make a loan, the parties to a transaction may provide for the payment of senior liens. But the parties to a transaction in which title is insured could as readily transfer property subject to such liens. They would have an exception in their title policies, but they could make a price adjustment to deal with the issue.

The court's conclusion that title companies have some kind of duty to insure that judgment lienholders are paid when the property changes hands goes far beyond the scope of a title insurer's duty that this editor, who has been somewhat on the radical side of the "title examiner's duty" debate, has every espoused.

Comment 6: Even if there was legitimacy to the imposition of a duty upon insurers toward judgment lienholders that courts should recognize, the device of denying equitable subrogation does little to protect the interests of the lienholders. In most cases, a title company faced with a missed judgment lien could easily bargain with the insured junior lienholder to take an assignment of that lienholder's rights. Now the title insurer's interest is not that of an insurer, but that of a mortgagee.

Will the court deny subrogation on the grounds of the nature of that mortgagee's business? Aside from the fact that this kind of analysis would seriously detract from the free alienability of mortgage loans a vital element of real estate commerce today courts will have great difficulty coming up with reasoned distinctions as to which mortgagees will be denied subrogation and which granted it.

Comment 7: What about the "blind pig" analysis? The editor concludes that the court was right here because it would be inequitable to grant subrogation to a refinancing lien when the borrower of the refinancing lien is distinct from the borrower under the lien as to which subrogation was sought. Clearly the court can't go out and haul in the original borrowers, so necessarily the senior loan, if subrogation is granted, would be to different borrowers. This would create an entirely different set of risks for the intervening lienholders. Their position would be altered, and the fundamental notion of subrogation is that it is granted because there is no alteration in the intervening lienholder's position.

Here, even more to the point, Kim's judgment lien would be subordinated to a mortgage debt owed by Lee, the very party against whom Kim has a judgment. Efforts to collect that judgment might well impoverish Lee and make it more likely that any unsatisfied portion of the lien would be foreclosed away by the senior mortgagee. Before the refinancing, the senior lien was owed by Lee's parents, who it appears were more solvent, and at least not subject to collection efforts by Kim.

Comment 8: There is so much to say about this case, we can't really get to the frothing debate between the editor and the Restatement as to whether parties who pay off senior liens with actual knowledge of intervening junior liens ought to enjoy subrogated status. The editor says "No." Parties who engage in these practices likely are doing so for no good reason, and there is no particular justification for courts to treat them differently than their own practices would support. The Restatement says "Yes," under the "no harm/no foul" rule. Since subrogation by definition will lie only when the intervening lienholder does not suffer, let equity freely flow.

Under the rule here Washington Supreme Court totally bypasses that debate, because it concludes that title insurers ought not to be protected whether or not they had knowledge of the intervening lien when the insured a refinancing loan. Negligent and deliberate conduct are treated alike. It's a cold world for Washington title insurers..

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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