by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
randolphp@umkc.edu

MORTGAGES; SUBROGATION: Lender who pays off prior lien will not be subrogated to that lien as against earlier lender known to the payoff lender, even when earlier lender had agreed to subordinate to a payoff loan. Lawyer's Title Ins. Corp. v. Feldsher, 49 Cal. Rptr. 2d 542 (Cal. App. 1996)

Borrower had given a mortgage to F on certain property that was already subject to a number of liens. As part of the deal, several of the existing lienholders subordinated to the new mortgage, but three did not. Collectively, these secured debts in excess of $500,000, half of that in the form of two mortgage loans that had only nine months remaining on their terms. F, the new mortgagee, agreed to subordinate to a subsequent first lien mortgage not to exceed $250,000 that paid off these prior liens, if borrower could arrange for such a mortgage. The court indicates that F believed that these short loans would be paid off quickly and that he anticipated that any subordinating loan would be a refinancing of the single longer term mortgage. In the court's view, it was important to F that there be only one mortgage senior to F within a year of F's deal.

Later, Borrower did arrange with G to borrow $300,000 secured by the property, and to pay off one of the two prior loans, in the amount of $210,000. This left one loan in the amount of $50,000 still outstanding at the top of the priority list, with the F loan and, presumably the other subordinated loans still in line. G believed that his loan would have the priority of the $210,000 mortgage, based upon a general understanding about the subordination agreement that G was somewhat vague in testifying about, even though G was a seasoned mortgage banker. G did have actual knowledge of the F mortgage and could have discovered by inquiry that F required a first mortgage as a condition of subordination and that F had neither been asked nor agreed to subordinate to the G mortgage. G apparently did not know about the exact language of the F subordination language in the earlier documents.

G executed a closing statement that did not show any express subordination agreement. On the other hand, G obtained a title policy that showed a portion of his loan senior to the F loan and another portion junior. [The court's statement is somewhat vague on the exact language of the title policy.]

Later, borrower defaulted on the F note and F foreclosed and bought at the foreclosure sale. Then G surfaced, claiming partial priority over F's title. The title company paid G $222,000 and took an assignment of the $210,000 subrogation claim of G, so the title company is the real party in interest in this case.

Held: Subrogation denied. Although G's actual knowledge of the F mortgage did not preclude a G from obtaining subrogation rights when it pays off a mortgage senior to F, subrogation is based upon all the equities, and G's equitable position is weak because G was careless in failing to verify F's subordination and F would be harmed by giving G a subrogation position senior to F. G's conduct constituted "culpable and inexcusable neglect" that is a bar to the equitable relief sought here.

The title company pointed out that the proceeds of G's loan paid off a lien that was acknowledged senior to F's, and therefore improved F's position at foreclosure by $210,000. Therefore, it argued, to deny subrogation to the G loan was to give F unjust enrichment.

The court counters this argument by stating that F had carefully arranged the subordination arrangement in anticipation that F would be junior only to one lien, and that F anticipated that the loan to which F was subordinating would pay off that lien, not one of the other two senior liens. Consequently, the court concludes that F's expectations would be frustrated if F were to find itself stuck subordinate to an additional loan with long terms.

Comment: There is almost a mocking term in some of the court's descriptions of the conduct of G and the positions taken by the title company. This is all the more remarkable in that the court does not show a very good understanding of the either subordination or subrogation.

Although good practice would, of course, indicate that it would be wise to get confirmation from a subordinating lender at the time one loans in reliance upon a subordination promise, the fact is that it is possible to have a precommitted subordination that would operate automatically upon the occurrence of certain facts. G might well have believed that there was such an automatic subordination at work when G made the loan. In fact, if G had a pro forma title policy or other documentation from the title company indicating that it was insuring G's seniority to the F loan, there was every reason for G to believe that there was a binding automatic subordination. In fact, although F's subordination agreement did not require that F expressly execute a subordination document, it did commit F to subordinate only to a first lien mortgage. But G did not know that. If G relied upon the title company's reading of the documents, it is difficult for the editor to conclude that G was "culpably negligent" in not reading F's agreement himself. Of course, good practice would have indicated that G retain a lawyer to check the whole situation.

The court indicates that F never expected to be subordinate to a loan with longer payoff terms than those two short term senior loans. This may be true, but is not a grounds for denial of subrogation in this case. Contrary to what the court's language would suggest, subrogation, unlike subordination, would not involve substitution of the terms of G's loan for the terms of the $210,000 loan it paid off. In short, F would be required to pay off that loan immediately (which, of course, it would have had to do if the loan had not been paid by G and the borrower had been unable to refinance it any other way.)

The editor has criticized in the past the extreme generosity shown by courts in granting subordination to lenders who fail to engage in careful practice. There should be some basis for equitable relief in the bona fides of the party seeking such relief. But, certainly judged by the standards normally applied in such cases, the title company had a good case that G acted in good faith and was not "culpably negligent." Further, the court's analysis of the unjust enrichment issue seems questionable. It assumes, without any apparent evidence in the record, that the $210,000 senior to F would have been paid off some other way that would not have affected F if G had not advanced the money. Surely F should be made to establish that fact before dodging G's lien.

Comment 2: An alternative way to view the case is to point out that F was a bona fide purchaser without knowledge of G's claim at the time F bought at F's foreclosure sale. This would cut off G's equities. The court says that F learned of G's deed of trust after the foreclosure sale. (Presumably, since the court does not indicate otherwise, G got what notice of the sale a junior lienholder would get in such a procedure in California, and thus the trustee or F's lawyer must have known of G - at least as a junior lienholder. Someone working in F's interest must have searched title prior to the sale - but this would not mean that anyone knew of G's priority claim.)

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