Daily Development for Friday, February 28, 2003

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; EQUITABLE SUBROGATION: Where a refinancing lender is aware of a future advances feature in a prior mortgage and doesn't take steps to cancel the prior mortgage or the future advances feature when it pays off the balance of that mortgage, the refinancing lender will not be subrogated to the amounts paid on the first mortgage in preference to other advances later made pursuant to the future advance feature.

First Union National Bank v. Nelkin, 354 N.J. Super. 557, 808 A.2d 856 (App. Div. 2002).

Homeowners executed a home equity mortgage on their condominium unit. It was an "Open End Mortgage," which was a revolving line of credit from which they could obtain advances. The Open End Mortgage was recorded.

About nine years later, the homeowners began experiencing financial difficulties and they applied for another mortgage loan to refinance existing debt. The lender obtained a payoff statement from the first bank. The payoff statement stated "that if the payment is intended to close the 'Revolving Line of Credit,' the payor must 'include written authorization from all individuals whose names appear on our account records.'" The refinancing loan closed and a check was sent to the first bank in the amount required for payoff. It appeared, however, that no authorization from the homeowners was ever sent to the first bank to close the open end mortgage account. The first mortgage was never cancelled of record. The second mortgage was recorded. Subsequently, the second mortgage was assigned twice.

The homeowners later drew upon the entire line of credit established by the first (open end) mortgage, notwithstanding their execution of a subsequent mortgage. They defaulted on both mortgages, triggering a foreclosure action by the first bank. The second bank contended that its mortgage should be considered as superior to the first (open end) mortgage because the proceeds from its mortgage had paid the first mortgage in full. The lender also argued that the doctrine of equitable subrogation should have been applied to elevate its position to that of the first bank because it would be "inequitable for [the first bank] to apply the funds provided [i.e., the second loan] to pay down the mortgage and then to foreclose on the condominium."

The lower court denied the second bank's claim. It observed that the "open end mortgage was not a traditional mortgage but an equity line of credit, which is more akin to a credit card because mere payment of the balance does not cancel or close the account." It felt that there was no proof to indicate that the procedure required to close the account had been followed.

The lower court "concluded that the equity [the first bank] had militated against subrogating [the later] mortgage to that of [the first bank]."

The second bank appealed, but unsuccessfully. The Appellate Division "first examin[ed] the principles underlying the doctrine of equitable subrogation. The doctrine, with its 'equity underpinnings,' is used 'to compel the ultimate discharge of an obligation by the one who in good conscience thought to pay it.'" The Court pointed out that subrogation rights can be created by agreement, by statute, or judicially as an equitable device. "In the absence of [] an agreement or assignment, a mortgagee who accepts a mortgage whose proceeds are used to payoff an older mortgage is equitably subrogated to the extent of the loan so long as the new mortgagee lacks knowledge of the other encumbrances. ... In that situation, the new mortgagee by virtue of its subrogated status can enjoy the priority afforded the old mortgage. ... Equitable subrogation may still be afforded even though lack of knowledge on the part of the new mortgagee occurs as a result of negligence. ... On the other hand, the new lender is not entitled to subrogation, absent an agreement or formal assignment, if it possess actual knowledge of the prior encumbrance."

In addition to finding that a new mortgagee lacks knowledge of the preexisting encumbrance, "application of the doctrine requires the court to find either that: (1) the old mortgagee was unjustly enriched; or (2) the old mortgagee acted fraudulently." Here, none of those pre-requisites were present. The second bank had knowledge of the first mortgage. The first mortgage was identified as an "Open End Mortgage" and set forth that "the mortgage remained open until the mortgagor pays 'all amounts due' and the mortgagee is 'no longer required to make loan advances' to the mortgagor."

Further, the original second lender was specifically advised that the first mortgage line of credit needed to be closed. In addition, the first bank was not unjustly enriched. Even if the payoff from the second loan covered all that was owed at the time, the homeowners borrowed additional money, thereby creating a new obligation.

The first bank's foreclosure on the borrower's condominium unit did not result in the first bank "receiving a double payment for the amount owed"

prior to receiving payment from the second loan. Moreover, there was no evidence of fraud on the part of the first bank. It was clear on the record that the first mortgage was an open end line of credit and the first bank advised the second lender that written authorization was required to close the revolving credit account. In addition, no support was found for the second lender's claim that the first lender "should be equitably estopped form asserting its priority. Estoppel is designed to insure that the loss is born[e] by the party who 'made the injury possible or could have prevented it.'"

Comment 1: The second lender had difficulty demonstrating that it had taken steps to cancel to open end feature of the original home equity line of credit because the closing files of the original bank (to which the party to this lawsuit succeeded) had been seized by the FBI. One of those things!

Comment 2: You might wonder what happened to the title company and the closing attorney. The court indicates that the file that the second lender did have available showed that the predecessor had paid for a title policy, but there was no policy to be found. Both the title insurer and closing attorney had been defendants in the original suit, and had prevailed on summary judgment. That determination was not part of the appeal here.

Comment 3: Normally equitable remedies are not available when the interests of third parties have intervened. Here, to grant the second lender subrogation to the original lien that it had paid off would have given it priority over the home equity line of credit that had been funded later in apparent good faith. The court noted that this was not a proper function of equity.