Daily Development for
Thursday, July 10, 1997

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

MORTGAGES; LEASES; SUBORDINATION; GROUND LEASES: "Subordination Agreement" that contained elements of both a subordination agreement and a mortgage will not be deemed to be unambiguously a mortgage and therefore extrinsic evidence is necessary to determine the nature of the document.

Travelers Insurance Company v. Holiday Village Shopping Center Limited Partnership, 931 P.2d 1292 (Mont. 1996).

Ground lessors executed a "subordination agreement" on the lessee's behalf so that the lessee could obtain financing to construct a shopping mall on the leased land. The agreement contained elements of both subordination and mortgage and, therefore, lessors argued, it was unclear as to whether the subordination agreement was to be treated as a mortgage by lessor to lessee's lender. For instance, the subordination agreement included language stating that the lender had a lien on the lessor's property, but also provided protection for the mortgagee against the termination of the lease. Here is an excerpt from the subordination agreement:

"[Lessor] subordinates all of its right, title and interest in and to said real property to the lien of said mortgage and agrees that said mortgage shall continue to be a first lien upon said property prior and superior in right to any right, title and interest of the undersigned in and to said real property. The undersigned, however, shall not be liable for the payment of any indebtedness secured by said mortgage or the performance of any of the covenants or obligations of the mortgagor thereunder. The undersigned further assures Travelers that the undersigned will not terminate the above described lease without the prior written consent of Travelers except in the case of a default thereunder by [Borrower/Lessee] in which case the undersigned agrees to give Travelers written notice thereof, specifying the default and Travelers shall have ninety (90) days after receipt of said notice within which to cure said default, and if the default is cured within said period, or if the default is one which cannot be cured within said period, but steps are taken in good faith during said period and diligently pursued, the lease shall not be terminated. . ."

The mortgagee later released the borrower from its obligations under the mortgage. The ground lessors argued that they were in the position of sureties to the borrower, and that under principles of suretyship, the release of the mortgagor without their notice or consent deprived them of the right of exoneration and therefore released them from the mortgage. The mortgagee responded that the ground lessors were not sureties, but simply mortgagors pursuant to the mortgage created in the "subordination agreement."

The District Court had held that there was no ambiguity and that the elements relating to a mortgage acted to make the document a mortgage unambiguously.

On appeal, held: Reversed: The Montana Supreme Court held that the agreement was ambiguous, and, therefore, resort to extrinsic evidence was appropriate. Two judges dissented on the grounds that the subordination agreement clearly and unambiguously was not a mortgage, but rather an agreement that the rights of the ground lessor would not be exercised against the mortgagee for the term of the original lease should the mortgagee foreclose on the mortgagor's leasehold estate.

Comment 1: It is quite appropriate that this issue gets washed in public in this case. The use of a subordination agreement rather than a mortgage in this context is not unusual. Clearly Travelers Insurance, the mortgagee here, was a sophisticated lender and had certain objectives in mind in using a subordination agreement rather than requiring the ground lessor to execute a mortgage.

Further, it is likely that the ground lessors viewed themselves as acquiescing in the subordination only on the condition that they indeed did have a right of exoneration back against the mortgagors. The facts of the case do not make clear whether and to what extent the ground lease, the subordination, or other instruments, expressly gave the ground lessors rights against the ground lessee in the event that the mortgagee foreclosed on the fee.

But didn't Travelers, which was drafting the instruments and making all the demands, have a responsibility here to insure that the documents indeed spelled out clearly the rights of the parties?

Comment 2: The above having been said, the subordination instrument does appear to subject the lessor's property to the lien of the Traveler's mortgage, and it is difficult to see how any other conclusion could be drawn. It certainly is difficult to see how the dissenters reached their conclusions about the meaning of the instrument. It is also possible, however, that some further equitable interpretation of the rights of the parties would be appropriate in a case in which the primary debtor is released from liability in a case in which the ground lessors have been led to believe that they have a recourse right against that debtor.

Comment 3: The editor welcomes comments from commercial finance mavens as to why lenders in this situation often use documents entitled "subordination agreement" to accomplish what appears to be a simple mortgage arrangement. This is done often enough, and by sufficiently sophisticated parties, that the technique is not an accident. What gives?

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