by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
Thanks to Jack Murphy for suggesting this case.
The case is very complex, so the DD is a little longer than usual, but any "old hand" real estate professional will recognize the issues here and, I believe, find the case and its resolution interesting.
ESCROW; ESCROW AGENT'S DUTY TO DISCLOSE: An escrow agent is agent for all parties to an escrow for purposes or imputed knowledge with regard to information received by the agent pursuant to its carrying out the duties of that escrow (but not otherwise); it has a duty to disclose such information; and the principles all are treated as if they had such information.
Triple A Management Co., Inc. v. Frisone, 81 Cal Rptr. 3d 669 (Cal.App. 1999).
This case is discussed under the heading "Mortgages; Assignments forSecurity;
MORTGAGES; ASSIGNMENTS FOR SECURITY;SUBORDINATION: A collateral
assignee of a mortgage note has no power to subordinate the note to another
secured party, but is not liable for the warranty of title contained in
such subordination if it attempts to do so.
Triple A Management Co., Inc. v. Frisone, 81 Cal Rptr. 3d 669
Farms acquired a 140 acre tract from Western, giving a purchase money mortgage of $540,000. Four years later, some of the property apparently became valuable for development purposes, and Farms agreed to sell 20 acres of the property to Greenwood, for cash and a new purchase money mortgage in the amount of $425,000. The terms of the Greenwood sale included Farms agreement to subordinate its purchase money mortgage to a "development loan" not to exceed $1.6 million. Western agreed to release the 20 acres from its mortgage on the larger tract if Farms assigned this new purchase money note and mortgage to Western. (All the mortgages in involved are deed of trust mortgages).
The parties opened an escrow with Stewart, and Stewart was instructed
to draft the necessary assignment to Western.
While this escrow was pending, Greenwood "flipped" the property
to Sullivan. The purchase price was almost double what Greenwood
was paying for the property. Sullivan agreed to assume the mortgage
note to Farms, gave a note secured by a third deed of trust, and in addition
agreed to pay $350,000 cash. Greenwood planned to obtain the case
by borrowing a new loan from Frisones and giving them a senior deed of
trust on the property.
The parties to Greenwood/Sullivan transfer opened a second and
independent escrow with Stewart Title. The instructions in this escrow
stated (and the language is important) that title would vest in Sullivan
subject to "Deed of Trust to be of record at close of escrow in favor of
[Farms] and collaterally assigned to [Western] securing a note in the amount
of $425,000 [which] shall be subordinated to the loan in favor of [Frisones]."
Frisones instructed Stewart to release their funds only when the circumstances
were clear that Frisones' lien would be a first lien on the property that
Stewart would insure as a title insurer.
The same closing agent was assigned to both escrows.
In carrying out the first escrow, Greenwood executed its note
and deed of trust and Farms then executed a document entitled "CollateralAssignment"
on a form provided by Stewart. Aside from the title, the form was
worded as an absolute assignment. Apparently after these instruments
were deposited in escrow, but prior to closing, Greenwood revealed that
it desired that Farms subordinate its interest in theGreenwood/Farms mortgage
to a proposed mortgage to Frisones (the one that was funding the second
sale from Greenwood to Sullivan). Farms adamantly refused, giving
as its reason that it did not want to go back into negotiations with Western
concerning the release of the property and assignment of the Greenwood/Farms
Although Farms refused to subordinate, Greenwood arranged for Stewart
to draft a subordination agreement for Western to sign. That subordination
agreement stated on its face that some of the proceeds of the loan to which
Western would subordinate would not be invested in the property (contrary
to the condition of the original deal which requred that this be
a "development loan.") A Greenwood principal (since disappeared)
assured Western, and also Stewart, that Farms had agreed to the subordination.
Further, Western's officer testified that the Stewart escrow agent had
told him that this subordination was what was required by the original
deal. This officer read the documents only cursorily and did not
notice that the subordination agreement was not consistent with the terms
of the Farms/Greenwood deal, but he testified that he believed that Farms
was also executing a separate subordination and would be very cautious
in examining the documents. (Remember that Western was well secured
by the other 120 acres in addition to this assignment.)
The transaction closed, Frisones got their title insurance, and
Sullivan even made one payment on the Greenwood/Farms/Western loan (which
it had assumed) before the whole house of cards collapsed.
Note that, as this was a California purchase money mortgage, no deficiency
was possible, and Sullivan's assumption didn't mean much. Everything
depended on the land security.
Western, as collateral assignee of the Greenwood note, sent
notice of default and substituted trustees on the Greenwood deed
of trust mortgage, but before it got too far into foreclosure, Farms paid
off the original note for which the Greenwood note had been assigned as
collateral and Western reassigned the note and mortgage and stepped aside.
Farms then filed an action for a declaration that its mortgage was superior
to Frisones' mortgage, notwithstanding the subordination agreement executed
by Western while Western was a collateral assignee.
The trial court ruled in favor of Farms. It held that Frisones
knew nothing of the subordination agreement, and did not rely upon it.
Its agent, Stewart, did rely on the subordination agreement, the court
stated, but Stewart was unreasonable in doing so in light of what
it knew about the interest of Farms. Implicitly, the court was concluding
that Farms was not bound Western's unilateral subordination and that Stewart
should have understood that.
The trial court also awarded Farms damages based upon Stewart's
negligence in the preparation of the original collateral assignment and
subordination agreement. Farms got its attorney's fees in litigating
this matter as damages.
On appeal: held: Affirmed. Frisones is subordinate. Stewart
Stewart and Frisones argued that Frisones was a bona fide encumbrancer
without knowledge of the fact that the subordination agreement, executed
by the record and actual assignee of the Greenwood note, might be defective
in that it did not bind Farms.
The court pointed out, however, that a subsequent encumbrancer "is not entitled to view the record through rose colored glasses' or with blinders on . . . [Further, a] lender is not entitled to ignore warning signs that come to him from outside the recorded chain of title, to the extent such information . . . reasonably brings into question the state of title reflected in the recorded chain of title."
Of course, Frisones itself knew virtually nothing. But the court
ruled that Stewart, acting as escrow agent in the second escrow, had constructive
knowledge of the certain information that should have put it on notice
thatFarms' consent was necessary in order for Frisones to enjoy the benefits
of the subordination agreement. The court acknowledges that information
contained in the first escrow could not be imputed to Frisones, even if
theStewart agent had actual knowledge of it, because Stewart did not obtain
that information in the scope of its agency. In this particular,
the appeals court departed from the conclusion of the trial court.
Even though the escrow were running simultaneously, and conducted by the
same officer, there can be no imputation of knowledge where there is no
But the appeals court concluded that there was adequate information
in the documentation of the second escrow, where Stewart clearly was acting
as an agent for Frisones, that should have triggered an inquiry as to whether
Farms ought to execute a subordination. As indicated above, the escrow
instructions in the second escrow referred to the deed of trust as one
that Farms would "collaterally assigned to Western securing a note."
Further the title of the document that embodied the assignment to Western
stated at the top that it was a "collateral assignment,"
The court notes that the UCC states that a party holding collateral
must use reasonable care in the custody and preservation of collateral
in his possession. In the case of instruments (such as notes), the
secured party has a duty to take reasonable care to preserve "rights against
prior parties." The court seems to view both aspects of this duty
as applicable here, although in fact the issue in questions concerns the
collateral assignor's rights as against a subordinate party. Despite
this misreading of the UCC, it does make sense that a collateral
secured party would not have the right to subordinate a the rights in the
collateral without the debtor's consent, and indeed the court cites California
authority to that effect. The court concludes that nothing in the
UCC changes the common law on this point, at least prior to default by
the debtor (as was the case here).
The security agreement that Farms executed provided that Western "had no duty to take any action to preserve any rights of or against any prior or other parties in connection with the Collateral." The court reads thislanguage as a statement that Western had no duty to take an affirmativeaction to protect the security position, but not as a blanket permssion forWestern to elect to take action that would frustrate the security position.
Finally, as one final nail in the coffin, the court in a footnote held
that Frisones had no right against Western under the warranty of title
contained in the subordination agreement that Western executed. The
court held that the warranty was ineffective when the party receiving the
warranty had reason to know that the warrantor was not claiming title in
Comment 1: There are a number of important points made in this
case.Some of them are supported by some authority, but other points have
little or no authority. The editor is uncertain as to whether there
is law contrary to the conclusions reached by the court here, but certainly
the holdings are significant in any event because the issues are quite
Comment 2: The notion that any information an escrow agent obtains
in the course of an escrow is imputed to the principle is one that may
catch many by surprise. The court admits that the escrow is in fact
an agent for both parties. Nevertheless, the escrow has a duty to
divulge any information it receives. More than that, it must anticipate
that representations made to it that appear to be inconsistent with certain
details in the documents may be false and need to be further examined.
Note here that one of the parties told the escrow that Farms had agreed
to the subordination. If indeed Farms had so agreed, then there
would be an estoppel and Frisones would be in the clear.
The court's view was that it was the agent's responsbility to inquire
further to disbelieve its own principle and check with another
of its principles, even though there was nothing in the documents that
would be inconsistent with Farms consenting to the subordination.
It is unclear whether the reason for this further inquiry is the agent's
knowledge that Farms originally opposed subordination or simply the bare
statement inthe documents that the assignment of the Sullivan note
was for collateral only.
Comment 3: Although the court minimizes the signficance of the
language stating that Western, as assignee, had no duty to take steps to
protect the collateral, isn't this language susceptible of the interpretation
that Western did have the power to agree to a subordination? The
court states at one point that the UCC duty to protect collateral
is absolute, and cannot be modified by contract, but at other points appears
to assume that a contractual power to modify would be honored.
If a contractual duty to modify was possible, would the escrow agent be
reasonable in assuming that this language embodied that power? If
so, doesn't that change everything?
Comment 4: What about the warranty holding? Shouldn't the
warranty have been viewed here as an assurance by Western that it was acting
with the authority of Farms in agreeing to the subordination? Even
if this representation was incorrect, and not binding upon Farms, shouldn't
Western be liable for making it?
Comment 5: Some in other states may be surprised that an escrow
company would be engaged in drafting substantive conveyancing documents
in a complex commercial real estate deal. The editor is sorry to
report that such activity is common place in California, where many parties
to commercial transaction try to avoid lawyer's fees by using the escrow
as their drafter. Sometimes the escrow instructions amount
to the only written statement of the parties' understanding. Escrow
companies have been only too willing to oblige in these situations. This
case may be a "wake up call" to some of those companies, or at least to
their O&E insurers.
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