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

Dale Whitman has submitted another fine "guest DD" item. Consequently, I have bumped the DD I had in line for Thursday and will post it for Friday.

MORTGAGES; SUBROGATION.When a mortgage lender pays off and refinances a mortgage prior loan, and when that lender has an express agreement with the borrower that the new mortgage will have the priority of the one being paid, it acquires that priority irrespective of the usual "innocence" requirement of the doctrine of equitable subrogation.

Wolf v. Spariosu, 706 So.2d 881 (Fla. Dist. Ct. App. 1998).

Spariosu, the borrower, held real estate subject to two mortgage loans. Spariosu subsequently entered into a contract with Maysonet for landscaping work, but Spariosu did not pay for the work, and Maysonet filed a construction (mechanics') lien on the land, subordinate to the mortgages. Then Sparosu contacted City First Mortgage and obtained a loan from it to refinance the two prior mortgages.

The two mortgages were indeed paid off with the proceeds of the City First loan. City First expressly agreed with Spariosu that its mortgage would be substituted in place of the two prior mortgages. When Spariosu defaulted in payment to City First, it assigned its mortgage to Wolf, which filed a foreclosure action. Maysonet appeared and claimed that its lien on the real estate had priority over Wolf's mortgage. Wolf disputed this claim, arguing that its mortgage was superior under both the doctrines of equitable subrogation and conventional subrogation.

The court held that Wolf's mortgage had priority under the doctrine of conventional subrogation. It conceded that, if equitable subrogation were used, Wolf might lose the priority contest, since equitable subrogation is available in Florida only if the party who pays the prior mortgage has no actual knowledge of the intervening lien. (The court does not expressly state that Wolf's predecessor, City First, had knowledge of Maysonet's lien, but it appears probable that it has such knowledge.)

However, under conventional subrogation, a consideration of the subrogee's innocence of knowledge of the intervening lien is irrelevant. Conventional subrogation arises when the party paying the prior mortgage has an express agreement with the borrower to acquire the prior mortgage's priority position. Since City First had such an agreement here, and since Maysonet's lien was in no worse position as a result of subrogation, Wolf was entitled to the priority of the liens that City First paid off.

Comment 1: Florida law, as described by the court, is consistent with the majority view: equitable subrogation is available only if the party paying the prior mortgage has no actual knowledge of the intervening lien. (The cases in which this situation arises are typically cases in which the refinancing lender has obtained a title examination, but the examiner erroneously failed to report the intervening lien. Thus, it's usually a title insurance company that stands the cost of losing priority.)

The Restatement (Third) of Property (Mortgages) Sec. 7.6 purports to broaden the right of equitable subrogation. It states that the refinancing lender is entitled to the priority of the mortgage it paid off, even if had knowledge of the intervening lien, if it "reasonably expected to receive a security interest in the real estate with the priority of the mortgage being discharged." However, only a minority of courts have adopted this more liberal attitude. It is difficult to see why most of the courts have resisted liberalizing subrogation, since it is always based on the premise that the intervening lienor is no worse off if subrogation is granted. (I note, however, that our editor, Professor Randolph, seems to disagree with my preference for a liberal application of subrogation - on the grounds that institutional lenders ought to be able to protect themselves and should be assumed to have acted knowledgeably.)

Comment 2: Conventional subrogation, as distinct from equitable subrogation, turns out to be an extremely useful doctrine for refinancing lenders, since it renders any inquiry into the refinancing lender's innocence of knowledge of intervening liens irrelevant. Note that the refinancing lender can create a conventionsubrogation merely by an agreement with the borrower. The intervening lienor need not be involved in the agreement at all. In this case, for example, Maysonet, the holder of the intervening lien, was not a party to the agreement calling for substitution of the prior lien's priority.

Comment 3:. What can a refinancing lender do to ensure that it will have the priority of the loan it pays off? There are three possible steps it can take.

a. It can recite that it expects to gain the priority of the mortgage it is paying. This may help to bring it within the doctrine of the Restatement -- but that is only useful if the courts are willing to follow the Restatement's viewpoint; thus far, most have not.

b. It can enter into an express agreement with its borrower that it will gain the priority of the mortgage it is paying. As in the present case, this will convert the argument from one of equitable subrogation into one of conventional subrogation, and greatly improve the refinancing lender's probability of gaining priority over intervening liens.

c. If can insist that the mortgagee who is paid off give, not a release, but an assignment of that mortgage to the refinancing lender. That assignment can be recorded, thus making it clear on the face of the records that the refinancing lender has the original lender's priority. It can then enter into whatever modifications of the old loan are necessary to conform it to the agreed terms of the refinancing loan. (Such modifications should, of course, clearly recite that the priority of the preexisting loan is intended to be retained; see Restatement Sec. 7.3.)

This method is the strongest approach, but it has two potential weaknesses. One is simply that the old mortgage lender may be unwilling to cooperate in giving an assignment rather than a release. There is plenty of legal authority that says the old lender has a duty to give an assignment upon request, but that authority is of little practical value if the old lender refuses; nobody will have time to bring a lawsuit to force an assignment.

A second potential problem is that, if the terms of the new mortgage are more burdensome than the old one (e.g., a higher interest rate or higher payments), it is strongly arguable that the intervening lienor will gain priority to the extent of the higher burden. In other words, the intervening lienor must not be prejudiced by subrogation, whether equitable or conventional in nature. This is consistent with the legal doctrines relating to modification and replacement of mortgages; see Restatement Sec. 7.3. But this potential loss of partial priority isn't an outgrowth of the refinancing lender's taking an assignment, rather than relying on equitable or conventional subrogation; they, too, raise the same risk, to the extent that the intervening lienor would otherwise be injured.

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