As always, I keep my eyes peeled for significant news stories that touch upon secured lending, and in particular issues relating to defaults on commercial loans. Here are a couple links to recent articles from Time:
As promised, this post will speak to the second issue in the Bank of America case that was the subject of my February 15 post. This discussion will help secured lenders who may struggle with knowing whether Indiana law permits the release of a prior mortgage when such mortgage secured a revolving line of credit that has been paid in full.
Contracts and performance. Due to the importance of the language in the 1999 Bank One mortgage, I must outline it here:
[W]ithout limitation, this Mortgage secures a revolving line of credit, which obligates [Bank One] to make future obligations and advances to [borrower] up to a maximum amount of $ 80,000.00 so long as [borrower] complies with all the terms of the Credit Agreement. . . . It is the intention of [borrower] and [Bank One] that this Mortgage secures the balance outstanding under the Credit Agreement from time to time from zero up to the Credit Limit as provided above and any intermediate balance. . . .
PAYMENT AND PERFORMANCE. Except as otherwise provided in this Mortgage, [borrower] shall pay to [Bank One] all amounts secured by this Mortgage as they become due, and shall strictly perform all of [borrower's] obligations under this Mortgage. . . .
FULL PERFORMANCE. If [borrower] pays all the indebtedness when due, terminates the Credit Agreement, and otherwise performs all the obligations imposed upon [borrower] under this Mortgage, [Bank One] shall execute and deliver to [borrower] a suitable satisfaction of this Mortgage and suitable statements of termination of any financing statement on file evidencing [Bank One's] security interest in the Rents and the Personal Property. [Borrower] will pay, if permitted by applicable law, any reasonable termination fee as determined by [Bank One] from time to time. . . .
In 2001, when a portion of the proceeds from the Bank of America loan was used to pay the entire outstanding balance of the Bank One loan, Bank One did not send “correspondence or instructions” to Bank of America or the borrower. In addition, neither the borrower nor Bank of America took action to terminate the Bank One credit agreement.
The fight. The litigation surrounded whether the prior Bank One mortgage had priority over the subsequent Bank of America mortgage. Bank of America contended that, under I.C.§ 32-28-1-1(b), it was entitled to a release of the Bank One mortgage because Bank of America discharged the debt underlying that mortgage and, furthermore, because that mortgage was ambiguous as to whether written notice of termination by the mortgagor was required for the mortgage to be released. I.C. § 32-28-1-1(b) states, in pertinent part: “When the debt . . . on . . . the mortgage . . . has been fully paid, lawfully tendered, and discharged, the owner, holder, or custodian shall: (1) release; (2) discharge; and (3) satisfy of record; the mortgage . . ..” The Court concluded that the Bank One mortgage stated three requirements for “full performance:” (1) borrower must pay all the indebtedness when due, (2) borrower must terminate the credit agreement and (3) borrower must perform all other obligations. Each of those three was required of the borrower before Bank One was obligated to release the mortgage.
Bank One the winner. It was undisputed that, even though the indebtedness under the mortgage had been paid, the borrower took no affirmative action to terminate the credit agreement. As a result, the Court held that Bank One was not required to release its lien on the real estate. Bank of America complained that the Bank One mortgage did not require written notice of termination and that Bank One failed to notify the borrower or Bank of America what act was required to terminate the credit agreement. The Court rejected the argument and reasoned that the Bank One mortgage “clearly require[ed] some affirmative act of termination. . . . The Bank One mortgage required [borrower] to terminate the Credit Agreement; Bank One did not need to reiterate to [borrower] her contractual obligations.”
Always follow-up. The important court holding here is that “absent documentation to the contrary, we decline to hold that merely to pay off an outstanding balance is sufficient to terminate a revolving line of credit, as that would violate the very nature of the credit.” Unlike a mortgage securing a term note, the Bank One mortgage secured a revolving line of credit that contemplated future advances, regardless of whether there was an occasional zero balance.
Secured lenders operating in Indiana, particularly those involved in refinancing, need to be aware that, if confronted with facts similar to the Bank of America case, merely paying off a line of credit may be insufficient in itself to terminate a prior note/credit agreement/mortgage. So, review and analyze the loan documents and ensure you jump through all the hoops to terminate the prior transaction and lien. Otherwise, you may be faced with an unexpected subordinate lien position.
The January 29, 2008 decision by the Indiana Court of Appeals in Bank of America v. Ping, 2008 Ind. App. LEXIS 71 (BankAmericaOpinion.pdf) provides an interesting contrast to the JPMorgan Chase decision addressed in my February 9 post. The Bank of America case shows how a refinancing lender’s mortgage failed to leapfrog the priority position of an earlier-recorded junior lender’s mortgage, which secured a line of credit. The Bank of America result was the opposite of the JPMorgan Chase result, even though the facts were similar.
Oops. In 1999, borrower opened an $80,000 revolving line of credit, secured by a mortgage, with Bank One. In 2001, Bank of America loaned the borrower $103,000, secured by a mortgage, and the borrower used a portion of the proceeds to pay the entire balance on the Bank One line of credit. However, neither the borrower nor Bank of America took any action to terminate the Bank One credit agreement or to release the mortgage. The borrower subsequently incurred more than $76,000 in additional debt under the Bank One line.
Partial subrogation. Similar to the refinancing lender in JPMorgan Chase, Bank of America argued that the doctrine of equitable subrogation entitled it to place its mortgage “into the shoes” of the prior Bank One mortgage. Generally, subrogation requires the subrogee (here, Bank of America) to discharge the entire debt held by the original obligor (the borrower). The Bank of America Court stated:
Partial subrogation to a mortgage is not permitted because it would have the effect of dividing the security between the original obligee (lender/prior mortgagee) and the subrogee (lender/refinancing mortgagee), imposing unexpected burdens and potential complexities of division of the security and marshalling upon the original mortgagee.
The Court focused on the nature of the loan (a revolving line of credit) and language in the Bank One mortgage regarding termination/release requirements. (See subsequent post discussing this case.) The Court also noted that Bank of America’s request for subrogation was for the amount of the “payoff” but not for the amount of the borrower’s subsequent withdraws. The Court concluded that this constituted a partial subrogation, which is not permitted in Indiana.
Culpable negligence. Unlike the earlier JPMorgan Chase case, the Court in Bank of America applied the “culpable negligence” exception in refusing to permit equitable subrogation. Generally, “a volunteer or one charged with ‘culpable negligence’ may not be entitled to equitable subrogation. . . . ‘Culpable negligence’ focuses on the activity of the party asserting subrogation and ‘contemplates action or inaction which is more than mere inadvertence, mistake or ignorance’.” Id. Here, the Court held that Bank One was culpably negligent in failing to terminate the Bank One mortgage when the payoff funds were submitted.
Lesson learned. The Indiana Court of Appeals, in what may have been a close call considering the reasoning and opposite result in JPMorgan Chase, held:
Bank of America failed to take any affirmative steps to terminate the Bank One mortgage after Bank of America had paid in full the line of credit. And, as a result, Bank One held open [borrower’s] line of credit, and Bank One continued to advance [borrower] funds from the account. Bank of America’s argument would result in an inequitable subrogation. Indeed, Bank One did not enjoy a windfall but advanced additional funds under the line of credit and acted properly under its Credit Agreement and Mortgage. Given the plain meaning of the Credit Agreement and the Mortgage that secured it, it was incumbent on Bank of America to secure a release of the Bank One Mortgage as a condition of its new loan to [borrower]. That Bank of America failed to do so should not be allowed to prejudice Bank One. On these facts, Bank of America is not entitled to invoke the doctrine of equitable subrogation.
As will be alluded to more in my subsequent post about this case, the lesson for lenders is to obtain and review the loan documents applicable to the loan that is being paid off. There may be, and usually is, language in the agreements mandating that measures be undertaken to secure a release of the prior mortgage and/or to terminate the prior loan agreement. Lenders normally are aware that it’s in their best interests to ensure the prior mortgage has been released. Why that didn’t happen in this case was not explained in the opinion.
If you or your colleagues are interested, click here for a link to an electronic version of the brochure for a continuing legal education seminar at which I'm scheduled to present on March 18, 2008 in Indianapolis. They've entitled the conference "Real Property Foreclosure: A Step-by-Step Workshop."
On November 21, 2007, the Indiana Court of Appeals issued a decision that applied the rules of equitable subrogation. JPMorgan Chase v. Howell, 2007 Ind. App. LEXIS 3055 (JPMorganOpinion.pdf) shows how a refinancing lender’s mortgage can leapfrog the priority position of an earlier-recorded junior lender’s mortgage.
Chronology. Defendant Bank One held a mortgage recorded in October of 1999 that secured a line of credit. Plaintiff Equity One held a mortgage recorded in May of 2004 that secured a loan to pay off a prior senior mortgage lender and the Bank One line of credit. For a variety of reasons, the $42,000+ payoff amount sent to Bank One was short by about $300. Bank One did not close the borrower’s line of credit, and thereafter the borrower ran up a balance on the Bank One line of approximately $43,000. The borrower defaulted on the notes and mortgages held by both Equity One and Bank One. Equity One filed a foreclosure action seeking the foreclosure of its mortgage and a declaration that its mortgage was a first priority lien. Bank One countered by asserting that its mortgage had priority. The question, therefore, was whether Bank One’s October, 1999 mortgage had priority over Equity One’s May, 2004 mortgage.
General rule. Generally, in Indiana, a mortgage takes priority “according to the time of its filing.” I.C. § 32-21-4-1(b). Applying that general rule, Bank One’s mortgage would take priority over Equity One’s mortgage.
Exception. The doctrine of equitable subrogation, however, can trump I.C. § 32-21-4-1(b). The doctrine is recognized in I.C. § 32-29-1-11(d) and by the Indiana Supreme Court in Bank of New York v. Nally, 820 N.E.2d 644 (Ind. 2005). Here are some of the principles:
Subrogation will arise from the discharge of a debt and will permit the party paying off a creditor to succeed to that creditor’s rights in relation to the debt.
“In the case of a purchaser of a note and mortgage for value, the classic formulation is that the purchaser’s right of subrogation to the mortgage he or she discharged includes its priority over junior liens of which he or she did not have actual knowledge, and where he or she was not culpably negligent in failing to learn of the junior lien.” Nally, 820 N.E.2d at 651.
A mortgagee (lender) refinancing an existing mortgage is entitled to equitable subrogation even if it had actual or constructive knowledge of an existing lien, unless (a) the junior lien holder is disadvantaged or (b) the mortgagee is culpably negligent. Id. at 653-54. (The rationale is that a lender that provides funds to pay off an existing mortgage expects to receive the same security (priority) as the loan being paid off.)
Why Equity One prevailed. Equity One paid off the prior senior mortgage, which mortgage was released. Bank One only held a junior mortgage securing a line of credit. The Court held there was no disadvantage to Bank One by the application of equitable subrogation. To the extent Equity One was negligent for failing to confirm whether it had fully satisfied the Bank One mortgage, the Court concluded such negligence did not prejudice Bank One. Indeed the payoff/refinancing funded by Equity One benefited Bank One “to the tune of over $42,000.” Absent the application of equitable subrogation, Bank One would have received an unearned windfall, against which the doctrine is designed to protect.
Result. The Court of Appeals held that plaintiff Equity One was entitled to foreclose its mortgage on the property to the extent of the funds paid to satisfy the prior, senior mortgage, plus interest. The Equity One mortgage, despite being recorded long after the Bank One mortgage, had priority.
If as a secured lender you are confronted with a situation in which a prior lien was not released as it should have been and thus an unexpected priority issue arises with regard to your lien position, then one of the first things you should do is put your title insurance company on notice of the problem. The title insurance company may hire and pay for attorneys to litigate the priority dispute, as I’m virtually certain was the case in JPMorgan Chase. In addition to incurring litigation costs, the title insurance policy may also provide indemnity (reimbursement for damages). The reality is that many equitable subrogation cases are prosecuted by title insurance companies in the name of their insured to recoup indemnity payments.
If a borrower defaults, and if a secured lender exercises its rights under a mortgage or security agreement to foreclose, the borrower still is able to avoid losing the collateral. This is because, in Indiana, borrowers have a right of redemption. “Redeem” means “to buy back. To free property from mortgage . . . by paying the debt for which it stood as security.” Black’s Law Dictionary. Redemption (basically, a payoff) is the way for a borrower to keep the property, end the lien enforcement litigation and free itself of the plaintiff/lender’s mortgage or security interest. In Indiana, two main statutes cover redemption.
Real estate. I.C. § 32-29-7-7 “Redemption by owner before sheriff’s sale” states:
Before the [sheriff’s] sale under this chapter, any owner or part owner of the real estate may redeem the real estate from the judgment by payment to the:
(1) clerk before the issuance to the sheriff of the judgment and decree; or (2) sheriff after the issuance to the sheriff of the judgment and decree;
of the amount of the judgment, interest, and costs for the payment or satisfaction of which the sale was ordered. If the owner or part owner redeems the real estate under this section, process for the sale of the real estate under judgment may not be issued or executed, and the officer receiving the redemption payment shall satisfy the judgment and vacate order of sale . . ..
Personal property. Indiana provides for the right to redeem non-real estate collateral in its UCC statute, I.C. § 26-1-9.1-623:
(a) A debtor, any secondary obligor, or any other secured party or lienholder may redeem collateral. (b) To redeem collateral, a person shall tender:
(1) fulfillment of all obligations secured by the collateral; and (2) the reasonable expenses and attorney’s fees described in IC 26-1-9.1- 615(a)(1).
(c) A redemption may occur at any time before a secured party:
(1) has collected collateral under IC 26-1-9.1-607; (2) has disposed of collateral or entered into a contract for its disposition under IC 26-1-9.1-610; or (3) has accepted collateral in full or partial satisfaction of the obligation it secures under IC 26-1-9.1-622.
(Click here for I.C. § 26-1-9.1). The rights and time period parallel those associated with mortgages/real estate. The full amount due must be submitted before repossession or disposition of the property.
Timing. Under Indiana law, the right to redeem the property from the foreclosure judgment terminates with the sheriff’s sale. In Re Collins, 2005 Bankr. LEXIS 1800 (S.D. Bankr. 2005). “Once a sheriff’s sale takes place, a mortgage-debtor is no longer the title holder . . ..” Id. Judge Coachys concluded, in Collins, that a sheriff’s sale is complete when the hammer falls and that the actual delivery of the sheriff’s deed is purely ministerial. Id. Upon a sale, title is transferred, and the loan is terminated. To avoid losing the property, the borrower/owner must pay the entire debt (usually, the accelerated amount) before the sale or disposition of the property. Otherwise, the party’s over.