Indiana Commercial Foreclosure Law

Indiana Supreme Court Draws The Equitable Subrogation Line At Priority

This follows up on my June 21, 2007 and August 24, 2009 posts on Indiana’s doctrine of equitable subrogation, specifically the opinions arising out of the Gibson v. Neu case.  The Indiana Supreme Court wrote the final chapter in Neu v. Gibson, 2010 Ind. LEXIS 376 (Ind. 2010) (.pdf), which is Indiana’s definitive statement regarding the scope of the doctrine. 

Circumstances.  Nowak owned a residence with a mortgage loan from lender Irwin.  He subsequently granted a second mortgage to Gibson.  Nowak later sold the residence to Neu, who utilized a mortgage loan from Wells Fargo to pay off the Irwin mortgage.  Neu and Wells Fargo (and their title insurance company) overlooked Gibson’s junior mortgage, which survived the sale.  In the first Gibson v. Neu opinion (the subject of my June 21, 2007 post), the Court of Appeals granted priority to Neu and Wells Fargo over Gibson.  Because that decision remained undisturbed by the Indiana Supreme Court, Indiana law appears to be settled that the amount of the equitable lien is at least the amount of money that was used to pay off the prior mortgage.  The Supreme Court’s opinion dealt with the additional rights and remedies, if any, to which the subrogees (Neu and Wells Fargo) may have been entitled.

Foreclosure.  Gibson had not exercised his foreclosure rights, evidently due to “the presently depressed real estate market.”  It seems that Gibson was biding his time for the value of the home to turn around.  On the other hand, Neu sought a sheriff’s sale, presumably to quiet title to his real estate.  This likely would have extinguished Gibson’s lien and netted no proceeds to him, resulting in a substantial financial loss.  The Court of Appeals previously determined that Neu and Wells Fargo were permitted to request a sheriff’s sale to enforce their equitable lien.  Indeed the Irwin mortgage included that right.  But Nowak’s obligation under the Irwin mortgage ended when Neu and Wells Fargo satisfied that debt.  Since the Irwin mortgage was discharged, “no party can possibly foreclose under the terms of the Irwin mortgage any longer.”  The Court therefore drew “the equitable subrogation line at priority [because] these circumstances [do] not unfairly prejudice [Neu yet they] preserve Gibson’s rights as an inferior lienholder.” 

Interest.  Both the Court of Appeals and the Supreme Court denied Neu’s and Wells Fargo’s claim to include mortgage interest in the amount of the equitable lien based upon the Irwin mortgage.  The Court of Appeals concluded that some interest could be recovered at the statutory post-judgment rate of 8% from the date of the payoff of the prior mortgage, but the Supreme Court would not even go that far.  “The trial court’s earlier ruling giving [Neu] priority ahead of [Gibson] seems like a substantial step of equity that largely rescued [Neu] from the calamity that might have otherwise befallen [him] (namely, ending up in line behind Gibson).” 

Attorney’s fees.  Similarly, the Supreme Court held that “the equities weigh against [Neu] recovering fees . . ..”  Again, the Irwin mortgage was not in default, so that mortgage could not form the basis for including attorney’s fees and costs in the equitable lien under the circumstances of the Neu case. 

Prevailing theme – fairness.  “The key to subrogation is an equitable result,” the Court said.  Equitable subrogation:

Substitutes one who fully performs the obligation of another, secured by a mortgage, for the owner of the obligation and the mortgage to the extent necessary to prevent unjust enrichment.  This avoids an inequitable application of the general principle that priority in time gives a lien priority in right.  In considering whether to order subrogation and thus bypass the general principle of priority, courts base their decisions on the equities, particularly the avoidance of windfalls and the absence of any prejudice to the interests of junior lienholders.

The line of Neu v. Gibson decisions provides substantial clarity to the equitable subrogation doctrine and specifically the nature and extent of the equitable lien.  The lien exists primarily to establish priority, but the scope of the lien is limited.  What is fair will carry the day.

Indiana Equitable Subrogation: Beyond Lien Priority

Equitable subrogation law, as it relates to mortgage foreclosure actions, continues to evolve in Indiana.  On April 28th, the Court of Appeals issued Neu v. Gibson, 2009 Ind. App. LEXIS 746 (Ind. Ct. App. 2009) (.pdf).  The 2009 opinion follows the May 30, 2007 opinion from the same case, about which I posted on June 21, 2007.  The latest decision educates secured lenders on the amount of, and ability to enforce, an equitable subrogation lien.  The case specifically addresses whether interest/attorney’s fees can be recovered as a part of the lien and whether the lien holder is entitled to a sheriff’s sale.

Who was involved and when. 

Irwin – In 2004, Irwin loaned $507k to Nowak, which loan was secured by a first mortgage on Nowak’s residence.

Nowak – Later in 2004, Nowak bought Gibson’s business with a $350k promissory note, secured by a second mortgage on Nowak’s residence. 

Gibson – Second mortgagee on Nowak’s residence. 

Neu – In 2005, Neu purchased Nowak’s residence, without Gibson’s knowledge, for $595k; Neu borrowed $200k from Wells Fargo, secured by a mortgage, and used $395K of Neu’s own money.  The transaction resulted in the pay off of the Irwin mortgage. 

Wells Fargo – Made a $200k mortgage loan to Neu used to buy Nowak’s residence and to pay off the Irwin mortgage.

The problem.  In 2005, Nowak defaulted on the promissory note and mortgage granted to Gibson.  A few months later, Nowak filed bankruptcy.  So, Gibson’s only source of recovery was the Nowak real estate.  But the title company, in connection with the 2005 Nowak/Neu closing, missed Gibson’s second mortgage.  My June 21, 2007 post talks about the Court’s previous ruling that Gibson’s mortgage was subordinate to the equitable lien of Neu and Wells Fargo.  While the 2007 Neu v. Gibson opinion dealt with priority, the 2009 appeal involved the remedies available to an equitable lien holder.  Neu and Wells Fargo filed a motion to establish the amount of their equitable lien and to sell the real estate by sheriff’s sale to satisfy their lien. 

Fees.  Neu and Wells Fargo contended that they should be able to recover, as part of their equitable subrogation lien, interest and attorney’s fees.  Remember the Irwin mortgage had been paid in full and discharged.  “Thus, any default under the Irwin mortgage by Nowak was cured when Nowak repaid the loan from Irwin in full in connection with the sale to [Neu].”  Wells Fargo, as the new lender, was subrogated to the lien of the Irwin mortgage “only as security for Wells Fargo’s debt owed by [Neu] and not as security for the debt owed by Nowak . . ..”  Because neither Neu nor Wells Fargo succeeded to the contractual rights of the Irwin mortgage, they were not entitled to interest or attorney’s fees stemming from the Irwin mortgage.  It stands to reason that late charges and other contractually-based damages also would not be recoverable.

Interest.  The Court denied the attorney’s fees claim and the claim for mortgage interest. Nevertheless, the Court concluded that some interest can be recovered, which should be calculated on the post-judgment statutory rate (generally, 8%) “from the date of their payoff of the Irwin Mortgage.”  See, 12/18/07 post. 

Sheriff’s Sale.  Neu and Wells Fargo asserted that they should be permitted to request a sheriff’s sale of the real estate, and they cited to Indiana’s quiet title statute, Ind. Code § 32-30-2-20.  The Court concluded that Neu and Wells Fargo were indeed permitted to request a sheriff’s sale to enforce their equitable lien.  A sheriff’s sale likely would extinguish Gibson’s mortgage lien and net no proceeds for Gibson.  Rightly or wrongly, the two Neu v. Gibson opinions cut severely against the financial interests of junior mortgagees overlooked by title companies upon refinancing or a subsequent sale. 

The Neu case helps teach us about the rights and remedies of a party holding an equitable subrogation lien.  Although issues involving equitable subrogation are relatively rare in the commercial foreclosure context, secured lenders and their counsel practicing in Indiana certainly should be aware that the doctrine exists. 

Equitable Subrogation Denied

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.   

Illustrating Indiana’s Doctrine Of Equitable Subrogation

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.

EQUITABLE SUBROGATION AND OTHER TIDBITS FROM GIBSON V. NEU

Commercial lenders operating in Indiana can take away a few nuggets of useful information from the May 30 Indiana Court of Appeals opinion in Gibson v. Neu, 2007 Ind. App. LEXIS 1140 (GibsonOpinion.pdf).  Among other things, the Court talks about default, notice and, most prominently, the doctrine of equitable subrogation, which provides relief in certain priority disputes where a lien is missed in a pre-closing title search.

Factual background.  The dispute in Gibson arose out of defaults on a note and real estate mortgage that were a part of a stock purchase transaction.  As a part of the deal, the purchaser gave the seller a junior mortgage on his $600,000 residence.  During a time period in which the purchaser was not consistently making note payments (defaulting), the purchaser sold his home and paid off the senior mortgage, but failed to address the seller’s junior mortgage.  In fact, the buyer of the home’s title insurance company missed the seller’s junior mortgage in the title search.  When the seller went to foreclose on that mortgage, the seller learned that the purchaser had sold the home and that there existed a new mortgage on the property.  A fundamental issue in the lawsuit was which mortgage had priority – the stock seller’s or the home buyer’s.  Although these title goof-ups occur mainly in the residential mortgage arena, commercial lenders are not immune to such problems and therefore should have a working knowledge of the doctrine of equitable subrogation.

Two minor points.  A couple things are worth mentioning here: 

1. A default is a default.  The purchaser’s monthly payments under the note were $7,000.  At the time of the default in question, the purchaser only was $500 behind, and the purchaser made a $5,000 payment the next month.  The purchaser tried to claim that he had “substantially performed” under the note and thus should not have been deemed in default.  The Court of Appeals rejected the argument and followed the strict language in the loan documents, concluding that the purchaser was not current in his payments.  Id. at 10-12.  So, at least according to Gibson, payments mean “full” payments, not “substantial” payments. 

2. Notices of default.  Clients sometimes ask whether they need to provide notice of default and an opportunity to cure.  In Indiana, the answer to that question lies in the language of the note and/or mortgage.  There is no statutory or common law requirement to provide notice and an opportunity to cure.  Gibson supports this proposition – “under the plain language of the note and mortgage, [seller] was not required to give [purchaser] notice of default.”  Id. at 12-13.  Notice is not required as a matter of law – only if the loan documents call for it.

Equitable subrogation.  Pursuant to Ind. Code 32-21-4-1(b), a mortgage takes priority according to the time of its filing [a/k/a recording].  In Gibson, the prior mortgage of the seller in the stock purchase transaction generally would have priority over the home buyer/lender’s mortgage.  The home buyer contended, however, that the doctrine of equitable subrogation operated to give him priority.  The application of the doctrine can be a bit clouded and complicated.  The Court of Appeals discusses the doctrine at length on pages 14 through 25 of the opinion and includes in its analysis the Indiana Supreme Court’s 2005 decision in Bank of New York v. Nally, 820 N.E.2d 644 (Ind. 2005).  There are a number of factors to be considered, and it appears the factors could vary depending upon whether the loan was a refinance as opposed to original funding.  For what it’s worth, the “classic formulation” of the doctrine in the case of a purchaser of a note and mortgage for value is that the “purchaser’s right of subrogation to the mortgage he or she discharged includes its priority over junior liens of which (a) he or she did not have actual knowledge, and where (b) he or she was not culpably negligent in failing to learn of the junior lien.”  Id. at 14.  Nally complicated that classic formulation a bit, however.  Some of the other factors the courts will weigh include (a) avoidance of an unearned windfall, (b) absence of prejudice to the interest of junior lien holders, (c) lender’s justified expectation of receiving a security interest in the property and (d) the achievement of an equitable [fair] result.  Gibson is an illustration of the granting of equitable subrogation over a prior mortgage.  The home buyer (and lender) prevailed.

The obvious issue not addressed in the opinion was the role the home buyer’s title insurance company played.  Once the buyer and/or his lender learned that the title work missed the prior mortgage, I suspect someone immediately made a claim to the title insurer and that the title insurer provided some form of coverage for the claim.  In fact, the title insurer very likely covered the costs of the litigation.  Fortunately for the buyer and lender, and also the title insurance company, the Court of Appeals found that their mortgage had priority, so there were no damages.  The home buyer and lender were, therefore, protected from what could have been a disastrous financial result.  So, don’t forget to buy title insurance and, if a title issue arises, don’t forget to immediately assert a claim.