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.