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.