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How Can A Subsequent Mortgage Have Priority Over A Prior Mortgage?

In Indiana, a mortgage lien generally takes priority in title “according to the time of its filing.”  I.C. § 32-21-4-1(b).  In other words, the mortgage that gets recorded first is senior.  But sometimes prior mortgages are not paid off at closings as intended.  In such cases, the doctrine of equitable subrogation can trump the lien priority rule in I.C. § 32-21-4-1(b).  Finance Center Federal Credit Union v Brand, 967 N.E.2d 1080 (Ind. Ct. App. 2012) illustrates this. 

Scenario.  Funds received from GMAC at a refi closing fully satisfied the borrower’s obligations to both Meridian Group, the senior lender, and Finance Center, the HELOC lender.  Finance Center failed to release its mortgage, which contained a provision requiring the borrower to send notice requesting the release of the lien.  Finance Center received no such notice, left the line of credit open, and later advanced additional funds to the borrower.  The borrower later defaulted on the GMAC mortgage, and in the foreclosure action the issue became whether GMAC or Finance Center was first in priority.

Argument.  Generally, as long as the refinancing lender is not culpably negligent, it is entitled to stand in the shoes of the senior lien and retain its priority status. For more on the doctrine, please click on my February 9, 2008 post, which discussed a similar case.  However, culpable negligence, if established, is an exception to the doctrine of equitable subrogation.  Finance Center contended that GMAC was not entitled to a first lien because GMAC was culpably negligent for not ensuring the notice letter got to Finance Center. 

No culpable negligence.  The Brand opinion noted that the “culpable negligence” exception “contemplates action or inaction which is more than mere inadvertence, mistake or ignorance and focuses on the activity of the party asserting subrogation [the subsequent lender].”  Finance Center asserted that GMAC was culpably negligent by failing to obtain a release of the HELOC mortgage.  The Court disagreed and concluded that GMAC’s mere failure to ensure that it had properly paid off Finance Center was not enough to pass the culpable negligence test:

[a]ny negligence in GMAC’s failure to ensure that the [borrower’s] second mortgage with Finance Center was released did not prejudice Finance Center because the Finance Center mortgage was always junior to the senior Meridian Group mortgage, which was fully satisfied with the loan proceeds from the GMAC refinancing.  Allowing GMAC to step into the shoes of the Meridian Group mortgage will leave Finance Center in the very same junior position.  This is a clearly equitable result.  See Nally, 820 N.E.2d at 655 (“The mere fact that a person seeking subrogation was negligent does not bar him or her from relief where such negligence is as to his or her own interests and does not affect prejudicially the interest of the person to whose rights subrogation is sought.”) 

In Brand, the doctrine of equitable subrogation applied, and the Court determined that the refinancing lender’s mortgage (the GMAC mortgage) was a first and senior lien on the subject real estate.

If, as a secured lender, you close a real estate loan thinking that all prior mortgages had been paid off, but you later learn that a mortgage was not released as it should have been, then you and your counsel’s first thought should be to explore the relief afforded by Indiana’s doctrine of equitable subrogation.  The second thought should be to make a claim on your title insurance policy - if you purchased one.

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