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EQUITABLE SUBROGATION LEAP FROG
06/19/2012

What is equitable subrogation you ask?  Let me illustrate.  Lets say on January 1, 2005, Bank #1  loaned a Developer $1,000,000 to build a shopping center, with the note secured by a Deed of Trust on the Property.  Then, lets say the Contractor hired by Developer to build the shopping center began its work of improvement on February 1, 2006.  Then, lets say on July 1, 2006, Bank #2 loaned the Developer $2,000,000, with the note secured by a Deed of Trust on the Property as well.  Bank #2 is claiming it refinanced, thereby paying off, Bank #1's January 1, 2005 loan.  Then, lets say Contractor does not get paid by the Developer, and as a result records a mechanic's lien on the Property for $2,000,000 on December 1, 2007.  The Contractor is claiming because commencement of construction began well before July 1, 2006, his mechanic's lien has priority over Bank #2's loan.  Bank #2 is claiming because it paid off Bank #1, under the theory of "equitable subrogation", it can leap-frog over Contractor's priority of lien to the Property.  So, WHO'S ON FIRST?

The view adopted by section 7.6 of the Restatement (Third) of Property: Mortgages, states that a mortgagee will be subrogated when it pays the entire loan of another as long as the mortgagee "was promised repayment and reasonably expected to receive a security interest in the real estate with the priority of the mortgage being discharged, and if subrogation will not materially prejudice the holders of intervening interests in the real estate."  Because the Restatement approach is the most persuasive, Nevada adopts the view expressed by it.  However, there is limited Nevada case law on the doctrine of equitable subrogation.  The Nevada Supreme Court first applied the doctrine in Laffranchini v. Clark (1915), where it held that the holder of an invalid mortgage was entitled to be equitably subrogated to the priority position of the lender whose loan she had paid.  Where Nevada law is lacking, its courts have looked to the law of other jurisdictions for guidance.

            Much like in our present example above, in Ex parte Lawson (Ala.,2008), Subcontractor brought actions against homebuilding company that obtained a construction loan secured by a mortgage, home purchasers, and lenders that were purchase-money mortgagees, seeking to enforce materialman's liens that were recorded after the construction mortgage and purchase-money mortgages.  The Alabama Supreme Court using a similar legal standard as Nevada, held that the constructive notice supplied by the materialman's lien statute defeats the lenders' equitable subrogation claim.  It said the materialman's lien statutes "are an expression of legislative intent that should stay the hand of equity in this situation.  If we held otherwise, we would violate the equitable maxim that equity follows the law."  Utah cases have also held the same.  In Richards v. Security Pacific Nat'l Bank (Utah 1993) the court held that under Utah's mechanic's lien statute a subsequent lender had constructive notice of the intervening mechanic's lien so that the subsequent lender was not entitled to use the doctrine of equitable subrogation to defeat the mechanic's lien.  In the State of  Washington, its Supreme Court held, as a matter of first impression, that it would also adopt the approach of the Restatement (Third) of the Law of Property §7.6 (1997), under which a refinancing mortgagee's actual or constructive knowledge of intervening liens does not automatically preclude a court from applying the doctrine of equitable subrogation.  The Washington court quoted the following: "If all persons who negligently confer an economic benefit upon another are disqualified from equitable relief because of their negligence, then the law of restitution, which was conceived in order to prevent unjust enrichment, would be of little or no value" and "ne is not penalized for lack of care unless this results in harm to someone else ."

As many things in the law, every case is different because its fact are different.  In our example above, the court should look to see (i) Whether or not Bank #2 had an express or implied agreement with Bank #1; (ii) Was Bank #2 loan terms materially different; (iii) Did Bank #2 reasonably expect to receive a security interest in the Property with the same priority of Bank #1; and (iv) if subrogation would materially prejudice Contractor.  So what's the answer you may ask?  Who wins?  That, as always, is up to the courts to decide.  Nevertheless, everyone should know their rights when dealing with complex real estate issues.  The attorneys at our firm can consult with you to provide the legal advice, guidance and expertise necessary to assist you with these issues, and many others.

 

For more information contact us at office@fdlawlv.com.

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