Title: American Sterling Bank v. Johnny Mgmt. LV

State: nevada

Issuer: Nevada Supreme Court

Document:

426Nev, Advance Opinion 4]

IN THE SUPREME COURT OF THE STATE OF NEVADA

AMERICAN STERLING BANK, A | No. 52822
MISSOURI CORPORATION,

Appellant, | FILED
JOHNNY MANAGEMENT LV, INC., A
NEVADA CORPORATION, | oct 28 2010
Respondent.

id

 

Appeal from a district court judgment entered after a bench
trial in a real property action. Eighth Judicial District Court, Clark
County; Susan Johnson, Judge.

Affirm
Gerrard Cox & Larsen and Douglas D. Gerrard and Gary C. Milne,

Henderson,
for Appellant,

Fennemore Craig, P.C., and Christopher H. Byrd and Anthony B. Golden,
Las Vegas,
for Respondent.

    
     

 

BEFORE THE COURT EN BANC.

OPINION

By the Court, HARDESTY, J.

‘This appeal concerns the application of the doctrine of
equitable subrogation where a refinancing mortgage’s due date was
accelerated. We have previously adopted the rule in Restatement (Third)
of Property: Mortgages, section 7.6, that a lender whose loan proceeds
were used to pay the balance of a prior note is equitably subrogated to the

10-28AG0

 
 

former lender's priority lien position so long as an intervening lienholder
is not materially prejudiced. Houston v, Bank of America, 119 Nev. 485,
490, 78 P.3d 71, 74 (2003). The Restatement reasons that holders of

intervening interests cannot complain about the application of the

 

equitable subrogation doctrine because the intervening lienholder is “no
worse off than before the senior obligation was discharged.” Restatement
(Third) of Prop.: Mortgages § 7.6 cmt. a (1997).

In this appeal, we consider whether an intervening lienholder
suffers an injustice or prejudice precluding equitable subrogation where
the terms, including the maturity date, of the refinancing loan are
materially different than the terms and maturity date of the senior
obligation, We conclude that material differences in interest rates and
payment terms do not cause prejudice to the intervening lienholder
because equitable subrogation generally limits the paying lender's priority
to the amount and terms of the retired senior obligation. However, a
materially accelerated maturity date for the paying lender's loan can, and
did in this case, prejudice the intervening lienholder, precluding equitable
subrogation. We therefore affirm.

FACTS

In May 2005, Jamal El Jwaidi and Kamila Zakoscielna
(collectively, the Borrowers) obtained two purchase money loans from
Steward Financial, Inc., to purchase real property in Las Vegas, Nevada.
‘The first Steward promissory note (Ist Steward note) was in the amount of
$2 million and was secured by a first deed of trust against the property.
‘The second Steward promissory note (2nd Steward note) was for $500,000,
matured in 15 years, or 2020, earned an 8.375 percent fixed interest rate,
with principal and interest payable at approximately $3,800 monthly, and
was secured by a second deed of trust on the property. ‘The beneficial

 
interest in the 2nd Steward note and deed of trust were later assigned to
GMAC Mortgage Corporation

On September 14, 2005, the Borrowers obtained an additional
loan in the amount of $650,000 from respondent Johnny Management LV,
Inc. (JMLY), also secured by a deed of trust against the property and
recorded in the third priority lien position. However, just prior to
recording the JMLV loan, the Borrowers opened escrow with appellant
American Sterling Bank (ASB) at Fidelity National Title of Nevada to
refinance the 2nd Steward note. Escrow closed on the ASB note on
September 27, 2005, and the Borrowers obtained a loan in the amount of
$805,000 that bore a variable interest rate with monthly interest-only
payments of approximately $5,469, with the entire principal balance
payable in six months, or March 2006." At closing, Fidelity National Title
paid $519,092 on behalf of ASB to GMAC to satisfy the 2nd Steward note.
Failing to discover the existence of the previously recorded JMLV deed of
trust, ASB recorded its deed of trust on the property on September 27,
2005.

Prior to the initiation of this litigation, the Borrowers paid
their payments on the ASB note, but eventually defaulted on their
monthly payment obligations on the JMLV note. JMLV initiated
foreclosure by recording a notice of default in March 2007 and later sought
a trustee's sale. The trustee's sale was scheduled to occur in July 2007.
Prior to the trustee's sale, ASB filed a complaint in the district court to

'The ASB note was subsequently renewed beyond March 2006 and
through the date of trial

 

 
enjoin the sale and declare ASB’s deed of trust to have priority senior to
IMLY’s deed of trust through the doctrine of equitable subrogation.

At trial, ASB argued that it was entitled to equitable
subrogation on the terms of the 2nd Steward note. ASB attributed all
payments received to the ASB note; however, ASB considered the 2nd
Steward note and the deed of trust securing it to be in default, thus
accruing interest, late fees, and costs. As a result, ASB claimed that not
only was it entitled to equitable subrogation up to the value that it paid to
satisfy the 2nd Steward note, $519,092, it was also entitled to interest,
late fees, and costs according to the terms of the defaulted 2nd Steward
note, raising the total lien value to $685,217.

IMLV argued that equitable subrogation should not apply in
this situation because JMLV would be prejudiced by granting ASB a lien
priority in front of JMLV's previously recorded deed of trust and that it
was inappropriate for ASB to apply all payments received from Borrowers
to the ASB note and treat the 2nd Steward note to be in default and
accruing interest, late fees, and costs. The district court agreed with
JMLV and determined that ASB acted inequitably by artificially
increasing the default value of the 2nd Steward note when the payments
were current on the ASB note. The district court also found that JMLV.
was prejudiced by the material differences in loan terms between the ASB
note and the 2nd Steward note.

On a motion to reconsider the district court's decision or, in
the alternative, stay the foreclosure, ASB clarified, for the first time, that
it was within the district court's discretion to grant or disregard the
additional interest, late fees, and costs attributed to the 2nd Steward note

and simply grant equitable subrogation for the principal value that ASB

 

 
paid to satisfy the 2nd Steward note, $519,092. Additionally, ASB
asserted that because equitable subrogation is subject to the torms of the

not

 

2nd Steward note, any difference in the terms of the respective notes
prejudicial. The district court denied ASB's motion to reconsider but did
grant a motion to stay the foreclosure pending this appeal.

DISCUSSION

In resolving this appeal, we consider the various prejudicial
and equitable factors that affect the application of equitable subrogation
according to section 7.6 of the Restatement (Third) of Property: Mortgages,
The principle and effect of equitable subrogation requires that we
determine first whether a difference in the terms between a discharged
promissory note and a potentially subrogated note is relevant and, if so,
whether any such difference is prejudicial. Then, we must evaluate the
district court's application of equitable subrogation as an equitable remedy
to determine whether it is proper to adjust the priority position of the
refinancing mortgage.

Standard of review

When the material facts of a case are undisputed, the effects of
the application of a legal doctrine to those facts are a question of law that,
24, 19 P.Bd

   

this court reviews de novo. Banegas v, SUIS, 117 Nev. 222,
245, 247 (2001). This same standard applies in the context of an appellate
court's review of equitable subrogation. Hicks v. Londre, 125 P.3d 452,
455 (Colo. 2005). This standard allows an appellate court “to

independently review the question of whether the doctrine of equitable

 

subrogation applies to the circumstances present in (a particular] case.

Id. However, equitable subrogation is also an equitable remedy that

requires the court to balance the equities based on the facts and
circumstances of each particular case. Murray v. Cadle Co,, 257 S.W.3d

 

 
on

 

291, 300 (Tex. App. 2008). Subrogation’s purpose is to “grant an equitable
result between the parties.” 2 Grant 8, Nelson & Dale A. Whitman, Real
Estate Finance Law § 10.6, at 26 (5th ed. 2007). This court has expressly
stated that district courts have full discretion to fashion and grant
equitable remedies, Bedore v. Familian, 122 Nev. 5, 11-12 & n.21, 125
P.3d 1168, 1172 & n.21 (2006), and we will review a district court's
decision granting or denying an equitable remedy for abuse of discretion.
See Douglas Disposal, Inc. v. Wee Haul, LLC,, 123 Nev. 552, 557, 170 P.3d
508, 512 (2007) (reviewing a request for injunctive relief under an abuse of
discretion standard); Jacoby v. Jacoby, 100 P.3d 852, 855 (Wyo. 2004)
(noting that trial courts have broad discretion to grant equitable relief).
““An abuse of discretion occurs if the district court's decision is arbitrary
or capricious or if it exceeds the bounds of law or reason.”” Nolan v, State,
122 Nev. 363, 376, 132 P.3d 564, 572 (2006) (quoting Crawford v. State.
121 Nev. 744, 748, 121 P.3d 582, 585 (2005) (quoting Jackson v, State, 117
Nev. 116, 120, 17 P.3d 998, 1000 (2001).
Equitable subrogation

Ordinarily, when a senior deed of trust is satisfied, the junior
lienholders remain in their respective order of priority and are
consequently elevated up the priority line. Hicks, 125 P.3d at 4656.
Equitable subrogation interrupts this procedure and “permits ‘a person
who pays off an encumbrance to assume the same priority position as the
holder of the previous encumbrance.” Houston v. Bank of America. 119
Nev. 485, 488, 78 P.3d 71, 73 (2003) (quoting Mort v. U.S, 86 F.3d 890,
893 (9th Cir. 1996)). It acts as an exception to modern recording statutes
and enables “a later-filed lienholder to leap-frog over an intervening
lien{holder].” Hicks, 125 P.3d at 456, 458. he practical effect of equitable

 

subrogation is a revival of the discharged lien and underlying obligation

6

 
and assignment to the payor or subrogee, permitting the subrogee to
enforce the seniority of the satisfied lien against junior lienors
Restatement (Third) of Prop.: Mortgages § 7.6 cmt. a (1997); Land Title
Ins. Cor. v. Ameriquest Mor. Co, 207 P.3d 141, 144-45 (Colo. 2009). We

note that if no junior interest existed, the subrogee could just sue on the

 

obligation and obtain a judgment on the lien; however, where an interest
exists that is subordinate to the mortgage, the judgment lien would be
inferior to the junior interest and of little value absent the application of
equitable subrogation. See Restatement (Third) of Prop.: Mortgages § 7.6
emt. a (1997).

In Houston, we addressed the principle of equitable
subrogation within the lien priority context and adopted section 7.6 of the
Restatement (Third) of Property: Mortgages. 119 Nev. at 490, 78 P.3d at
74, The Restatement disregards any actual or constructive notice of the
existence of an intervening junior lien and permits equitable subrogation
so long as the payor “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.” Id, (quoting Restatement (Third) of Prop.
Mortgages § 7.6(6)(4) (1997).

Although equitable subrogation has the effect of an
assignment of the discharged lien, it is not an absolute right and will not,
be granted if it will result in injustice or prejudice to an intervening lienor.
Houston, 119 Nev. at 491, 78 P.3d at 75; Rinn v, First Union Nat. Bank of
Maryland, 176 B.R. 401, 414 (D. Ma. 199
that an intervening lienholder is not materially prejudiced by applying

 

). In Houston, we recognized

 

equitable subrogation because it remains in the same priority lien

 

 
position, and on the contrary, may receive a windfall by being elevated to
a higher priority status if subrogation is not applied. 119 Nev. at 491, 78
P.3d at 74-75; sce also Lamb Excavation v. Chase Manhattan Mortg., 95
P.3d 42, 647 (Ariz. Ct. App. 2004)
Prejudice throu

In this case, the district court determined that JMLV was
prejudiced, in part, because of the drastic difference in terms between the
ASB note and the discharged 2nd Steward note. ASB asserts that the
difference in terms is irrelevant and cannot be prejudicial because section
7.6, comment e of the Third Restatement limits equitable subrogation to
the terms of the discharged 2nd Steward note. While we do not agree that
the difference in terms is irrelevant, we recognize that Restatement
section 7.6, comment ¢ neutralizes potential prejudice by limiting
subrogation to the terms of the discharged note and security interest
Restatement (Third) of Prop.: Mortgages § 7.6 emt. e (1997). A payor or
subrogee may not enforce loan terms that are materially different from the
terms of the discharged note. Land Title Ins. Cor., 207 P.3d at 145. “This

 

principle is derived both from the fact that equitable subrogation acts only
as a revival and assignment of the discharged obligation and security,
rather than a substitution of a new obligation in place of another.” Id.
Section 7.6, comment ¢ requires that “[tJhe payor is
subrogated only to the extent that the funds disbursed are actually
applied toward payment of the prior lien. There is no right of subrogation
with respect to any excess funds.”? Restatement (Third) of Prop.

*Because there is no subrogation for amounts in excess of the
amount paid to discharge the prior lien, Restatement (Third) of Prop.
Mortgages § 7.6 emt. e (1997), it would appear equitable that the lien

continued on next page

 

 
Mortgages § 7.6 cmt. e (1997). It also recognizes that when a new lender,
such as ASB, demands a higher interest rato, an intervening lienholder is
not prejudiced because subrogation is “granted only to the extent of the
debt balance that would have existed if the interest rate had been
unchanged.” Id,

We agree, in general, that under section 7.6 of the Third
Restatement, JMLV would not be prejudiced by any material difference in
the value or interest rates between the ASB note and the 2nd Steward
note. Although the ASB note has a principal value of $805,000 and a
variable interest rate, under the doctrine of equitable subrogation, ASB
‘could only be equitably subrogated up to the value of the original 2nd
Steward note, $519,092, and would only be subject to the debt balance at
the existing interest rate of 8.375 percent. Id, Because of these
restrictions, which serve to neutralize the effect of a change in the
principal value and/or interest rate, we conclude that, in this instance, a
difference in value and interest rates is not prejudicial and should not
preclude equitable subrogation.

We recognize, however, that section 7.6, comment e is silent
with respect to the prejudicial effect of materially accelerating the

maturity date of the note.* Unlike the principal value or interest rate, an

 

2. continued
securing these excess amounts necessarily becomes a junior lien behind all
other previously recorded liens,

*The Restatement explains that prejudice typically “flows from a
delay by the payor in recording his or her new mortgage, in demanding
and recording a written assignment, or in otherwise publically asserting
subrogation to the mortgage paid.” Restatement (Third) of Prop
Mortgages § 7.6 cmt. f (1997). There is no apparent prejudice on these

continued on next page

 

 
alteration of the maturity date affects various other terms and conditions
of the note, including the due date for final payment, a borrower's default,
and subsequently, the lender's ability to foreclose on a security interest
Wo dotormine that because the impact of an accelerated maturity date has
extended consequences and cannot be neutralized to the same degree as
the principal value and interest rates, equitable subrogation should only
be applied after determining whether an accelerated maturity date has a
materially prejudicial effect on junior lienholders.

Restatement (Third) of Property: Mortgages section 7.6,
comment ¢ and section 7.3, comments b and ¢ recognize that an extension
of the maturity date in the paying loan is not generally prejudicial because
it typically reduces the likelihood of foreclosure of a senior lien. We
further note that an extension of the maturity date often results in
reduced monthly payment obligations, which ultimately benefit the junior
lienholders. Likewise, an accelerated maturity date, under certain
circumstances, may also be beneficial to the junior lienholder because the
senior obligation is extinguished earlier and often at a reduced interest,
rate. See Grant S. Nelson & Dale A. Whitman, Adopting Restatement

lortgage Subrogation Principles: Saving Billions of Dollars for
Refinancing Homeowners, 2006 BYU L. Rev. 305, 322 (2006). But in
extreme situations, where the maturity date is drastically accelerated
while the principal value and monthly payment obligations are
significantly increased, an accelerated maturity date may be considered
prejudicial as it directly affects the likelihood of default on the senior lien.

continued
grounds nor has JMLV asserted that any prejudice arose from any delay
on behalf of ASB in this case.

 

 
Soe id, at 323 n.66. Additionally, ASB has failed to demonstrate how this
court should equitably bifurcate the ASB note to apply both the maturity
date of the 2nd Steward note and the maturity date of the ASB note in
order to prevent prejudico to any junior lienholders that are subject to the
2nd Steward deed of trust. Under such extreme circumstances, we
conclude that an accelerated maturity date may have a prejudicial impact
on junior lienholders,

In this case, the 2nd Steward note had a principal balance of
$619,092 that would mature in June 2020 and a monthly principal and
interest payment obligation of approximately $3,800. However, the
maturity date of the ASB note required a final principal payment of
$805,000 in March 2006, six months from the date of the note’s execution,
and required an interest-only monthly payment obligation of
approximately $5,469. The maturity date of the ASB note was
approximately 14 years earlier than the original 2nd Steward note. JMLV
asserts that the acceleration of the maturity date and the increased
monthly payment obligations has increased the likelihood of default on the
senior lien and would substantially burden JMLV’s ability to cure any
default, Because the 2nd Steward deed of trust is intended to act as
security for the ASB note, a default on the ASB note would entitle ASB to
foreclose on the 2nd Steward deed of trust; therefore, any increased risk of
default caused by the ASB note would be prejudicial to a junior lienholder.
As a junior lienholder, JMLV assumes a certain risk of foreclosure on
senior liens. JMLV’s assumption of risk included that the senior
obligation would require a $3,800 payment for approximately 15 years;
however, JMLV did not assume the risk that the Borrowers would be

required to make a final principal payment 14 years sooner than the due

 

 
ome

 

date of the 2nd Steward note. By securing the ASB note with the 2nd
Stoward deed of trust, the increased risk of default on the ASB note
prejudicially effects JMLV's calculated risk of foreclosure on a senior lien.
Because JMLV has boon prejudiced by the drastically accelerated
maturity date through an increased risk of default and increased inability
to cure the default, we conclude that, under these circumstances, equitable
subrogation is not appropriate

Equitable subrogation as an equitable remedy

The district court refused to grant equitable subrogation
because it determined that ASB did not act equitably by requesting to
subrogate the ASB note that contained substantially different terms than
the 2nd Steward note and to be subrogated to a senior priority lien
position that had an inflated value above the original value of the lien.
‘The district court reasoned that subrogation, under the circumstances,
would be detrimental to a junior lienholder. We ultimately affirm the
district court's conclusion but reject the district court's reasoning to the
extent that it relies on the difference in interest rate and principal value of
the notes. See Lamb Excavation v. Chase Manhattan Mortg., 95 P.3d 542,
547 (Ariz. Ct. App. 2004) (reasoning that the difference in interest rates
does not preclude equitable subrogation); see also St. James Village, Inc. v
Cunningham, 125 Nev. __, __, 210 P.3d 190, 196 (2009) (affirming the
district court's decision, although the court “relied on different grounds in
reaching its decision’).

We conclude that a material acceleration in the maturity date
between the senior note and the paying note can accelerate default on the
senior lien, resulting in injustice and prejudice to an intervening lienor.
While it is practical to neutralize any prejudice resulting from a difference

in interest rate and principal value, the prejudicial effect of a material

12

 
8

 

acceleration in the maturity date cannot be accounted for by the same
means. Additionally, at trial, ASB confirmed that it was receiving
monthly payment obligations on the ASB note but only allocated those
payments to the ASB deed of trust, a junior lien interest, while it also
considered the 2nd Steward note and deed of trust to be in default and

 

accruing additional interest, late fees, and costs. Because the 2nd
Steward note was accruing interest and increasing in value, ASB did not
limit its subrogation claim to the value paid for the discharged deed of
trust, $519,092, but claimed that it was entitled to the additional interest,
late fees, and costs totaling $685,217. ASB did not clarify that the district
court should, as an alternative, limit subrogation to the value paid to
satisfy the original 2nd Steward note, $519,092, until after the entry of
judgment, Also, ASB failed to explain what the Borrowers or interested
junior lienholders could have done in order to prevent the 2nd Steward
note from accruing this additional interest.

We agree that it is inequitable and prejudicial to inflate the
value of a subrogated deed of trust to the detriment of all junior
lienholders and then assert a claim for subrogation to that inflated
position. Although arguments were presented about the allocation of the
payments ASB received, we do not address at this time how payments on a
subrogated note should be allocated when the note is secured by more
than one deed of trust. However, because the material difference in the
maturity date between the 2nd Steward note and the ASB note
unavoidably prejudiced JMLV, and ASB acted inequitably by inflating the
value of the subrogated deed of trust, we conclude that the distriet court

{did not abuse its discretion by refusing to apply the equitable subrogation

13,

 
    
  
  
 
    
  
    
       

doctrine in this case.*

Accordingly, we affirm the district court's judgment.

 

Hardesty
|We concur:

aARa eys
Parraguirre

 

Gibbons

Pickering

‘Additionally, we note that JMLV has been prejudiced by having to
defend its recorded lien against ASB’s request for equitable subrogation.
/As equitable subrogation is an equitable remedy, it is important to note
that JMLV is an innocent party that has been brought into this action
through ASB's failure to properly protect its anticipated security interest.
It would be inequitable to require JMLY to bear not only its own costs in
defending this action but also ASB's costs either directly or through an
increase in value secured by a senior lien.