Opinion ID: 2366974
Heading Depth: 1
Heading Rank: 6

Heading: Prejudice through a material difference in terms

Text: 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 e neutralizes potential prejudice by limiting subrogation to the terms of the discharged note and security interest. Restatement (Third) of Prop.: Mortgages § 7.6 cmt. 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 e requires that [t]he 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. [2] Restatement (Third) of Prop.: Mortgages § 7.6 cmt. e (1997). It also recognizes that when a new lender, such as ASB, demands a higher interest rate, 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. [3] Unlike the principal value or interest rate, an 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. We determine 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 e and section 7.3, comments b and c 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 Mortgage 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. See 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 prejudice 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 $519,092 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 date of the 2nd Steward note. By securing the ASB note with the 2nd Steward 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 been 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.