Opinion ID: 2571489
Heading Depth: 1
Heading Rank: 4

Heading: Different Jurisdictional Approaches

Text: ¶ 12 Courts generally consider knowledge in one of three ways when applying equitable subrogation to a refinancing lender. First, the Restatement approach that says actual or constructive knowledge of intervening interests is irrelevant; second, a minority approach that says a plaintiff with either actual or constructive knowledge cannot seek equitable subrogation; and third, a majority approach [5] that says a plaintiff with actual knowledge cannot seek equitable subrogation, while one with constructive notice can.
¶ 13 The Restatement posits a subrogee's knowledge of junior interests is irrelevant. See RESTATEMENT (THIRD) § 7.6 cmt. e, at 520 ([S]ubrogation can be granted even if the payor had actual knowledge of the intervening interest. . . . The question in such cases is whether the payor reasonably expected to get security with a priority equal to the mortgage being paid.). The American Law Institute (ALI) properly emphasizes equitable subrogation's concern of unjust enrichment: Subrogation is an equitable remedy designed to avoid a person's receiving an unearned windfall at the expense of another. Id. cmt. a. [6] And junior lienholders will be unjustly enriched whether the subrogee knew about them or not.
¶ 14 But the ALI recognizes its approach conflicts with a majority of state court decisions. Of those states that require some knowledge, there is a further distinction. A minority of those jurisdictions deny equitable subrogation if a party knows or should have known there were intervening interests. The rationale for this rule is a party should not profit by its negligence in failing to check the records. The Missouri Supreme Court, in its first equitable subrogation case, explained its reluctance to allow a party to profit by its negligence: That plaintiff's security was less valuable than he expected it would be when he made the loan was the result of his own negligence, and not of the fault, wrong, or mistake of any other person. Against the consequences of that negligence, for which he has no one to blame but himself, a court of equity cannot relieve him by interfering with the legal rights of others who are without fault. Bunn v. Lindsay, 95 Mo. 250, 7 S.W. 473, 476 (1888). ¶ 15 For practical purposes, this rule swallows the doctrine and is widely criticized. A more recent Alabama Supreme Court case rejected this approach: 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. Ex Parte AmSouth Mortgage, 679 So.2d 251, 255 (Ala.1996) (`[O]ne is not penalized for lack of care unless this results in harm to someone else.') (quoting Restatement of Law of Restitution § 59 cmts. at 232 (1937)); see also Trus Joist Corp. v. Nat'l Union Fire Ins. Co., 190 N.J.Super. 168, 462 A.2d 603, 609 (1983) (There is no doubt that a mortgagee who negligently accepts a mortgage without knowledge of intervening encumbrances will subrogate to a first mortgage with priority over the intervening encumbrances. . . . This result is reached so that the holders of the intervening encumbrances not be unjustly enriched at the expense of the new mortgagee.), rev'd sub nom., Trus Joist Corp. v. Treetop Assocs., Inc., 97 N.J. 22, 477 A.2d 817 (1984); Prestridge v. Lazar, 132 Miss. 168, 95 So. 837, 838 (1923) (We are unable to see how constructive notice to appellant of appellee's [junior] mortgage could have anything to do with the right of the former to subrogation. . . . The question is: What is natural justice under the actual facts of the situation?); Grant S. Nelson & Dale A. Whitman, Adopting Restatement Mortgage Subrogation Principles: Saving Billions of Dollars for Refinancing Homeowners, 2006 BYU L.REV. 305, 315-16 (We have vigorously criticized this approach and find it impossible to understand in light of the fact that subrogation in this situation harms no one, leaving the intervening lien exactly where it started. In contrast, refusal to grant subrogation gives the intervening lienor an unexpected, unearned, and unwarranted promotion in priority. (footnote omitted)). ¶ 16 This rule renders equitable subrogation nearly useless since a refinancing mortgagee will almost always have either actual or constructive knowledge of junior lienholders. And equitable subrogation has little use when there are no junior lienholders because then the plaintiff is the only party with an interest in the collateral; his priority is immaterial. RESTATEMENT (THIRD) § 7.6 cmt. a. (Subrogation to a mortgage is usually of importance only when a subordinate lien or other junior interest exists on the real estate.). The doctrine is then practical in only those few instances when the mortgagor fraudulently hides the junior interests. See State Sav. Trust Co. v. Spencer, 201 S.W. 967, 971 (Mo.Ct.App.1918) (allowing subrogation when the borrower forged subordination documents). These cases are rare.
¶ 17 The final approach accepts that constructive notice should not block equitable subrogation but still denies equitable subrogation if a party has actual knowledge of the intervening interests. This rule is followed by many, but by no means all, jurisdictions. [7] Three reasons are often given to support this rule. First, equitable subrogation would obstruct the predictability and stability of the recording act and the rule first in time, first in right. Second, analogous to the reasoning in Bunn, one should not be allowed to knowingly leap-frog another's priority: [A]llowing subrogation . . . would permit [a party] to accomplish indirectly through `equity' what it could not otherwise accomplish directly. Picker Fin. Group L.L.C. v. Horizon Bank, 293 B.R. 253, 263 (Bankr.M.D.Fla. 2003). Third, some courts suggest a lender can rarely, if ever, reasonably expect to assume a first-priority position when he has actual knowledge of intervening liens. Rusher v. Bunker, 99 Or.App. 303, 306-07, 782 P.2d 170, 172 (1989) (citing GEORGE E. OSBORNE, MORTGAGES § 282, at 573 (2d ed.1970)). ¶ 18 These reasons are unconvincing. First, equitable subrogation cannot be said to present too great a threat to the recording act scheme if jurisdictions are willing to allow an ignorant subrogee with only constructive knowledge to come before a prior recorded interest. If those jurisdictions were truly concerned equitable subrogation might frustrate first in time, first in right then they would deny it in all instances instead of distinguishing between constructive notice and actual knowledge. [8] ¶ 19 Second, while the recording act provides stability and notice to lenders (both vital elements to any successful real estate lending scheme), we cannot rigidly adhere to its strictures where it works an injustice. [9] Furthermore, WFB West is not cutting in line; equity and the law are working toward the same end. While WFB West came along second, the mortgage it purchased from Washington Mutual came first, and Bank of America knew this mortgage had priority before its own. Equitable subrogation maintains the proper scheme and the original priorities. See RESTATEMENT (THIRD) § 7.6 cmt. e. ¶ 20 Third, making inferences about a refinancing lender's expectations are unwise and under the Restatement unnecessary because a lender must prove he indeed intended to get the priority. See E. Boston Sav. Bank v. Ogan, 428 Mass. 327, 334, 701 N.E.2d 331, 336 (Mass.1998) (finding a plaintiff, with knowledge, deserved equitable subrogation because plaintiffs expected to have first priority and paid a price that reflected that expectation); Robert M. Smith, Note, What Happened to the Equity in Equitable Subrogation?, 64 Mo. L.Rev. 503, 514 (1999). Under the Restatement, a lender will be found to lack expectation when there is affirmative proof that the mortgagee intended to subordinate its mortgage to the intervening interest. RESTATEMENT (THIRD) § 7.6 cmt. e (Ordinarily lenders who provide refinancing desire and expect [to get security with a priority equal to the mortgage being paid] even if they are aware of an intervening lien.). But allowing these inferences ignores the practical effect of denying equitable subrogation: the junior interest will be unjustly enriched because he will be given a higher priority merely because the debtor refinanced. See E. Boston Sav. Bank, 701 N.E.2d at 334. The trial court specifically found WFB West expected to have first priority when it advanced funds to Sugihara to pay off the Washington Mutual mortgage. Finding of Fact 20. ¶ 21 Equitable subrogation should never be allowed if a junior interest is materially prejudiced, but if the junior interests are unaffected, then there is no reason to deny it. Bank of America could have assumed Washington Mutual's first-priority mortgage instead of taking a second-priority position. But Bank of America accepted the risks inherent in its security and does not deserve an unearned windfall simply because Sugihara refinanced. See id. at 331, 701 N.E.2d 331; Burgoon, 92 F.2d at 730-31; see also First Commonwealth Bank v. Heller, 2004 PA Super. 431, 863 A.2d 1153, 1158 n. 8 (We also note that this majority approach runs counter to, or at the very least does nothing to further, the purpose of the doctrine as elucidated by the Restatements, i.e., to prevent an unjustified and unwarranted windfall on behalf of the intervening lien holder.). ¶ 22 Additionally, this approach either puts a premium on a refinancing mortgagee's ignorance or denies subrogation when there are any knowable intervening interests. First, mortgage companies could purposefully remain ignorant of intervening interests. This approach places a premium on ignorance  not such a bad thing in the present context. If the refinancing lender can preserve the right to subrogation by avoiding knowledge (e.g., by refraining from obtaining a title examination), then refraining from examining the title is an entirely rational step and has the added advantage of saving money. Nelson & Whitman, Adopting Restatement Mortgage Subrogation Principles, supra, at 315, see also Houston v. Bank of Am. Fed. Sav. Bank, 119 Nev. 485, 489, 78 P.3d 71, 73 (2003) (In our view, however, this rule promotes willful ignorance; it encourages prospective mortgagees to avoid conducting title searches.). ¶ 23 And if a refinancing lender must still perform a title search to demonstrate . . . that it reasonably expected to receive a security interest in the real estate with the priority of the mortgage being discharged, RESTATEMENT (THIRD) § 7.6(b)(4), then equitable subrogation would be possible only in those rare cases when there are no knowable interests because a mortgagor fraudulently hid junior interests from a refinancing lender. This mirrors the results of the minority rule, which denies equitable subrogation whenever a subrogee had actual or constructive knowledge. Therefore, the criticisms engendered by that rule would apply with equal force to this approach. Any junior lender could effectively block any refinancing or restructuring between senior lenders and refinancing mortgagees and be unjustly enriched by their newfound higher priority.