It’s every title company’s nightmare.  In the process of closing a secured real estate transaction, a previously-recorded deed of trust is missed, and now the title insurer is potentially responsible for the loss to the insured lender caused by the loss of priority to the intervening deed of trust.  If monies from the insured transaction were used to retire a prior encumbrance on the property, then the doctrine of equitable subrogation may apply.

New California Case:  On September 27, 2012, the Court of Appeal applied the doctrine of equitable subrogation to award priority to a refinance lender whose deed of trust was recorded two months after an intervening deed of trust.  (JP Morgan Chase Bank, N.A. v. Banc of America Practice Solutions, Inc., 2012 WL 4457776, Cal.App. 4 Dist., September 27, 2012 (“JP Morgan”).)  This is the first California case in sixteen (16) years to address the doctrine of equitable subrogation in a lien priority case.  (See Lawyers Title Ins. Corp. v. Feldsher (1996) 42 Cal.App.4th 41.)  The decision also affirmed a summary adjudication that applied equitable subrogation based upon undisputed facts involving the element of “superior or equal equities.”

The Court of Appeal determined that the refinance lender (Chase) was deemed to be equitably subrogated to the rights of the first and second trust deed holders, whose loans Chase had paid off at closing.  In so doing, the court held that the intervening commercial lender (Banc) was not prejudiced as a result because Banc “bargained” to be in junior position to the two prior deeds of trust.

In JP Morgan, the borrowers sought to refinance two prior deeds of trust recorded against their residence.  Chase agreed to provide the refinancing loan based on the condition that its deed of trust would be recorded in first priority position.  That refinance transaction closed and Chase’s deed of trust was recorded on October 25, 2006.  The monies from Chase were used to pay off the prior first and second deeds of trust.

Unbeknownst to Chase (i.e., no actual knowledge), one of the borrowers had sought a business loan from Banc of America Practice Solutions (Banc) for his medical practice and the borrowers gave Banc a deed of trust on their residence.  The Banc deed of trust was recorded on August 24, 2006, two months before Chase’s deed of trust.  Banc was fully aware of the prior two deeds of trust recorded against the property.

Elements of Equitable Subrogation in California:  One of the earliest statements of equitable subrogation in California was contained in Simon Newman Co. v. Fink (1928) 206Cal. 143, which applied equitable subrogation to:

  1. One who advances money to pay off an encumbrance on realty;
  2. At the instance of either the owner of the property or the holder of the encumbrance;
  3. With the understanding (express or implied) that the advance made is to be secured by a first lien on the property;
  4. Is not a mere volunteer;
  5. Is not chargeable with culpable and inexcusable neglect; and
  6. The superior or equal equities of others will not be prejudiced.

In California, most of the discussion of equitable subrogation in lien priority cases focuses on the last two elements – i.e., what constitutes “culpable and inexcusable neglect” and what factors to consider in determining the equities of the competing lienors.  Californiacourts have already applied equitable subrogation to refinance transactions.  (Katsivalis v. Serrano Reconveyance Co. (1977) 70 Cal.App.3d 200.)

In California, Constructive Notice Is Not Inexcusable Neglect:  Banc initially argued that Chase was barred from asserting equitable subrogation because Chase was charged with constructive knowledge of Banc’s deed of trust (which was recorded two months before Chase’s deed of trust).  But California has long rejected this argument of constructive knowledge.  It has “long been the rule in California” that actual knowledge of the intervening lien, not just constructive knowledge, is required to defeat equitable subrogation.  (Smith v. State Savings & Loan Assn. (1985) 175 Cal.App.3d 1092, 1098.)

JP Morgan Focuses On The Parties’ Intended Priority Positions:  In addressing whether Banc’s equities were equal or greater than Chase’s, the court focused on the parties’ intended priority positions.  Chase intended to be in first priority position and did not know of the intervening lien.  Indeed, the escrow company was instructed not to disburse the loan proceeds if Chase’s deed of trust would not be in first priority position.  In contrast, Banc knew of the prior two deeds of trust and “anticipated and received a third deed of trust on the property.”  Thus, Banc was not prejudiced by the application of equitable subrogation because it received exactly what it bargained for – a deed of trust in third priority position.

Substantively, this issue appears to be the principal focus of the JP Morgan decision.  In balancing the possible unjust enrichment to the intervening lienor (by not applying equitable subrogation), with the possible prejudice to the intervening lienor (by applying equitable subrogation), theCalifornia courts will focus on the actual intended priority positions of the parties.  Here, applying equitable subrogation put each lienor in the priority position they either expressly or implicitly bargained for.

Procedurally, JP Morgan affirms the application of equitable subrogation through a motion for summary adjudication (and then entry of judgment based on that order).  Though this procedure was not addressed in the opinion, the implication is that a court’s determination of certain fact-based elements of equitable subrogation (e.g., the prejudice to the intervening lienor) does not preclude a motion for summary judgment based on undisputed facts.

JP Morgan is consistent with priorCalifornia decisions applying equitable subrogation in lien priority cases.  The first key question is whether the subsequent lienor had actual knowledge of the intervening lien.  If not, the court will focus on the intended priority positions of the competing lienors in considering the equities of the parties.