The Indiana Court of Appeals recently interpreted an ambiguous subordination agreement, finding the subordinated creditor was entitled to the appointment of a receiver over the mortgaged property.  PNC Bank, National Association v. LA Develop., Inc., --- N.E.2d ---, No. 41A01-107-MF-314, 2012 WL 3156539 (Ind. Ct. App. Aug. 6, 2012).  In PNC Bank, the bank loaned funds to a developer in 2004 for the development of two properties.  The loans were secured by mortgages on the properties.  The mortgages contained a provision under which the developer agreed to the appointment of a receiver.

In 2008, the developer needed additional funds to complete one of the developments.  A second lender agreed to loan the developer the additional funds.  As part of the loan transaction, the bank entered into separate subordination agreements with the developer and the second lender regarding the bank’s mortgages on the property.  Under the subordination agreement between the bank and the second lender, the bank agreed that “all liens, mortgages, encumbrances, security interests, and assignments . . . are hereby expressly SUBORDINATED AND MADE SECONDARY AND INFERIOR . . . .”  Id., at *4 (emphasis in original). 

In 2011, the bank filed a complaint to foreclose its mortgages on the two properties and immediately moved for the appointment of a receiver over the properties.  The second lender filed an objection to the bank’s motion, arguing, among other things, that the bank subordinated its entire mortgages, including the right to request the appointment of a receiver, to the second lender’s mortgage.  The trial court agreed, denying the bank’s request for the appointment of a receiver.

The Indiana Court of Appeals reversed, holding that the subordination agreement was ambiguous.  It found that both the bank’s interpretation—that it only subordinated its liens—and the second lender’s interpretation—that the bank subordinated of all of its rights and remedies under the mortgages—were both reasonable. 

In order to interpret the ambiguous subordination agreement, the court turned to the writings related to the transaction that were executed at the same time as the subordination agreement.  The court looked to the forbearance agreement, executed with the subordination agreement, which provided that the bank was “entitled to take any and all action and exercise all rights and remedies granted to it under the Loan Documents by applicable law.”  Id. at *10.  The forbearance agreement also expressly stated that the bank reserved and retained all rights and remedies in connection with any action or failure by the developer.  Id.  The Court of Appeals held that the second lender’s argument did not reconcile with this language in the forbearance agreement, which expressly provided that the bank retained all of its other rights.  Id. at *11.

The court further reasoned that the second lender’s argument was incorrect because the bank’s default rights and remedies were not located only in the mortgages.  For example, the loan agreement permitted the bank to foreclose on the other property, an action the second lender conceded was authorized by the subordination agreement.  The court explained that if the bank waived all of its enforcement rights, then its ability to foreclose on the other property would be included in that waiver.  Id.  The second lender could not pick and choose which rights and remedies the bank subordinated or waived.  Id. at *12.

Lenders entering into subordination agreements in Indiana should be careful to address in the agreement the exact rights and remedies that are being subordinated.  After PNC Bank, the subordinated creditor may be able to force the appointment of a receiver, even though its lien is junior, if the subordination agreement does not clearly subordinate that remedy.