In a case involving a complex set of facts, the Michigan Court of Appeals (the “Court”) recently published an opinion concerning a priority dispute between mortgage lenders involving the doctrine of equitable subrogation (Wells Fargo Bank, N.A. Trustee v. SBC IV REO, LLC and Capitol National Bank, No. 328186, November 29, 2016).

Background Facts

The case involves a borrower who obtained a home loan in 2003 secured by a mortgage, and then subsequently, in 2005, obtained another loan from the same lender (Lender A) and gave Lender A a new mortgage. The new mortgage loan was used, in part, to pay off the 2003 loan, and the 2003 mortgage was discharged.

In 2004, after the original mortgage was recorded but before the new mortgage to Lender A was recorded, a second mortgage, involving a different Lender (Lender B), was recorded in connection with the same home. This made Lender B a junior lienholder at the time its mortgage was recorded.

The loan made by Lender A in 2005, secured by the new mortgage, was in a total amount that was greater than the amount then due under the original 2003 note. The borrowers used part of the new loan to pay off the original 2003 note, and kept the surplus proceeds. Therefore, as explained by the Court in its opinion, “the new loan and mortgage involved more than a mere refinancing transaction; there was an increase in the principal amount.”

A number of years later, the borrowers defaulted on the 2004 mortgage given to Lender B, and foreclosure proceedings were commenced.[1] The foreclosure proceedings resulted in Lender B purchasing the property at a sheriff’s sale.

Following the sheriff’s sale, Lender A[2] (the “Plaintiff”) filed suit against Lender B, which was the owner of the home following foreclosure (the “Defendant”), asserting priority of the 2005 mortgage due to equitable subrogation.

The trial court rejected Plaintiff’s equitable subrogation argument and granted summary disposition in favor of the Defendant. The Plaintiff then appealed.

The Court’s Analysis

The Court noted there was no dispute between the parties that, under Michigan’s race-notice principles, Lender B’s 2004 mortgage, which was recorded before Lender A’s 2005 mortgage, had priority. However, Plaintiff argued that, under the doctrine of equitable subrogation, the 2005 mortgage should be placed in the same priority position that had been enjoyed by the original 2003 mortgage (i.e., a position superior to that of Lender B’s mortgage).

Interestingly, the Court gave relief to both Plaintiff and Defendant on the issue of equitable subrogation.

The Court explained that it could find no prejudice to the Defendant in granting Plaintiff priority of its 2005 mortgage regarding those loaned funds used to pay off the original mortgage. Consistent with its ruling in CitiMortgage, Inc. v Mortgage Electronic Registration Sys., Inc., 295 Mich App 72 (2011), the Court stated “the theory underlying equitable subrogation is that a junior lienholder’s position is left unchanged by the conduct of the lender seeking subrogation and that the junior lienholder is not wronged or otherwise prejudiced as a consequence.”

However, because Plaintiff’s 2005 mortgage loan involved the lending of money in addition to the amount required to pay off the original 2003 mortgage loan, the Court found that permitting equitable subrogation would be prejudicial to the Defendant as to that additional amount of loaned funds.

The Court therefore concluded that the Defendant retains title to the property purchased at the sheriff’s sale, but that its ownership is subject to the Plaintiff’s equitably subrogated mortgage securing the amount of debt equal to the amount required to pay off the original 2003 note (and presumably accrued interest on that amount).

The Court of Appeals decision in this matter affirms the enforceability of the doctrine of equitable subrogation to give priority to a refinancing lender’s mortgage lien, but clearly limits the application of the doctrine to only that amount of the refinancing loan which is required to pay off the original mortgage loan made by the same lender.

Outstanding Issues

This decision raises interesting questions related to foreclosure of an equitably subrogated mortgage. What amount should an equitably subrogated first mortgage lender bid at its own foreclosure sale if the outstanding loan balance is greater than the amount used to pay off the foreclosing lender’s original mortgage? A bid of the entire outstanding balance could result in a claim of “surplus” by the junior lender. Likewise, what amount should the junior mortgage lender have to pay to redeem from the first mortgage foreclosure sale and preserve the junior’s lien? If the actual bid by the first mortgage lender at the foreclosure sale exceeded the amount of the original note payoff, should the required redemption payment be reduced to the original note payoff amount?