The Kentucky Supreme Court, on March 24, 2012, in the case of Mortgage Electronic Registration Systems Inc.[MERS] v. Roberts, 366 S.W.3d 405 (Ky. 2012), conclusively held that the doctrine of equitable subrogation was unavailable to protect a subsequent lender and mortgage holder when its loan proceeds were used to pay off a prior lender’s mortgage and an intervening properly filed judgment lien created actual or constructive notice. The Court expressly held that the so-called “Wells Fargo rule” under which equitable subrogation is not available if the lender has constructive knowledge of an existing tax lien also applied to an intervening judgment lien, overruling the prior decision in Louisville Joint Stock Land Bank v. Bank of Pembroke, 9 S.W.2d 113 (Ky. 1928).
Kentucky clearly is a race-notice jurisdiction. KRS 382.270-.280. In the Wells Fargo Bank decision in 2011, the Kentucky Supreme Court stated that in order to have first priority, “one must not only be the first to file the mortgage, deed or deed of trust, but the filer must also lack actual or constructive knowledge of any other mortgages, deeds or deeds of trust related to the property.” Wells Fargo Bank, Minnesota, N.A. v. Kentucky Department of Revenue, 345 S.W.3d 800, 804 (Ky. 2001).
In MERS v. Roberts, 366 S.W.3d 405 (Ky. 2012), the Court stated “a prior interest in real property takes priority over a subsequent interest that was taken with notice, actual or constructive, with prior interest.” Id. at 408. In MERS v. Roberts, the property owners purchased the property in 1993 and financed it and refinanced it several times between 1993 and 1998. On August 26, 1998, a $108,000.00 mortgage to The Money Store Home Equity Corporation was recorded.
On June 28, 2000, a judgment lien was recorded against the property owner’s real estate. There was no dispute at that time that The Money Store mortgage was superior to the judgment lien.
In 2003, the property was mortgaged for $125,800.00 to New Century Mortgage Corp. with the proceeds used to pay off the 1998 mortgage held by The Money Store which was then released of record and the New Century Mortgage recorded in October 2003. The New Century mortgage was later assigned to Mortgage Electronic Registration Systems or MERS in late September 2003, and that assignment of mortgage was recorded in March 2004. The trial court granted summary judgment in favor of MERS based on the doctrine of equitable subrogation reordering the priority of the liens to the extent that the MERS funds had been used to satisfy The Money Store’s 1998 mortgage. The Court of Appeals reversed the decision concluding that the doctrine of equitable subrogation did not apply when the lender was not diligent in conducting its lien search. The Kentucky Supreme Court accepted discretionary review.
The Kentucky Supreme Court recognized that there were three possible approaches in determining whether equitable subrogation is available: (1) the majority approach which bars equitable subrogation only if the subsequent lien holder has actual knowledge of the existing lien even if there is constructive notice; (2) actual or constructive notice of the lien recorded before the new mortgage precludes application of equitable subrogation; or (3) the Court has discretion to disregard both actual and constructive notice if the junior lien holder is not prejudiced by the Court’s reordering of priorities. 366 S.W.3d at 408.
In the 2011 Wells Fargo decision, the Kentucky Supreme Court adopted the second approach holding that equitable subrogation is barred if the subsequent lien holder has either actual or constructive knowledge of the pre-existing tax lien. 345 S.W.3d at 807.
In 2012 in the MERS decision, the Kentucky Supreme Court refused to change its holding in Wells Fargo and, in fact, extended the holding to an intervening judgment lien and not only the tax lien at issue in Wells Fargo. The Kentucky Supreme Court, in MERS v. Roberts, further clarified Wells Fargo by rejecting that the Wells Fargo decision applied only to professional lenders. The Court held that the “identity of the lender is not truly relevant as to whether the purposes of the recording statutes are being promoted and thus it is not relevant to whether equitable subrogation is available.” Although both Wells Fargo and MERS v. Roberts involved professional lenders, the Kentucky Supreme Court expressly stated that the approach adopted in Wells Fargo applies equally to all lien holders. Id. at 413.
Whether there are any circumstances in which equitable subrogation would now apply remains undecided. Certainly the recording of a prior lien properly of record at the time a subsequent mortgage pays off a prior mortgage defeats the application of equitable subrogation in Kentucky.