Wednesday, December 28, 2011

FYI: Mich Ct of Appeals Limits Doctrine of Equitable Subrogation

The Michigan Court of Appeals recently limited the doctrine of equitable subrogation, to circumstances in which the original mortgage lien and the refinanced mortgage lien were held by the same lender or its bona fide successor in interest.  A copy of the opinion is attached.
The borrowers purchased property on September 6, 2000, with a mortgage granted to original lender.  On May 4, 2001, the borrowers refinanced their loan and discharged the original mortgage in favor of a new mortgage that was also granted to the original lender (the "2001 Loan").  The borrowers later obtained a home equity loan from another subsequent lender, granting the subsequent lender a second mortgage on the property (the "Second Lien"). 
On November 25, 2002, the borrowers refinanced their 2001 Loan, releasing the mortgage securing the 2001 Loan in favor of another mortgage lien also granted to the original lender (hereinafter, the "Refinanced Mortgage Lien").  Although the Second Lien was recorded, the original lender was unaware of it at the time it took the Refinanced Mortgage Lien.  On August 22, 2005, the borrowers filed for bankruptcy, and the property was sold at a foreclosure sale.  The purchaser of the foreclosed property, along with the original lender's successor in interest, sued to quiet title. 
The issue was whether the Second Lien or the Refinanced Mortgage Lien was superior.  Generally, the Second Lien would have been the junior lien, but for the subsequent refinancing.  On cross-motions for summary disposition, the trial court held that the Refinanced Mortgage Lien could not be first in priority over the Second Lien, under the doctrine of equitable subrogation, and the appeal followed. 
Looking to the Restatement of Property (Mortgages), 3d, § 7.3 (hereinafter, "Restatement"), as limited to the situations in Comment b to the Restatement, the Court of Appeals concluded that it was consistent with precedential Michigan law.  The Court, therefore, adopted the Restatement. 
As relevant to this case, section 7.3(a) of the Restatement provides that if a senior mortgage is released of record and within the same transaction is replaced with a new mortgage, then the later mortgage retains the same priority as its predecessor.  Exceptions to that general rule are where any changes to the terms of the mortgage or the obligation secured thereby are materially prejudicial to the holder of the junior interest in the real estate; or where the one who is protected by the recording act acquires an interest in the real estate when a senior mortgage is not of record. 
Comment b to the Restatement states: "[u]nder 7.3(a) a senior mortgagee that discharges its mortgage of record and records a replacement mortgage does not lose its priority against the holder of an intervening interest unless that holder suffers material prejudice."  Additionally, the associated Reporter's Note explains that "courts routinely adhere to the principle that a senior mortgagee who discharges its mortgage of record and takes and records a replacement mortgage, retains the predecessor's seniority as against intervening lienors unless the mortgagee intended a subordination of its mortgage or 'paramount equities' exist."
In adopting the Restatement, the Court warned that the lending mortgagee that seeks subrogation and priority over an intervening interest relative to its newly recorded mortgage must be the same lender as the one that held the original mortgage before the intervening interest arose.  Thus, the Court could not adopt the Restatement in its entirety, due to its broader scope. 
The Court of Appeals concluded, however, that at the time that the lien is sought to be enforced, any bona fide successor in interest may stand in the shoes of the original lending mortgagee, for the purposes of equitable subrogation.  Further, any application of equitable subrogation will be subjected to a careful examination of the equities of all parties and potential prejudice to an intervening lienholder.
Finally, the Court addressed the "mere volunteer" rule.  That rule provides that equitable subrogation cannot be extended to a party that is a mere volunteer.  Under the doctrine of equitable subrogation, a new mortgagee is not permitted to take the priority of the older mortgagee simply because the proceeds of the new mortgage were used to pay off an indebtedness secured by the old mortgage.  The Court held that the "mere volunteer" rule has no bearing in the context of a case where the new mortgagee was also the original mortgagee. 
The Court concluded that equitable subrogation is available to place a new mortgage lien in the same priority as a discharged mortgage lien, if the new mortgagee was the original mortgagee.  However, in order for the general rule to apply, the holders of any junior liens must not be prejudiced. 
The Court further concluded that the Restatement, as adopted in the limited form expounded by the Court, sets forth a reasonable and proper framework for determining whether junior lienholders have been prejudiced and whether the equities ultimately favor equitable subrogation. 
Accordingly, the Court of Appeals reversed and remanded the case to the trial court for further determinations of fact consistent with its ruling

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
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