Alert - Putting the "Equity" into Equitable Subrogation: The Effect of Recent California Cases on the Doctrine of Equitable Subrogation

February 25, 2014
Download

For the first time in recent memory, California courts have addressed, and in the process clarified, the manner in which the doctrine of equitable subrogation applies to lien priority disputes.  By doing so, the courts have emphasized that the inherent focus of the doctrine is (a) one of fairness, and (b) to attempt to place competing interests in the position for which they originally bargained.  Two (2) recent cases,  JPMorgan Chase Bank, N.A. v. Banc of America Practice Solutions, Inc. (2012) 209 Cal.App.4th 855, and Elbert Branscomb v. JPMorgan Chase Bank, N.A. (14 C.D.O.S. 1206), provide a ray of hope for lenders who are dealing with the ramifications of the housing crisis, where shoddy underwriting practices often led to lenders obtaining a junior, instead of an intended senior, lien against mortgaged property.

The elements of equitable subrogation are: (1) the advancement of funds to pay off an encumbrance on realty; (2) at the instance of the owner or the holder of the encumbrance; (3) with the express or implied understanding that the advance made is to be secured by a first lien on the property; (4) the lender is not a volunteer; (5) the lender is not chargeable with culpable and inexcusable neglect; and (6) the superior or equal equities of others will not be prejudiced.  (Katsivalis v. Serrano Reconveyance Co. (1977) 70 Cal.App.3d 200, 210.)  In the context of equitable subrogation, California courts have consistently defined “culpable or inexcusable neglect” as the possession of actual knowledge of an intervening lien. (See, e.g., Smith v. State Savings & Loan Assn. (1985) 175 Cal.App.3d 1092.)

In JPMorgan Chase Bank, JPMorgan Chase Bank (“Chase Bank”) refinanced first and second liens on Jon and Julie Siems’ home.  It was undisputed that Chase Bank would receive both a first and second deed of trust (i.e., liens) against the Siems’ home as security for repayment of its loan.  Unbeknownst to Chase Bank, the Siems’ concurrently sought a loan in the amount of $2,000,000 from Banc of America, in order to finance Mr. Siems’ medical practice.  It was undisputed that the Banc of America loan was intended to be secured by a third deed of trust against the Siems’ home, which was intended to be junior to the Chase Bank loan.  By mistake, the Banc of America loan closed prior to the Chase Bank loan, and the Banc of America deed of trust was recorded in senior position to the Chase Bank deeds of trust. 

Chase Bank moved for summary adjudication of its equitable subrogation claim, arguing that it was entitled to priority over Banc of America because the Chase Bank loan was intended to pay-off the existing first and second liens.  The trial court granted summary adjudication, and the appellate court upheld the decision.  In so holding, the JPMorgan Chase Bank court reasoned that it was apparent that Chase Bank intended to pay-off the first and second liens, and thus assume the senior positions on the subject property.  Banc of America was aware of the first and second liens when it made its loan, and understood that it would be in a junior position to the existing deeds of trust.  The JPMorgan Chase Bank Court held that the equities weighed heavily in favor of Chase Bank, as equitable subrogation would place it and Banc of America in the lien positions that were consistent with their respective intent and understanding when their original loans were made.  As the JPMorgan Chase Bank court explained it, “[g]etting exactly what one bargained for is neither punishment nor prejudicial.”

The Court in Branscomb piggy-backed on the JPMorgan Chase Bank decision and held that notwithstanding a defendant lender’s actual knowledge of the pre-existing lien, it was entitled to equitable subrogation because doing so would place all parties in the respective positions for which they bargained.  In Branscomb, there existed three (3) liens recorded against the subject property: (1) a 2005 deed of trust, in the amount of $5,100,000, in favor of Washington Mutual; (2) a 2006 deed of trust, in the amount of $1,100,000, in favor of MMB; and (3) a 2007 deed of trust, in the amount of $100,000, in favor of Branscomb.  In 2007, the property was refinanced.  Washington Mutual made a new loan which was intended to be secured by a first lien against the property.  MMB made a new loan intended to be secured by a second lien.  At this time, the record title for the property reflected the $100,000 deed of trust in third position.  At the time of the refinance, the escrow agent for Washington Mutual and MMB had actual knowledge of the $100,000 deed of trust.

During escrow, the $100,000 deed of trust was not paid-off.  As a result, at the close of the refinance transaction, Washington Mutual obtained a second position lien, and MMB obtained a third position lien.  Upon realization of the situation, both lenders moved for equitable subrogation.  The trial court denied the request for equitable subrogation on the ground that the lenders “had actual knowledge” of the $100,000 lien, were responsible for the escrow officer’s negligence and had a cause of action against the escrow.  The appellate court reversed.

In doing so, the Branscomb Court explained that “although the lender defendants knew of the $100,000 lien, the evidence does not show they had actual knowledge the lien would remain on the property, and rise to first position, after the refinance transactions closed.”  The Branscomb Court explained further that the escrow officer’s negligence was not a bar to equitable subrogation, as the escrow officer’s conduct did not affect the equities of the parties.

In reaching its conclusion, the Branscomb Court appears to have narrowed the traditional understanding of “actual knowledge” as it relates to equitable subrogation.  According to the Branscomb Court, “actual knowledge” means an actual understanding that junior liens would remain attached to the property and be elevated into a senior position.  It is difficult to imagine circumstances under which a lender who intended to be in first position would make a loan notwithstanding its understanding that a junior lien against the subject property would not only remain secured, but would elevate to a senior position upon consummation of the refinance transaction. 

In reliance on the JPMorgan Chase Bank decision, the Branscomb Court explained that the overriding concern in its opinion was that the parties be returned to the respective positions for which they bargained, and expected.  The renewed emphasis on employing the court’s inherent equitable powers to place the parties in the positions for which they bargained, notwithstanding the presence of negligence and/or actual knowledge, represents a shift in California’s application of the doctrine of equitable subrogation.  In weighing the negligence of a party versus the potential of a elevating a junior lender from its intended position, the courts appear to have come down firmly on the side of ensuring that all parties get what they bargained for.

JPMorgan Chase Bank and Branscomb should provide comfort and solace to California lenders who find themselves continuing to confront the ramifications of the housing crisis, where loans were often made without a thorough investigation of the title history of the subject property.  Even in cases where lenders knew, or should have known, that existing liens were attached to the subject property, California’s recent expanded application of the doctrine of equitable subrogation may represent a light at the end of the tunnel by making available a course of action by which the lenders’ mistakes may be overcome and their liens restored to their intended positions.