IN COURT OF APPEALS
Bonnie Jean Piehl, Trustee, et al.,
Option One Mortgage Corporation,
Filed July 26, 2005
Robert H. Schumacher, Judge
Bradley N. Beisel, Beisel & Dunlevy, PA, 282 US Trust Center, 730 Second Avenue South, Minneapolis, MN 55402-2444 (for appellant)
Considered and decided by Peterson, Presiding Judge; Schumacher, Judge; and Wright, Judge.
S Y L L A B U S
A professional lender's negligent failure to discover a properly recorded mortgage against real property prior to acquiring its own mortgage against that property is not an excusable mistake of fact entitling the lender to be equitably subrogated to the rights of a prior senior lienholder.
O P I N I O N
ROBERT H. SCHUMACHER, Judge
In this mortgage-priority dispute, appellant Option One Mortgage Corporation challenges the district court's judgment that respondent David R. Ripley's mortgage against the subject property is prior to and superior to its own. Option One argues it should be equitably subrogated to the interests of the creditors and lienholders it paid off when it acquired a mortgage against the property without performing a title search sufficient to discover the existence of Ripley's prior recorded interest. In the alternative, Option One argues Ripley's mortgage should be equitably subordinated to its own. We affirm.
In 1995, Gregory
M. Hewitt purchased a parcel of real estate in
At the same time
Hewitt applied for the loan from
The Option One mortgage
closed on January 31. In the four weeks
between the date that Ripley recorded his mortgage and the date of the Option
One closing, Pioneer Abstract did not perform, and Option One and
At the closing, Pioneer
Abstract received approximately $270,000 from Option One. The closing statement reflects that the
closing agent used those funds to immediately pay off the contract for deed and
the tax liens, which together totaled approximately $242,000. Hewitt received approximately $15,000, which
he subsequently paid to Ripley. At the
closing, both Hewitt's representative and Ripley's representative signed or
initialed documents representing to Option One,
The closing occurred on a Friday. The following Monday February 3 Ripley recorded the quitclaim deed he had received from Hewitt on January 28. Option One recorded its mortgage on February 7. The same day, Ripley transferred the property to Bonnie Jean Piehl, trustee of the Ripley family trust. Piehl recorded the warranty deed on February 12.
The only payment Hewitt ever made toward either the Ripley mortgage or the Option One mortgage was the approximately $15,000 he received at the January 31 closing and immediately gave to Ripley. By June, the Ripley mortgage was in default in the amount of approximately $255,000, and the Option One mortgage was in default in the amount of approximately $300,000.
On June 23, Ripley brought a mortgage-foreclosure action against the property and requested a judicial determination that his mortgage was superior to the interest of any other party, including Option One. By answer and counter-claim, Option One alleged that because it had caused the encumbrances on the property to be paid at the January 31 closing, it was equitably subrogated to the interests of the IRS and the contract-for-deed vendor. It asserted that its interest in the property was therefore prior and superior to Ripley's to the extent of the funds paid at the closing to satisfy the encumbrances, or approximately $242,000. Option One requested a judicial declaration that its mortgage was superior to Ripley's.
Just before trial, Option One submitted an amended answer and counter-claim, alleging that Ripley had intentionally concealed the fact of his mortgage from Option One prior to the January 31 closing, Ripley knew Option One would not have closed its mortgage had it known of Ripley's mortgage, and Ripley's failure to act in good faith should cause his mortgage to be equitably subordinated to Option One's.
Following trial, the district court concluded Ripley's mortgage had priority over the Option One mortgage. The court found there was no evidence Ripley or his agents conspired to defraud Option One. Observing that Ripley had recorded his mortgage nearly a month before Option One's closing and that Option One, a professional lender, had not excused its negligent failure to discover Ripley's recorded interest, the court determined Option One had failed to show it was entitled to equitable relief. The court denied Option One's posttrial motion.
Did the district court abuse its discretion in concluding Option One is not entitled to relief pursuant to either equitable subrogation or equitable subordination?
Option One argues
first that its mortgage should have priority over Ripley's by operation of the
doctrine of equitable subrogation. Generally,
the decision of whether to grant equitable relief is within the sound
discretion of the district court and will not be reversed on appeal absent clear
abuse. Nadeau v.
Minnesota Recording Act establishes mortgage priority from the date of
recording with the county recorder or the registrar of titles. Minn. Stat. § 507.34 (2004); see Home
Lumber Co. v. Kopfmann Homes, Inc., 535 N.W.2d 302, 304 (
It is undisputed here that Hewitt's mortgage to Ripley was recorded on January 3, 2003, and that Hewitt's mortgage to Option One was recorded on February 7. Option One argues, and Ripley does not dispute, that it did not have actual notice of the Ripley mortgage. But actual knowledge is not necessary, because constructive notice of the mortgage was imputed to Option One when Ripley recorded it. Therefore, Ripley's mortgage is prior and superior to Option One's unless, as Option One contends, equitable subrogation requires that the priority be reversed.
[equitable] subrogation is a highly favored doctrine, it is not an absolute
right, but rather, one that depends on the equities and attending facts and
circumstances of each case." Universal Title Ins. Co. v.
Jurisdictions around the country have adopted three different approaches in determining whether to apply equitable subrogation under circumstances in which a third party holds a lien on the property at the time the second lender pays off the former encumbrance. The first approach reasons that actual knowledge of an existing lien precludes the application of equitable subrogation, but constructive knowledge does not. See, e.g., Osterman v. Baber, 714 N.E.2d 735, 739 (Ind. Ct. App. 1999). The second approach bars the application of equitable subrogation when the party seeking subrogation possesses either actual or constructive notice of an existing lien. See, e.g., Harms v. Burt, 40 P.3d 329, 332 (Kan. Ct. App. 2002).
approach, adopted by the Restatement, disregards actual or constructive notice and
concentrates on whether the junior lienholder will be prejudiced by
subrogation. See Restatement (Third) of Property: Mortgages § 7.6 (1997). Under the Restatement, a mortgagee will be
subrogated when it pays the entire loan of another as long as the mortgagee
"was promised repayment and reasonably expected to receive a security
interest in the real estate with the priority of the mortgage being discharged,
and if subrogation will not materially prejudice the holders of intervening
interests in the real estate."
Minnesota has adopted the second approach (actual or constructive notice of an existing lien bars equitable subrogation) with the added criterion that when a sophisticated party such as a professional lender is seeking subrogation, it will be held to a higher standard for the purpose of determining whether it has acted under a justifiable or excusable mistake of fact in failing to duly investigate prior liens. Thus, in Peterson, the court held that because a "bank is a professional lender with knowledge of construction in progress giving rise to inchoate liens for contractors and materialmen . . . [i]ts failure to consider potential priority conflicts and to obtain subordination agreements from them . . . cannot be deemed justifiable as an excusable mistake." 261 N.W.2d at 348. See also Universal Title, 942 F.2d at 1317 (noting that "Minnesota courts impose stricter standards on professionals than lay persons in assessing whether mistakes are 'excusable' for purposes of the doctrine of legal subrogation").
We conclude that Peterson is apposite and controlling
here. In Peterson, a bank granted a loan against a second mortgage without considering whether existing mechanics' liens
against the first mortgage might have priority.
261 N.W.2d at 347. The bank argued the second mortgage should be
subrogated to the first mortgage and therefore granted priority over the
mechanics' liens to the extent that the proceeds of the second loan were used
to clear the balance of the first mortgage and delinquent taxes.
The bank in this case has not demonstrated such equities in its favor. Unlike the unsophisticated individual wholly unaware of a judgment lien, the bank is a professional lender with knowledge of construction in progress giving rise to inchoate liens for contractors and materialmen. Its failure to consider potential priority conflicts and to obtain subordination agreements from them, as well as its failure to ascertain that its mortgagor was maintaining insurance in force, cannot be deemed justifiable as an excusable mistake.
Universal Title, the Eighth Circuit
Court of Appeals, applying
We believe that the Peterson
case indicates that the
Universal is a professional enterprise, which is in the business of insuring marketable title to real property. Although Universal contends that it exercised prudent business practices in investigating the title to the . . . property, it fails to explain what precautions it took or why it failed to discover the properly recorded federal tax lien. Its claim that it sought and received assurances from the seller that there were no liens, other than those discharged at closing, is patently insufficient. . . . Universal's inability to explain its failure to find the properly recorded federal tax lien is significant, because Universal had the burden of persuasion at trial of demonstrating its entitlement to subrogation. In light of the Minnesota Supreme Court's decision in Peterson, we hold that . . . Universal's failure to detect the federal tax lien resulted from negligence, and therefore, it is not entitled to be legally subrogated to the rights of the prior senior lienholders.
Option One failed to conduct on its own or through its agents a second
title search in the nearly two months between the first search and the January
31 closing. Such a search would have
disclosed the existence of Ripley's mortgage interest in the property. We further observe, similar to the Eighth
Circuit's conclusion in Universal,
that in light of Option One's professional experience in processing loan
applications and preparing mortgages for closing, its attempt to justify its
ignorance of Ripley's interest with the assertion that it sought and received
assurances from Ripley and Hewitt that there were no liens, other than those
discharged at closing, is patently insufficient.
Option One contends the Minnesota approach frustrates the fundamental purpose of equitable subrogation by giving undue weight to the reasons the party seeking relief failed to acquire knowledge of prior recorded interests instead of focusing exclusively as does the Restatement on whether subrogation will satisfy the parties' original expectations without materially prejudicing other lienholders. Option One consequently urges that we adopt the Restatement position. It may well be, as Option One contends, that the Restatement would favor subrogating it to the prior lienholders' interests because doing so would presumably put both it and Ripley in their expected positions without prejudicing Ripley, who would be, in the words of the Restatement quoted by Option One, "no worse off than before the senior obligation was discharged." Restatement (Third) of Property: Mortgages § 7.6, cmt. a.
But this court is bound by the supreme court's holding in Peterson to consider the circumstances of Option One's failure to perform an updated title search. And Peterson further mandates that we hold the actions of a sophisticated party such as a professional mortgage company or title company to a stricter standard for the purpose of equitable subrogation and deny subrogation where the sophisticated party's negligence is inexcusable under the higher standard. Option One provided no excuse save for simple oversight for its failure to have a new title search performed in the nearly two months that elapsed between the title search performed on December 2, 2002, and the mortgage closing of January 31, 2003. This is simply insufficient, under Peterson, to excuse its failure to discover Ripley's prior interest.
In urging that we adopt the Restatement, Option One acknowledges that this court may not make new law or disregard an established position taken by the supreme court, but contends that because the supreme court has never specifically addressed whether the Restatement position should be adopted, this court may do so without exceeding its authority. But because applying the Restatement approach here would likely lead to a different result than would applying the Peterson approach, adopting the Restatement would, in fact, impermissibly create a new rule of law. See St. Aubin v. Burke, 434 N.W.2d 282, 284 (Minn. App. 1989) (refusing to adopt new rule of law, noting under Minnesota Court of Appeals Internal Rules this court will make new law "[o]nly when there are no statutory or judicial precedents to follow"), review denied (Minn. Mar. 29, 1989).
We are sympathetic to Option One's equitable position insofar as it appears to have unwittingly paid off encumbrances to Ripley's benefit, thereby reducing its own equity in the property. It also appears that because Ripley knew when he received the mortgage from Hewitt that Hewitt's interest in the property was significantly encumbered, subrogating Option One to the lienors' position would in fact put the parties in the position they expected to be in in the first place. But the fact remains that under Peterson, Option One's negligent failure to discover Ripley's interest is not excused and subrogation is barred.
Option One also argues the district
court abused its discretion by failing to grant it equitable relief by
subordinating Ripley's mortgage to its own.
We disagree. Option One's theory
of equitable subordination relies entirely on its assertion that Ripley and
Hewitt fraudulently and deceptively concealed Ripley's interest from Option One
in order to induce it to enter into a mortgage agreement with Hewitt. But the district court specifically found
that there "is no evidence that Ripley or anyone on Ripley's behalf
conspired with Hewitt or anyone on behalf of Hewitt to induce Option One or
In order to warrant equitable relief under the factual circumstances of this case, Option One was required to demonstrate either that its failure to discover Ripley's properly recorded mortgage in the subject property was an excusable mistake of fact under the standard applicable to professional lenders or that Ripley and Hewitt fraudulently induced Option One to accept a mortgage from Hewitt. Because it has done neither, we hold that the district court properly denied Option One relief under both the doctrine of equitable subrogation and the doctrine of equitable subordination.