D.C. Circuit Holds Lender Entitled to Equitable Subrogration Despite Its Actual Knowledge That Co-Owner Refused To Sign Mortgage

In Smith v. First American Title Insurance Company, the U.S. Court of Appeals for the District of Columbia held that, under D.C. law, a lender (New Lender) was entitled to equitable subrogation for amounts paid off by its loan against a co-owner’s (Co-Owner) interest in property jointly owned with Borrower, even though New Lender had actual knowledge that Co-Owner had refused to sign its refinance loan documents.  Consequently, equitable subrogation enabled New Lender to assert the same rights against Co-Owner and Borrower’s house that their prior lender held under the paid-off mortgage.  See Op. at 3.

A copy of the opinion is available here.

Background

Co-Owner and his mother, Borrower, jointly owned a house in the District of Columbia, which was subject to a $115,000 mortgage bearing a 6.5% interest rate (the “Prior Mortgage”), which they both signed.  Thereafter, a new lender (“New Lender”) offered Borrower a $135,000 mortgage, with a 9.65% interest rate (the “New Mortgage”), which allowed for Borrower to obtain $6,000 in cash at settlement.  Co-Owner refused to sign the paperwork because he thought the rate was too high. 

Nevertheless, New Lender proceeded to make the loan without Co-Owner’s signature on the New Mortgage, and such loan was used to satisfy and release the Prior Mortgage.  The Court noted that, technically, although the New Mortgage gave New Lender rights to Borrower’s half-interest in the Property, it did not give New Lender any rights to Co-Owner’s half-interest in the Property.  “As a result, without paying a cent, [Co-Owner] ended up with a half-interest in the house free of both the [Prior] Mortgage and the [New] Mortgage” Op. at 3.

Borrower later declared bankruptcy.  Because New Lender could not foreclose against the Property as a whole, New Lender filed suit in Bankruptcy Court seeking equitable subrogation against Co-Owner’s interest, which was permitted by the Bankruptcy Court and District Court.  Co-Owner and Borrower thereafter appealed to the U.S. Court of Appeals for the D.C. Circuit, which affirmed the application of equitable subrogation. 

Discussion

“The doctrine of equitable subrogation permits courts to declare that the owner of a mortgage (New Lender) has the same rights as an earlier-in-time owner of another mortgage (Prior Lender) on the same property, if certain conditions are met.  The purpose of equitable subrogation is ‘to prevent forfeiture and unjust enrichment.’”  Op. at 3 (citing Eastern Savings Bank, FSB v. Pappas, 829 A.2d 953, 957 (D.C. 2003) (internal quotation marks omitted)).

Under D.C. law, New Lender is entitled to equitable subrogation if it meets each prong of a five-part test: (1) New Lender paid off the Prior Mortgage to protect New Lender’s “own interest”; (2) New Lender has not “acted as a volunteer”; (3) New Lender “was not primarily liable” for the Prior Mortgage; (4) New Lender paid off the entire Prior Mortgage; and (5) subrogation would “not work any injustice to the rights of others.” Id. at 4-5 (quoting Eastern Savings Bank, FSB v. Pappas, 829 A.2d 953, 961 (D.C. 2003) (internal quotation marks omitted)).

The Court of Appeals determined that the first four prongs of the test for equitable subrogation were straightforward.  See Op. at 5.  As to the fifth prong, the Court concluded that equitable subrogation would not work an injustice.  “To begin with, equitable subrogation does not in any way affect [Borrower]’s rights. And equitable subrogation likewise does not work an injustice on [Co-Owner]. The Bankruptcy Court held that [New Lender] is entitled to equitable subrogation on the same terms as the [Prior Mortgage]. So, [Co-Owner] is obligated to [New Lender] only for the balance of the [Prior Mortgage], and only at the lower interest rate of the [Prior Mortgage].  Equitable subrogation simply prevents [Co-Owner] from enjoying a windfall.  It does not work an injustice because it makes him no worse off than he would have been under the [Prior Mortgage] had [Borrower] never agreed to the mortgage with [New Lender].” Op. at 5-6 (citations omitted).

Although the Court acknowledged that “[u]nder D.C. law, it is unsettled whether ‘actual knowledge bars equitable subrogation,’” Op. at 6, it predicted that the D.C. Court of Appeals (i.e., the state court) would allow for its application, noting that that the D.C. Court “endorsed an approach in which ‘no attention should be paid to technicalities which are not of an insuperable character, but the broad equities should always be sought out so far as possible. . . .,”  and therefore adopted a “rule requiring liberal application of the doctrine of subrogation.” Op. at 7 (quoting Burgoon v. Lavezzo, 92 F.2d 726 (D.C. Cir. 1937)).  Further, the federal appellate court noted that the D.C. Court of Appeals looks to the Restatement for guidance on questions of law involving equitable subrogation, which “has adopted the more liberal approach to equitable subrogation, under which actual knowledge does not bar application of the doctrine.” Op. at 7-8 (citing Restatement (Third) of Property: Mortgages § 7.6 cmt. e (1997)).

Moreover, the Court noted that “[i]n Burgoon, the court determined that equitable subrogation was appropriate because the lender could have achieved the same result by taking an assignment of the original loan.”  Op. at 8 (citing Burgoon, 92 F.2d at 736).  Likewise, here, “[i]nstead of taking out a new mortgage on the house, New Lender could have asked [Prior Lender] to assign [the Prior Mortgage [ to [New Lender]. Through assignment, [New Lender] would have obtained [Prior Lender]’s rights to [Co-Owner]’s half-interest in the house.” Op. at 8.

Consequently, the Court determined that New Lender was entitled to equitable subrogation under D.C. law.

Va. Supreme Ct. Holds After-Acquired Property Statute Does Not Affect Priority Of Third Parties; Prior Recorded Deed Of Trust Not “Duly Admitted To Record” Where Outside Chain Of Title

In Deutsche Bank National Trust Company v. Arrington, a priority dispute concerning real property, the Supreme Court of Virginia held that the after-acquired property statute, which validated prior conveyances where the grantor subsequently obtains an interest in property, “only applies between the parties to a deed and does not affect the rights of third parties or influence the relative priority of their interests.” Op. at 12.  The Court further held that a bank whose deed of trust was recorded first, but was made by a grantor outside the chain of title, was not “duly admitted to record” and therefore was not entitled to priority against lien creditors.

A copy of the opinion is available here.

In Arrington, the Court considered a priority dispute between a Bank’s deed of trust, and a subsequently recorded deed of trust in favor of the borrower’s former spouse (Wife) to secure payments as part of a contempt order.  Specifically, a divorce decree provided that certain property held by the couple would be conveyed solely to Husband, and that Husband would make several payments over time to Wife for ten years.  Following the entry of this divorce decree, in 2004, Wife conveyed her interest by deed of gift to Husband, which was recorded in the land records.

The following year, in 2005, Husband conveyed the Property to Third Party by general warranty deed, which was also recorded in the land records.  Despite such conveyance, which had divested Husband of record title, in 2006, Husband executed a deed of trust in favor of Bank, which was also recorded in the land records. 

Thereafter, in 2009, because he had fallen behind in his payments to Wife as provided in the divorce decree, to purge his contempt, the court required Husband to execute a deed of trust in favor of Wife (“Wife’s Deed of Trust”), which was recorded in the land records to secure repayment of amounts referenced in the divorce decree.

Prior to Wife’s recording her deed of trust, Third-Party executed a general warranty deed re-conveying the property back to Husband, which was recorded in the land records.   Immediately thereafter, Wife’s Deed of Trust was recorded, together with a copy of the divorce decree and contempt order.  

Bank filed a complaint seeking a declaration that the Bank Deed of Trust was a valid first priority lien on the Property.  In response, Wife filed an answer requesting a declaration that Wife’s Deed of Trust was a valid first priority lien.  Upon cross-motions for summary judgment, the trial court held that Wife’s Deed of Trust enjoyed priority, because when she recorded her deed of trust, Husband was the record owner of the property, whereas when the Bank recorded its deed of trust, Third Party was the record owner of the property.  The trial court also held that the after-acquired property statute, Virginia Code § 55-52, could not elevate the Bank Deed of Trust in priority over Wife’s Deed of Trust.  On appeal, the Supreme Court of Virginia affirmed.

The Court rejected the Bank’s argument that it held priority once Husband was re-vested with the property from Third Party under the after-acquired property statute.  The Court held that the statute itself was limited by its terms to the grantor and grantee, i.e., Husband and the Bank.  Specifically, the statute, Virginia Code § 55-52, provides:

When a deed purports to convey property, real or personal, describing it with reasonable certainty, which the grantor does not own at the time of the execution of the deed, but subsequently acquires, such deed shall, as between the parties thereto, have the same effect as if the title which the grantor subsequently acquires were vested in him at the time of the execution of such deed and thereby conveyed.

Id.  (Emphases added).

Determining that the statute applied not only to deeds, but also to deeds of trust, see Op. at 7, the Court explained, “[r]ead in its entirety, Code § 55-52 provides that when a grantor purports to convey property — without holding title — to a grantee, the grantor cannot thereafter deny that title has actually passed to the grantee. . . . Code § 55-52 governs the rights of a grantee vis-à-vis the grantor. It does not purport to affect the deeds of third parties, in this instance [Wife], or influence the relative priority of their interests.” Op. at 5-6. 

The Court thereafter determined the priorities of the parties based upon the recording act, Virginia Code § 55-96, which provides:

Every (i) such contract in writing, (ii) deed conveying any such estate or term, (iii) deed of gift, or deed of trust, or mortgage conveying real estate . . . shall be void as to all purchasers for valuable consideration without notice not parties thereto and lien creditors, until and except from the time it is duly admitted to record in the county or city wherein the property embraced in such contract, deed, or bill of sale may be.

Id.  Under the Recording Act, the Court explained, the “[Bank] Deed of Trust does not impair [Wife’s] priority if she is either (1) a purchaser for valuable consideration without notice or (2) a lien creditor, and the [Bank] Deed of Trust was not ‘duly admitted to record’ before she qualified as either. If she is a lien creditor and the [Bank] Deed of Trust has not been ‘duly admitted to record,’ then it is irrelevant whether she had notice of Bank's interest.” Op. at 8-9.

After easily determining Wife to be a lien creditor under her deed of trust, see Op. at 10-11, the Court determined that the Bank Deed of Trust was void as to Wife, because it was not “duly admitted to record” as it was recorded prior to Husband holding record title.  Op. at 12.  “Because the [Bank] Deed of Trust was not properly recorded in the chain of title, it was not ‘duly admitted to record’ even though it was recorded before [Wife] acquired her interest. Finally, because [Wife] is a lien creditor, whether she had actual or constructive notice of the [Bank] Deed of Trust is irrelevant. See Code § 55-96(A)(1). Therefore, [Wife] qualifies as a lien creditor under Code § 55-96(A)(1), and as a result, the [Wife] Deed of Trust has priority over the [Bank] Deed of Trust.”  Id.

Accordingly, the Supreme Court affirmed, concluding that the Wife’s deed of trust was entitled to priority.