Subordination Agreement that Omits Intervening Deed of Trust Is Subject to Partial Subordination
A fresh new case gives us the opportunity to study lien priorities and the effect of subordination agreements. Ordinarily real property liens have priority according to chronology – the oldest recorded lien is the highest in priority. This scheme can sometimes be altered by a subordination agreement, where a lender with an older, more senior lien, agrees to allow its lien to be junior to a more recently recorded lien. This is often done, for example, when a seller subordinates his purchase money lien to the lien of a construction lender, who will not loan unless it is assured of being in first position.
The case of Wells Fargo Bank v. Neilsen, (First Dist. Ct. of Appeal, No. A122626, Oct. 22, 2009) 2, DAR p.15084, shows what can happen with careless handling of a subordination agreement, and how lien priorities are assessed when there is an intervening lien that is not subject to the subordination agreement.
James Neilsen’s residence in San Mateo was liened by three Deeds of Trust. The First DOT to American Express Centurion Bank (AMEX) was recorded in January 2002. The Second DOT secured a loan from Wells Fargo (WFB) and was recorded in September 2002. The Third DOT was in favor of PHH Mortgage Corp. (PHH) and was recorded in November 2003.
As part of the PHH loan transaction in 2003, AMEX subordinated its lien to PHH’s DOT, but neglected to acknowledge the intervening lien of WFB. Thus PHH became senior to AMEX while remaining junior to WFB, and AMEX became junior to PHH while remaining senior to WFB.
In 2007 AMEX foreclosed and the property was purchased at the sale by WFB, apparently anxious to protect its lien, the status of which was uncertain and possibly subject to elimination by the foreclosure of AMEX’s possibly senior lien. From the sale proceeds the foreclosure trustee first paid AMEX the $28,726 owed on its lien, leaving about $368,000 remaining. The lenders made competing claims to the money, and the Owner/Brrower Neilsen contended that the “surplus” was his because the lenders failed to clarify their priority. The foreclosure trustee filed a petition to determine the priorities.
THE DECISION: The Trial Court held, and the Court of Appeal agreed, that PHH should be paid first, as a result of AMEX’s subordination, but only to the extent of AMEX’s lien (the amount WFB consented to be junior to, or subordinate to, when it made its loan). The original third priority lien moves to first position, but only to the extent of the lien that it is replacing. If it is smaller than the lien it is replacing, then the entirety of the lien moves into first position. If it is larger than the original first priority lien, then only so much of it as is equivalent to the original first priority lien moves into first position.
Then WFB gets paid what it was owed, because it was originally subordinate to AMEX.
Because PHH’s lien was larger than the AMEX lien that it was replacing, only $28,726 of it was bumped into first priority. Thereafter WFB remained in second priority, as it had consented to when it made its loan. The balance of PHH’s loan remained in third priority, but still ahead of AMEX because AMEX contractually subordinated.
Thus the lien priority was resolved like this:
|Lien Position||Before the Subordination||After the Subordination|
|1st||AMEX $28,726||PHH $28,726|
|2nd||WFB $78,433||WFB $78,433|
|3rd||PHH $322,000||PHH – all remaining funds, about $274,000|
|AMEX – nothing|
The Owner/Borrower’s got nothing and his claim was rejected, and the decision was upheld on appeal.
WHY THIS DECISION IS IMPORTANT: When reordering the priorities of liens, a first and a third position lender cannot make an agreement that changes the risk that a second position (intervening) lender agreed to accept when it made the loan. The second position lender cannot be bumped lower in priority as a result of an agreement that it did not participate in. Did these institutional lenders not think to order a Preliminary Report and purchase a lender’s policy of title insurance, insuring their priority?
This article written and © Peter N. Brewer, Esq.
Brewer Offord & Pedersen LLP (www.BrewerFirm.com) serves the legal needs of homeowners, real estate and mortgage brokers, agents, brokerages, title companies, developers, investors, other real estate professionals and their clients. Mr. Brewer and his firm also represent clients in debt collection, representation of creditors in bankruptcy proceedings, breach of contract matters, and other litigation and transactional work. The firm’s clients range from homeowners, brokers and lenders based in Santa Clara County, San Mateo County, San Francisco County, as well as throughout Northern California.
The foregoing has been prepared for informational purposes only and does not constitute legal advice. The information is summary in nature and does not address any particular situation. Readers should not act upon this information but should instead seek professional advice.