Commencement Bank v. Epic Solutions, Inc. (In re EM Prop. Holdings, LLC)
| Citation | 511 P.3d 1258 |
| Decision Date | 16 June 2022 |
| Docket Number | 100066-9 |
| Parties | In the MATTER OF the General Receivership of EM PROPERTY HOLDINGS, LLC, a Washington limited liability company Commencement Bank, a Washington banking corporation, Petitioner, v. Epic Solutions, Inc., a Washington corporation, Respondent. |
| Court | Washington Supreme Court |
Darren Robert Krattli, Eisenhower Carlson PLLC, 909 A Street, Suite 600, Tacoma, WA, 98402-4395, for Petitioner.
Sean Vincent Small, Lasher Holzapfel Sperry & Ebberson PLLC, 601 Union St. Ste. 2600, Seattle, WA, 98101-4000, for Respondent.
¶1 This case concerns the priority of mortgage liens, the scope of RCW 60.04.226, and whether to adopt certain sections of the Restatement (Third) of Property: Mortgages (Am. Law Inst. 1997). The principal issue before us is whether a senior mortgage holder's future advances clause maintains priority over an intervening junior mortgage on the same property. A future advances clause states that the security in question applies to a present obligation as well as certain future obligations. Historically, at common law this court has distinguished between obligatory and optional future advances. The legislature abrogated that distinction in the construction context when it adopted RCW 60.04.226.
¶2 Here, the senior mortgage holder, Epic Solutions Inc., argues that RCW 60.04.226 applies to this case. However, the language and context of the statute plainly demonstrate it applies only to construction liens. Instead, we are guided by common law, which distinguishes between obligatory and optional future advances. Under that rule, any advances that are optional lose priority to any intervening liens.
¶3 We are also asked to decide whether or not Restatement § 7.3 should be applied in its entirety for modifications of a mortgage. One of our previous cases, Hu Hyun Kim v. Lee , 145 Wash.2d 79, 31 P.3d 665 (2001), adopted Restatement § 7.3(a) and (b), but did not discuss subsections (c) or (d). Given the facts of Kim , we hold that only Restatement § 7.3(a) and (b) have been adopted by this court.
¶4 The parties and the Court of Appeals have referred to future advances and modification of mortgages interchangeably throughout this case. Though similar, these are different mortgages provisions, they carry different legal consequences, and they are governed by different provisions of the Restatement . Restatement § 7.3 is principally concerned with the modification of mortgages. But the parties and the court below applied Restatement § 7.3 to the future advances clause in the instant mortgage documents. Restatement § 2.3 is the provision that governs future advances while Restatement § 7.3 governs mortgage modifications. Moreover, applying both Restatement § 7.3 and RCW 60.04.226 to a future advances clause creates a conflict because the statute does not provide a "stop-notice" protection while the Restatement does.
¶5 For the reasons discussed below, we read RCW 60.04.226 as applying only in the construction context. We reverse the Court of Appeals and remand to the trial court to determine the correct priority of claims by applying the common law rules outlined in our cases for both future advances and modifications.
¶6 In 2015, Epic was hired to provide consulting services to TTF Aerospace Inc., EM Property Holdings (EMP), and the owners of these companies.1 The owners and Epic signed an amended and restated service agreement on August 7, 2015. The agreement did not state an end date but included a termination clause stating the agreement could be terminated by mutual agreement or upon 30 days’ written notice by either party.
¶7 On April 19, 2017, the owners issued a promissory note to Epic for $344,762.50. The note was secured by a deed of trust to a property in Auburn, also dated April 19, which was recorded on April 21. The deed of trust stated:
THIS DEED IS FOR THE PURPOSE OF SECURING PERFORMANCE of each agreement of Grantor(s) incorporated by reference or contained herein and payment of the sum of THREE HUNDRED FORTY-FOUR THOUSAND SEVEN HUNDRED SIXTY-TWO DOLLARS AND FIFTY CENTS ($344,762.50) with interest thereon according to the terms of a promissory note of even date herewith, payable to Beneficiary or order and made by Bradford Wilson, Timothy Morgan, and Philip Fields; all renewals, modifications or extensions thereof, and also such further sums as may be advanced or loaned by Beneficiary to Bradford Wilson, Timothy Morgan, and Philip Fields, or any of their successors or assigns, together with interest thereon at such rate as shall be agreed upon.
¶8 The owners amended the original promissory note on September 30, 2017, increasing the principal amount to $546,737.50, and granted an amended deed of trust on October 5. The amended deed was recorded on October 6 at 8:49 AM.
¶9 On October 2, Elite Aviation Interiors made a loan of $1.5 million to TTF, who issued a promissory note secured by a deed of trust for the Auburn property. The parties also signed a management agreement, which stated that Elite would appoint an Elite employee to work for TTF and support its operations. The deed of trust securing the loan was recorded on October 6 at 12:13 PM.
¶10 The owners amended the promissory note a second time in November, increasing the principal amount owed to Epic to $731,580.99. The deed of trust was also amended a second time on November 8 and recorded on November 13.
¶11 On November 9, the owners, through EMP, granted a deed of trust to a different entity, Commencement Bank. The deed secured prior loans granted by Commencement, up to a maximum of $1.5 million with the Auburn property as collateral. Commencement recorded its deed of trust on November 27. When it obtained its security interest, Commencement signed a subordination agreement with Elite, giving Commencement a priority position over Elite.
¶12 On February 26, 2019, the owners issued a third amendment to the original commercial promissory note, increasing the principal owed to Epic to $1,515,000.00. The deed of trust was not amended a third time. On August 7, 2019, the owners issued a declaration, unrecorded, stating that the current amount owed by TTF to Epic totaled $1,788,406.64.
¶13 In February 2020, a general receiver was appointed to take control of EMP's assets, including the Auburn property. Both Commencement and Epic filed claims in the receivership. Epic claimed $2,127,073.06 plus interest and attorney fees for services rendered. Commencement objected to Epic's claim. The Auburn property sold for $10,500,000.00. After the receiver paid other debts owed by TTF, the net proceeds from the sale of the property remaining for Epic's and Commencement's claims were $2,908,493.00.
¶14 The trial court ruled that Epic had priority over Commencement for the full amount it claimed, based on RCW 60.04.226 and Kim , noting that the priority of the future advances clause related back to the original deed of trust. The Court of Appeals affirmed in an unpublished opinion. In re Gen. Receivership of EM Prop. Holdings, LLC , No. 81686-1-I, 2021 WL 3146568 (Wash. Ct. App. July 26, 2021) (unpublished), https://www.courts.wa.gov/opinions/pdf/816861%20orderandopinion.pdf. Commencement appealed to this court, and we granted review. Commencement Bank v. Epic Solutions Inc. , 501 P.3d 150 (2022).
¶15 Since neither party disputes the facts in this case, our task of determining lien priority is a question of law, subject to de novo review. Kim , 145 Wash.2d at 85-86, 31 P.3d 665.
¶16 The common law rule for mortgage priority is that the first party to obtain a mortgage has first priority if multiple parties seek to realize upon their security during a foreclosure, also known as "first in time, first in right." See, e.g. , Hollenbeck v. City of Seattle , 136 Wash. 508, 514, 240 P. 916 (1925). However, Washington has a "race-notice" recording act, which grants priority to a party who obtains a mortgage later in time as long as that party records the mortgage first and had no actual or constructive notice of the previous mortgage. RCW 65.08.070.
¶17 At issue here is the impact of a future advances clause on the priority of the parties’ liens. A future advances clause in a mortgage secures a loan or extension of credit that the lender will disburse at a future date. 18 WILLIAM B. STOEBUCK & JOHN W. WEAVER, WASHINGTON PRACTICE: REAL ESTATE: TRANSACTIONS § 17.16 at 299 (2d ed. 2004). This type of mortgage is "one that contains a clause stating that it is security, not only for a present obligation, but for all or a certain class of obligations the mortgagor may incur in the future." Id. Most commonly used in the construction context, these mortgages can "cause some interesting and complex priorities disputes between the ... lender and other lien creditors." Id. For example, this type of mortgage raises a question of lien priority when a borrower obtains an intervening loan before the initial lender loans additional funds under the future advances clause.
¶18 Historically, our courts have applied a distinction between two types of future advances: optional advances and obligatory advances. See, e.g. , Elmendorf-Anthony Co. v. Dunn , 10 Wash.2d 29, 116 P.2d 253 (1941) ; Nat'l Bank of Wash. v. Equity Inv'rs , 81 Wash.2d 886, 506 P.2d 20 (1973). Pursuant to this distinction, any advances that are obligatory maintain priority over the intervening loan, but any advances deemed optional lose priority. Elmendorf-Anthony , 10 Wash.2d at 37, 116 P.2d 253.
¶19 The optional/obligatory distinction was at issue in National Bank . In National Bank , a construction lender included a protective clause in the mortgage stating the bank could withhold progress payments " ‘in the judgment of the Lender’ " if it determined the construction was not done in a "workmanlike...
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