East Boston Sav. Bank v. Ogan

• Decision Date: 05 November 1998
• Citation: 701 N.E.2d 331,428 Mass. 327
• Parties: EAST BOSTON SAVINGS BANK & another 1 v. Lois J. OGAN.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

Page 331

701 N.E.2d 331

428 Mass. 327

EAST BOSTON SAVINGS BANK & another ¹ v. Lois J. OGAN.

Supreme Judicial Court of Massachusetts,

Suffolk.

Argued Oct. 8, 1998.

Decided Nov. 5, 1998.

Avram G. Hammer, Marblehead, for defendant.

Earl D. Munroe (Michael M. McArdle with him), Marblehead, for plaintiffs.

Before WILKINS, C.J., and ABRAMS, LYNCH, FRIED, MARSHALL and IRELAND, JJ.

IRELAND, Justice.

This is a case of first impression concerning the doctrine of equitable subrogation. The defendant, Lois J. Ogan, appeals from a grant of summary judgment in favor of the plaintiffs, East Boston Savings Bank (East Boston) and Edward W. Toner, Jr. The Land Court granted a declaratory judgment in favor of the plaintiffs and ruled that the defendant's mortgage was subordinate to both the equity interest held by Toner and the mortgage interest of East Boston. The defendant appealed, and we transferred the case to this court on our own motion. We affirm the Land Court's judgment and hold that equitable subrogation applies in cases like the one before us today.

1. Facts. The following facts are undisputed. Steven and Jeffery Kline purchased a condominium unit (property) as tenants in common for $227,000 on September 19, 1988, and financed their purchase, in part, with a $187,500 mortgage loan from Eastern Savings Bank (ESB). On February 9, 1989, Steven Kline granted a second mortgage in his one-half undivided interest in the property to the defendant. This mortgage indicated that it was "subject to a mortgage to the Eastern Savings Bank." After this transaction the property was subject to the first mortgage to ESB, and the second mortgage to the defendant.

The Klines sold the property to Toner on November 10, 1994, for $183,000. As consideration, Toner gave a mortgage secured by the property for $130,000 to East Boston, and he provided $54,407.63 from his own funds. The balance of the ESB mortgage, $176,948.65, was discharged at the closing. This transaction was recorded promptly but, unknown to the parties at the time, East Boston's closing attorney never discovered the defendant's intervening mortgage. After the sale, on the record the property was subject to the mortgage of the defendant followed by the new mortgage to the plaintiff, East Boston.

2. Background. We have long held that our courts have broad power over mortgages. These powers have been exercised in order, for example, to reform mortgages, see General Bldrs. Supply Co. v. Arlington Co-op. Bank, 359 Mass. 691, 696-697, 271 N.E.2d 342 (1971) (discussing reformation of mortgages), and cases cited, to restore once-extinguished mortgages, see Childs v. Stoddard, 130 Mass. 110, 112 (1881) (mortgagee can seek to have discharge of mortgage set aside); Bruce v. Bonney, 78 Mass. 107, 12 Gray 107, 112 (1858) (same), and to adjust priorities among existing mortgages, see Worcester N. Sav. Inst. v. Farwell, 292 Mass. 568, 574, 198 N.E. 897 (1935) (subrogation adjusts priorities among mortgages). As both parties acknowledge: "It is the general rule that, where a mortgage has been discharged by mistake, equity will set the discharge aside and reinstate the mortgage to the position the parties intended it to occupy, where the rights of intervening lienors have not been affected." North Easton Coop. Bank v. MacLean, 300 Mass. 285, 292, 15 N.E.2d 241 (1938).

Subrogation is among these long-recognized powers. See Worcester N. Sav. Inst., supra, and cases cited. It allows "the substitution of one person in place of another ... so that he who is substituted succeeds to the rights of the other." Provident Co-op. Bank v. James Talcott, Inc., 358 Mass. 180, 188, 260 N.E.2d 903 (1970), quoting Jackson Co. v. Boylston Mut. Ins. Co., 139 Mass. 508, 510, 2 N.E. 103 (1885). The question whether to apply subrogation depends on a balance of the interests of the competing mortgagees because "[t]he right to subrogation rests upon equity." Massachusetts Hosp. Life Ins. Co. v. Shulman, 299 Mass. 312, 316, 12 N.E.2d 856 (1938), and cases cited. The court guards against the unjust enrichment of either party by granting to the later mortgagee the priority status intended by the parties to that transaction, only so long as the interests of the intervening mortgagee are not prejudiced. ²

Today we are urged by the plaintiffs to uphold the decision of the Land Court and to extend the doctrine of equitable subrogation. We have not previously addressed the question whether, and to what extent, equitable subrogation applies where a mortgage is extinguished as part of a sale. We have applied subrogation to a refinancing transaction. See Provident Co-op. Bank, supra; North Easton Co-op. Bank, supra at 292, 15 N.E.2d 241. ³ Because we find that the equities are substantially similar in refinancing and sales transactions, and that application of equitable subrogation to a sale is consistent with our precedent, we hold that equitable subrogation applies in this case.

3. Discussion. Equitable subrogation is an exception to the basic principle that determines priority among mortgages, "first in time is first in right." Where equitable subrogation applies:

"One who fully performs an obligation of another, secured by a mortgage, becomes by subrogation the owner of the obligation and the mortgage to the extent necessary to prevent unjust enrichment. Even though the performance would otherwise discharge the obligation and the mortgage, they are preserved and the mortgage retains its priority in the hands of the subrogee."

Restatement (Third) of Property (Mortgages) § 7.6(a) (1997). In other words, the new mortgage held by a mortgagor, who used the proceeds of the new mortgage to extinguish an earlier mortgage, may receive the same priority once given to the earlier mortgage.

Before equitable subrogation applies, a court must determine: "(1) the subrogee made the payment to protect his or her own interest, (2) the subrogee did not act as a volunteer,[ ⁴] (3) the subrogee was not primarily liable for the debt paid, (4) the subrogee paid off the entire encumbrance, and (5) subrogation would not work any injustice to the rights of the junior lienholder." Mort v. United States, 86 F.3d 890, 894 (9th Cir.1996), citing Han v. United States, 944 F.2d 526, 529 (9th Cir.1991). It is "a broad equitable remedy" and, depending on the individual case, it may apply even where one or more of these factors is absent. Mort, supra.

A court applying equitable subrogation must ensure that the intervening mortgagee is not unjustly enriched by succeeding to first priority, but it also must ensure that the intervening mortgagee does not receive a lower priority as a result of the subrogee's mistake. Thus, subrogation will not apply to the extent it prejudices the intervening mortgagee. For instance, subrogation will only occur to the extent that funds are owing on the original mortgage when the mistake is made. See Provident Co-op., supra at 189, 260 N.E.2d 903. "The payor is subrogated only to the extent that the funds disbursed are actually applied toward the payment of the prior lien. There is no right of subrogation with respect to any excess funds." Restatement, supra at § 7.6 comment e, at 520.

A second mortgagee, however, accepts risks inherent in that security. These include, for instance, a renewal or an extension of time for payment on the original mortgage. See Guleserian v. Fields, 351 Mass. 238, 242-243, 218 N.E.2d 397 (1966). Actions like these cannot be considered prejudicial to the junior mortgagee and, in fact, do not require the approval of the junior mortgagee. See id. at 243, 218 N.E.2d 397. Other situations may be different. For example, we have recognized that a first mortgage holder may not unduly prejudice the junior mortgagee when modifying a first mortgage. See Shane v. Winter Hill Fed. Sav. & Loan Ass'n, 397 Mass. 479, 485-486, 492 N.E.2d 92 (1986).

The court must also examine the actions of the subrogee. The degree of knowledge attributable to a subrogee concerning the existence of the intervening mortgage may nullify equitable subrogation. Some courts subrogate without regard for the subrogee's knowledge. See Klotz v. Klotz, 440 N.W.2d 406, 409-410 (Iowa Ct.App.1989); Trus Joist Corp. v. National Union Fire Ins. Co., 190 N.J.Super. 168, 179, 462 A.2d 603 (App.Div.1983), rev'd on other grounds, 97 N.J. 22, 477 A.2d 817 (1984); Providence Inst. for Sav. v. Sims, 441 S.W.2d 516, 520 (Tex.1969). See also Restatement, supra at Reporters' Note, at 529. Others will deny subrogation where the subrogee has actual knowledge, but will permit it where the subrogee has constructive knowledge. See, e.g., Smith v. State Sav. & Loan Ass'n, 175 Cal.App.3d 1092, 1098, 223 Cal.Rptr. 298 (1985); United Carolina Bank v. Beesley, 663 A.2d 574, 576 (Me.1995). Other courts deny equitable subrogation to a subrogee who has mere constructive knowledge of the intervening lien. See Independence One Mtge. Corp. v. Katsaros, 43 Conn.App. 71, 74-75, 681 A.2d 1005 (1996).

We decline to adopt a bright line rule concerning subrogee knowledge. We are persuaded by the reasoning of courts that not only allow subrogation where the subrogee has actual or constructive knowledge of the intervening mortgage, but also look to equity to decide if subrogation is inappropriate. See Davis v. Johnson, 241 Ga. 436, 439-440, 246 S.E.2d 297 (1978). "[K]nowledge is not necessarily fatal to the grantee's claim of subrogation, if equity would nonetheless dictate the recognition of subrogation." Restatement, supra at § 7.6, comment d, at 518. The court must determine, under the circumstances, if the subrogee acted with sufficient knowledge to merit denying subrogation where it would otherwise be the correct result.

Subrogee culpability, like their level of knowledge concerningintervening liens, is not susceptible to a clear rule that might distinguish acts that negate the use of subrogation from those that do not. The subrogee's...