Mortg. Elec. Registration Sys., Inc. v. Roberts, No. 2010–SC–000069–DG.

Decision Date24 May 2012
Docket NumberNo. 2010–SC–000069–DG.
Citation366 S.W.3d 405
PartiesMORTGAGE ELECTRONIC REGISTRATION SYSTEMS, INC., Appellant, v. Joseph ROBERTS, Appellee.
CourtUnited States State Supreme Court — District of Kentucky

OPINION TEXT STARTS HERE

Thomas Morgan Ward, Jr., Bethany A. Breetz, Chadwick Aaron McTighe, Stites & Harbison, PLLC, Louisville, KY, Counsel for Appellant.

Kenneth S. Kasacavage, Henderson, KY, Counsel for Appellee.

Opinion of the Court by Justice NOBLE.

This case presents the question whether the doctrine of equitable subrogation may be used to reorder the priority of a mortgage lien where the mortgage holder had constructive but not actual knowledge of a pre-existing lien when it paid off an earlier mortgage as part of a refinancing deal and there was no fraud or other misconduct that would have prevented the discovery of the lien. The trial court applied the doctrine to reorder the priority of liens, and the Court of Appeals reversed, finding that the doctrine did not apply under the facts of this case. Because equitable subrogation is not available to a lienholder who has actual or constructive knowledge of a preexisting lien, the Court of Appeals was correct that the remedy was not available to the Appellant in this case, Mortgage Electronic Registration Systems, Inc. (MERS). For that reason, this Court affirms.

I. Background

Jeffrey and Mary Michael purchased real property located at 6515 Tandy Lane in Henderson, Kentucky, on November 5, 1993. The Michaels refinanced the property three times in the next few years: in April 1994, August 1994, and December 1996. Each time they secured notes in increasingly greater amounts.

On August 26, 1998, the Michaels again refinanced, granting a mortgage on the property to The Money Store Home Equity Corporation in the amount of $108,000. The Money Store's mortgage was correctly recorded.

On June 28, 2000, Joseph Roberts recorded a judgment lien of $25,894.63 against the Michaels' property. There is no dispute that, at that time, The Money Store's mortgage was superior to Roberts' lien.

On September 18, 2003, the property was mortgaged for $125,800 to New Century Mortgage Corp. The proceeds of the New Century loan were used to pay off the 1998 mortgage held by The Money Store, which was then released of record. The New Century mortgage was recorded on October 7, 2003.

The New Century mortgage was assigned to Mortgage Electronic Registration Systems, or MERS,1 in late September 2003. The assignment of the mortgage to MERS was not recorded until March 22, 2004.

MERS filed a foreclosure action against the Michaels on May 17, 2004. Because of his judgment lien, Roberts was also named as a defendant. He filed an answer, counterclaim, and cross-claim, arguing that his judgment lien had priority over MERS's mortgage because it was filed first.

The circuit court entered summary judgment in favor of MERS. The court applied the doctrine of equitable subrogation to reorder the priority of the liens, holding that MERS had priority over Roberts to the extent of The Money Store's 1998 mortgage. The court ordered the property to be sold, with the proceeds to go first to MERS up to the amount of $89,584.36,2 then to Roberts up to the amount of $25,894.63, and then to any other liens.

The Court of Appeals reversed, holding that the doctrine of equitable subrogation did not apply in this case. This Court accepted discretionary review.

II. Analysis

The question before the Court is simply who has first priority: Roberts, because his judgment lien was filed before MERS's mortgage lien, or MERS, because of equitable subrogation.

A. Statutory Scheme.

Kentucky is a race-notice jurisdiction. SeeKRS 382.270–.280. In order to have first priority, “one must not only be the first to file the mortgage, deed or deed of trust, but the filer must also lack actual or constructive knowledge of any other mortgages, deeds or deeds of trust related to the property.” Wells Fargo Bank, Minnesota, N.A. v. Commonwealth, Finance and Administration, Department of Revenue, 345 S.W.3d 800, 804 (Ky.2011). Put another way, a prior interest in real property takes priority over a subsequent interest that was taken with notice, actual or constructive, of the prior interest.

There is no dispute that Roberts would have first priority if the recording statutes apply. Roberts' judgment lien was properly recorded more than three years before the New Century mortgage was granted and recorded. Because Roberts' lien was properly recorded and thus could have been discovered in the course of a title search, New Century had at least constructive notice of Roberts' lien. (The record is silent on whether New Century had actual notice of Roberts' lien.) Thus, under the statute, New Century's interest would have been subordinate to Roberts'. Accordingly, as the assignee of New Century, MERS's interest would also be subordinate to Roberts'.

B. Equitable Subrogation.

MERS argues that the judicially created doctrine of equitable subrogation should apply in this case to overcome a strict application of the recording statutes. “Equitable subrogation permits a creditor who pays the debt of another to stand in the shoes of the original creditor, enjoying all rights and remedies of the original creditor.” Wells Fargo, 345 S.W.3d at 806. If the doctrine applies in this case, New Century would be considered to have stepped into the priority shoes of The Money Store by providing the refinancing that paid off The Money Store's 1998 mortgage in full. MERS, the assignee of New Century's mortgage, would therefore have priority over Roberts' lien.

The Court of Appeals noted that Kentucky long ago recognized the doctrine of equitable subrogation in the mortgage context in Louisville Joint Stock Land Bank v. Bank of Pembroke, 225 Ky. 375, 9 S.W.2d 113 (1928), but distinguished the facts of that case from the present case. In so doing, the court held that equity could not support application of the doctrine of equitable subrogation in the present case because MERS and its predecessor had lost priority purely because of lack of diligence.

After the Court of Appeals handed down its opinion in this case, this Court addressed the doctrine of equitable subrogation in Wells Fargo Bank, Minnesota, N.A. v. Commonwealth, Finance and Administration, Department of Revenue, 345 S.W.3d 800 (Ky.2011), a case dealing with the priority of tax liens. This Court considered three possible approaches for determining whether equitable subrogation is available. Under the first approach, which is the majority approach, equitable subrogation is barred if the subsequent lienholder has actual knowledge of the existing lien, but not if the subsequent lienholder only has constructive knowledge. Id. at 807 (citing, among others, United Carolina Bank v. Beesley, 663 A.2d 574 (Me.1995)). Under the second approach, either actual or constructive knowledge of the existing lien precludes application of the doctrine of equitable subrogation. Id. (citing Harms v. Burt, 30 Kan.App.2d 263, 40 P.3d 329, 332 (2002)); see also, e.g., Independence One Mortgage Corporation v. Katsaros, 43 Conn.App. 71, 681 A.2d 1005 (1996). Under the third approach, which is the approach adopted by the Restatement (Third) of Property, a court has “the discretion to disregard both actual and constructive knowledge of a prior lien if the junior lienholder is not prejudiced by the court's reordering of priorities.” Wells Fargo, 345 S.W.3d at 807;see, e.g., Houston v. Bank of America Federal Savings Bank, 119 Nev. 485, 78 P.3d 71, 74–75 (2003).

In Wells Fargo, the Court adopted the second approach, holding that equitable subrogation is barred if the subsequent lienholder has actual or constructive knowledge of the existing lien. 345 S.W.3d at 807.

In this appeal, MERS asks this Court to reconsider the holding in Wells Fargo because, MERS argues, it ignored Kentucky precedent as well as important policy concerns. If the Court declines to overturn Wells Fargo, MERS asks the Court to limit its holding to the context of tax liens and to provide an alternate rule for equitable subrogation for judgment liens and other types of liens.

1. Wells Fargo did not ignore relevant Kentucky precedent.

MERS argues that this Court's opinion in Wells Fargo ignored Louisville Joint Stock Land Bank, the 1928 case that recognized the doctrine of equitable subrogation in Kentucky under facts somewhat similar to those in the present case. In Louisville Joint Stock Land Bank, the Court applied equitable subrogation to give first priority to a lender, Louisville Joint Stock Land Bank (“Land Bank”), that had taken a new mortgage and paid off a first mortgage in full, despite the existence of a second mortgage with the Bank of Pembroke that had been granted and properly recorded before the Land Bank had any interest in the property. 9 S.W.2d. at 116. Even though the Land Bank had constructive knowledge of the second mortgage, because the second mortgage was properly recorded and thus readily discoverable, the Court reasoned that equitable subrogation was available because the second lienholder, the Bank of Pembroke, would not be harmed by reordering the priority. Id. The Bank of Pembroke would remain in the exact same position it expected to be when it took the mortgage. Id. And equity demanded reordering because the owner of the mortgaged farm had fraudulently concealed the existence of the second mortgage from the Land Bank. Id. at 115.

As an initial matter, the facts of Louisville Joint Stock Land Bank are clearly distinguishable from the present case. In the 1928 case, the Bank of Pembroke had an agreement with the landowner that it would subordinate its mortgage to the new mortgage acquired by the Land Bank. Id. at 114. The landowner signed an affidavit that untruthfully stated that there was no prior or superior lien to that of the Land Bank. Id. And there was even some suggestion that an employee of the Bank of Pembroke had been involved in concealing the existence of the prior...

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