Printed with Permission from Robert Franco, Source of Title
“It is every title agent’s worst nightmare – a valid second mortgage is missed and the first mortgage is refinanced without paying it off. Then, the new mortgagee forecloses and discovers that its lien may be in second place.  The lender has a claim on their title policy, but all may not be lost… the doctrine of equitable subrogation can put the lender in the shoes of the original first mortgagee that they paid off, saving their priority.  But, should the court apply such a remedy to rectify the negligence of the title agent?  This was the focus of a recently decided case in the Court of Appeals of Ohio, Eighth District in Cuyahoga County – ABN AMRO v. Kangah.
On July 5, 2000 Kangah obtained a first mortgage from First Ohio Mortgage in the amount of $68,916, and a second from the Cuyahoga County Department of Development (“CCDOD”) in the amount of $7,500.  Both mortgages were properly recorded on July 12 with the CCDOD mortgage specifically referred to as the subordinate security instrument.

In May 2001, Kangah refinanced with ABN AMRO (“ABN”) and received proceeds totalling $77,000.  The ABN mortgage was filed on June 19, 2001.  First Class Title Agency failed to discover the CCDOD mortgage and paid off First Ohio, the outstanding taxes, and the fees and costs associated with the transaction.  On November 7, 2001 the First Ohio mortgage was released of record.

On November 8, 2006 ABN filed a foreclosure complaint and, not surprisingly, CCDOD filed an answer and cross-claim asserting that it had the first and best lien on the property.  ABN argued that the doctrine of equitable subrogation applies because it paid off the first mortgage and intended to hold the first and best lien on the property.  And, it was always the intent of CCDOD to hold a subordinate lien.

The general rule in Ohio is that the first mortgage that is recorded has preference over a subsequently recorded mortgage.  “The priority of a mortgage is determined by reviewing the recording chronology.”  However, the court went on to explain the exception to the rule.

In some circumstances, the doctrine of equitable subrogation can overcome the general statutory rule.  Equitable subrogation arises by operation of law when one having a liability or right or a fiduciary relation in the premises pays a debt by another under such circumstances that he is in equity entitled to the security or obligation held by the creditor whom he has paid.  In order to be entitled to equitable subrogation, the equity must be strong and the case clear.

In other words, a third party who, with its own funds, satisfies and discharges a prior first mortgage on real estate, is subrogated to all rights of the first mortgagee in that real estate.  Therefore, if the parties intended, a mortgagee who satisfies the first mortgage steps into the shoes of the first mortgagee.

The court went on to note that the doctrine of equitable subrogation has not been uniformly applied across Ohio.  Some courts have refused to apply it when the party asserting its applicability is negligent in its business practices (i.e., failing to record the mortgage in a timely manner), and the party is in the best position to protect its interests.  A couple of courts have declined to apply it when a title company failed to discover a preexisting and validly recorded mortgage, “in essence, eliminating the doctrine altogether.”  Other courts have allowed the equitable remedy where the title company “mistakenly failed to discover a preexisting and validly recorded mortgage.”

There are two competing policy concerns at issue with equitable subrogation in such a case.  First, the title agency was negligent in failing to discover the CCDOD mortgage.  It searched the title and issued coverage to protect ABM from a loss due to its mortgage not having the first and best lien on the property.  Should the doctrine reward the party who was negligent in performing its duties?

Second, CCDOD had bargained for a second mortgage position.  If Kangah had not refinanced, CCDOD would have still been in second place.  Is it fair to reward it by allowing its mortgage to assume the first priority because of a mistake made by the title agent?

In this case, the court found in favor of ABN and applied the doctrine of equitable subrogation. 

In the case at hand, we find that the doctrine of equitable subrogation applies because ABN intended to hold the first and best lien on the property, CCDOD agreed to its subordinate security interest, ABN’s title company’s failure to discover CCDOD’s mortgage lien was a mere mistake, and CCDOD was not prejudiced by its inferior position.”

There are two relevant issues conspicuously missing from the court’s analysis, however.  First, there is no mention of the amount of the First Ohio payoff.  At best, if the doctrine does apply, it would only protect ABN up to the amount that was owed on that mortgage – ABN could receive no better rights than First Ohio had at that time.  Of course, depending on the amount the property sold for at the sheriff’s sale, this might be a moot point.  However, the court should have indicated that ABN’s priority lien was limited by this amount.

Second, the court really didn’t discuss the issue of whether CCDOD was prejudiced by the application of the doctrine.  It merely assumed that since it bargained for a second position, it was not prejudiced by the subrogation.  This may not be entirely correct.  If the CCDOD mortgage had been found, the refinance could not have taken place unless CCDOD was paid off or it agreed to voluntarily subordinate its lien.  This would have given CCDOD the opportunity to evaluate its position and insist that it be paid off in 2001. 

Furthermore, Kangah borrowed about $8,000 more with ABN than it had with First Ohio.  Depending on the terms of the loans, this could have created more of a hardship for Kangah than he had under the First Ohio mortgage, making it less likely that CCDOD would be paid.  For example, if the terms of the ABN mortgage were such that the rate and payment increased more than it would have under the First Ohio mortgage, it could have been a contributing factor to Kangah’s default and eventual foreclosure.  (Was the ABN loan a variable rate sub-prime loan?)

Equitable subrogation is, as the name implies, an equitable remedy.  Its application should be determined on a case by case basis and applied with caution.  It is difficult to say in this case whether the court got it right – it very well may have.  However, courts should be cautious to make specific holdings in such cases and thoroughly evaluate the equities at issue. 

Robert A. Franco
SOURCE OF TITLE