Equitable Subrogation: Examining The Intended Lien Priorities Of The Parties

In California, lien priority on real property is governed by the “first in time, first in right” rule set forth in California Civil Code § 2897. Simply put, liens that are recorded first have priority over liens that are subsequently recorded. There exists, however, a long-established doctrine in California known as equitable subrogation that carves out an exception to California’s regular rule of “first in time, first in right” in situations where equity requires a different result.

Under the doctrine of equitable subrogation, as first broadly stated in 1928 in the California Supreme Court case Simon Newman Co. v. Fink, 206 Cal. 143 (1928), when one advances money to pay off an encumbrance on real property at the request of the property owner or the holder of the encumbrance, with an express or implied understanding that the advance made is to be secured by a first lien on the real property, and that lien is for whatever reason not a first lien on the property, the party advancing the sums will be given lien priority over the rights of prior encumbrancers so long as the advancing party is not chargeable with culpable and inexcusable neglect and unless the superior or equal equalities of others would be prejudiced. In the 1977 case Katsivalis v. Serrano Reconveyance Co. (70 Cal. App.3d 200 (1977)), the Court applied equitable subrogation to a refinance transaction.

In September 2012, the California Court Of Appeals issued its first opinion in sixteen years to address the doctrine of equitable subrogation and offering further insight into the balancing of equities that drives equitable subordination. In JP Morgan Chase Bank, N.A. v. Banc of America Practice Solutions, Inc. (209 Cal. App. 4th 855 (2012)), the Court applied the doctrine of equitable subrogation to award priority to a refinance lender whose deed of trust was recorded two months after an intervening deed of trust. To simply state the facts, JP Morgan Chase Bank (“Chase”) advanced funds to the borrowers to refinance their existing loans, with the Chase loan to be secured by a new first priority deed of trust. Unbeknownst to Chase, the borrower concurrently sought a business loan from Banc of America Practice Solutions (“Banc”) that was also to be secured by a deed of trust on the borrower’s property. Banc had actual knowledge that the property was already encumbered by first and second deeds of trust in place prior to the Chase loan and the Banc loan, and Banc therefore anticipated that its loan would be secured by a third deed of trust on the property. When the Chase and Banc loans were funded, Banc filed its deed of trust before Chase. Chase filed suit and obtained an order placing its deed of trust ahead of Banc’s deed of trust under equitable subrogation.

On appeal, the Court, adhering to the long established rule that actual knowledge of an intervening lien is required to defeat equitable subrogation, rejected the argument made by Banc that Chase should be denied equitable subrogation because Chase had constructive knowledge of Banc’s intervening deed of trust. In analyzing the equalities of the equities and ruling in favor of Chase, the Court focused on the actual intended priority positions of the parties. In the subject transaction, Chase had bargained for a first deed of trust after proceeds from the Chase loan were used to refinance the existing loans secured by the property. Banc had bargained for a third priority lien on the subject real property. In this case, applying equitable subrogation put each lienholder in precisely the lien positions that they have bargained for. As the Court aptly states in its opinion, “getting exactly what one bargained for is neither punishment nor prejudicial.” Id. at 862.