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Spair v. 21st Capital Corp.

2010 WL 147920 (Bkrtcy. D. N.J. 2010) (Unpublished)

EQUITABLE SUBROGATION — Application of the doctrine of equitable subrogation is not barred by the gross negligence of the later lender.

After performing a title search, a lender closed a mortgage loan transaction without obtaining a rundown to cover the period between the date of the title search and the date of the mortgage closing. During that period, an additional mortgage was placed on the property. “New Jersey is a race notice state. ... Accordingly, the first recorded instrument has priority over a later recorded instrument.” Consequently, under the recording statute, the previously unrecorded mortgage had over priority over the later mortgage. New Jersey, however, has “long accepted the doctrine of equitable subrogation,” which “is purely an invention of equity to accomplish justice. ... the doctrine of equitable subrogation provides that if a third-party loans or advances funds to pay off an existing mortgage or other encumbrance in the belief that no junior liens encumber the subject premises, and it later appears that intervening liens existed, the new lender will be deemed to be substituted into the position of the prior mortgage holder by equitable assignment of the prior mortgage to give effect to the new lender’s expectation and to prevent unjust enrichment of the junior encumbrances. The right of subrogation is recognized to the extent that the money advanced is actually applied to the payment of senior liens, plus interest on the amount so applied.”

The later recorded mortgagee maintained “that because its funds were used to payoff the existing first mortgage and it expected that it would receive a first mortgage position,” the earlier recorded mortgage should not have superiority. The holder of the earlier recorded mortgage argued “for the proposition that a new lender is not entitled to court imposed subrogation if it possesses actual knowledge of the prior encumbrance.” Although the earlier recording mortgagee did not argue that the later mortgagee had actual knowledge of the lien, it argued that the later recording mortgagee “was willfully ignorance of its existence because its conduct did not comport with industry standards.” Essentially, it argued that the later recording mortgagee, as a “grossly negligent party” should not be the beneficiary of equitable subrogation.

To the Court, it was undisputed that the mortgagor never identified the earlier recorded mortgagee in his Affidavit of Title given at tits closing with the later recorded mortgage and that the title search did not reveal the later recorded mortgage. The earlier recorded mortgagee’s argument was predicated on the later recorded mortgagee’s failure to conduct a run-down search. It contended that this was grossly negligent and reckless conduct because it was “industry practice to conduct a run-down search within 48 hours prior to closing.” An expert witness agreed, and the closing party’s expert witness “conceded that doing a run-down search was better practice.”

New Jersey case law addresses the issue of ordinary negligence as a bar to the application of the doctrine of equitable subrogation. The law in New Jersey “is that negligence is not a bar to subrogation [in such circumstances] unless subsequent intervening rights are involved.” There was no case law in New Jersey holding that “gross negligence or reckless disregard of industry practice is a bar to application of the doctrine of equitable subrogation.”

The United States District Court having found no applicable cases in New Jersey courts, attempted to discern what the New Jersey Supreme Court would decide if faced with the same issue. It looked at the rationale for upholding the doctrine of subrogation as expressed in New Jersey court decisions and declined to find that the “Supreme Court [i]f faced with this issue, would decide that gross negligence absolutely barred the application of equitable subrogation.” Once it found no absolute bar, it recognized that simple negligence is not a bar to application of the doctrine, the Court looked to see whether earlier recording mortgagee “would be unjustly enriched at the expense of” the later recording mortgagee if the doctrine were applied. Here, the earlier recording mortgagee expected that its mortgage would be in second position to the existing loan. Based on the doctrine of equitable subrogation, the earlier recording mortgagee would have moved to a “first mortgage position by mere happenstance.” Basically, by denying application of the doctrine of equitable subrogation, the earlier recording mortgagee would receive a windfall based on a mistake. Consequently, for this and other reasons, the Court applied the doctrine of equitable subrogation.

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