Voided reverse mortgage generates free money for poor Mrs. Black.

Lien priority disputes in Maryland courts are often resolved with the almost automatic application of equitable subrogation- where a lender pays off prior liens but fails to record a new lien it will be granted the prior lien status. This operates to defeat intervening liens, including federal tax liens, other mortgage liens and judgment liens. It is predicated on fairness. The property owner is encumbered by no greater lien than he had before, and the intervening lien holders do not receive a windfall because of another's mistake.

Our appellate courts have said that negligence on the part of the lender or settlement company in conducting a title search will not bar application of equitable subrogation. Some lawyers in our office joke that the bar is low enough that settlement companies could send a blind pig to conduct a title search and the lender would still prevail over intervening liens by the application of equitable subrogation.

And so the September 30, 2015  Nutter v. Black opinion by the Maryland Court of Special Appeals arrived on my desk like a cup of black triple espresso- I was wide awake even at page thirty-five, where the court slaughtered the blind pig. Where I fully expected equitable subrogation to save the lender, the appellate court declared "no." Most surprising was that the lender in this decision paid off a prior mortgage lien, gave the borrower cash, promptly recorded its own lien and then lost it all.

James B. Nutter & Co. gave Mrs. Black a reverse mortgage. But whomever searched title failed to pick up that Mrs. Black was the subject of a guardianship dating from 1989. Not only did the title search miss the guardianship in the court dockets, but it missed reference to the guardianship in a deed and deed of trust granted by Mrs. Black's guardian to the prior lender.

Mrs. Black was allowed to back out of her reverse mortgage!

Mrs. Black's court appointed guardian found out about the reverse mortgage by accident- he received notice from Bank of America of the payoff. The guardian then discovered the reverse mortgage, and found further that over $57,000 in cash had been deposited in Mrs. Black's personal accounts.

The resulting circuit court conflict between the reverse mortgage lender and Mrs. Black's guardian centered on Mrs. Black's capacity to make a mortgage. The lender took the position that Mrs. Black may have been incompetent but that it was the guardian's duty to promptly ratify or avoid the deal.  The lender argued that the guardian waited over a year, to the great prejudice of the lender. After all, the prior mortgage was paid, its lien was released, and Mrs. Black received a lot of cash.

The guardian held firm that because Mrs. Black had been adjudicated disabled she thus had no ability to make any agreements with the lender. He refused to ratify the reverse mortgage or to even return money paid by the reverse mortgage lender to payoff the Bank of America lien. And he demanded that the lien be declared void.

As a back up legal position the lender requested application of equitable subrogation. This would have given the lender the same lien position held by the bank paid off by the reverse mortgage.  And it would have left Mrs. Black in no worse position- she had a mortgage before, and she would have a mortgage after.

The trial court and the appellate court began their analysis at the same legal point. Both started with an examination of Mrs. Black's status as a legally disabled person. Surprisingly, Maryland has very little precedent discussing whether contracts with incompetent persons are "void" (like it never happened) or "voidable" at the election of the disabled person or the guardian. In fact, we have to search back to 1926 to find another similar case. But once this appellate panel answered the question, the remaining issues fell against the lender.

This opinion makes clear that once a disabled person is adjudicated incompetent, and awarded a guardian of person and property, then a contract to make a loan in exchange for a mortgage lien is void. It is a non-event. The documents have absolutely no legal value, and the lender who mistakenly contracted for the loan has nothing to enforce against the borrower or the property.

The position follows a simple declaration contained within the Maryland Estates & Trusts Code that upon adjudication all property of the disabled person vests in the guardian.  And so, in this case Mrs. Black was deemed not to have any property rights at the time she contracted for the loan. Having no property rights, she was without any ability to pledge the real property as security for the reverse mortgage.

At this point within the appellate court's analysis a title lawyer would reasonably expect application of equitable subrogation to salvage a partial victory for the lender- the court should have awarded a partial lien for the money loaned at least to the extent of the prior payoff. The apparent negligence exhibited by the lender in not finding guardianship records, or even the signatures of the guardian on the prior lien documents, should not have barred application of equitable subrogation.

So were my expectations as I turned to page 23 of the opinion, where I fully expected the warm blanket of equitable subrogation to safely swaddle the lender.

But this appellate panel determined the lender had no rights to receive anything in exchange for paying off the prior Bank of America loan. Quoting prior cases, the panel explained that:

It is undisputed that once properly yoked with the label of "mere volunteer" or "officious payor," a plaintiff is prohibited from recovering under theories of unjust enrichment or subrogation. It is less clear, however, precisely when a plaintiff's payment to a third party satisfying the liability of the defendant renders a plaintiff a volunteer and casts him or her "into legal outer darkness."

Once again, it was Mrs. Black's status as a legally adjudicated disabled person that drove the court to cast the lender "into legal outer darkness." Having no property rights, herself, Mrs. Black was not obligated to any lender. Only her guardian had any rights to contract, and thus only he had legal obligations relating to Mrs. Black's property.

The lender argued for application of equitable subrogation, saying that it had committed a reasonable mistake, even though the court records and title documents identified the guardianship. To this the panel said:

Because a disabled person lacks he capacity to enter into contracts and cannot encumber property...no mortgage lender exercising even an iota of diligence and prudence would extend a loan to an adjudicated disabled person.

And there it is- the three judge panel drop their microphones and exit, stage right, leaving the lender with no loan, no lien, and no cash.

UPDATE:  On January 29, 2016, the Maryland Court of Appeals denied a petition for writ of certiorari (a permissive appeal to the highest appellate court on matters of public policy). The decision will thus remain, undisturbed, as the current statement of law in Maryland.

Several Maryland appellate decisions have recited that the neglect of a lender will not prevent equitable subrogation from saving at least a partial lien to the extent of the payoff to the prior lender. And within the last year a federal appellate court interpreting Maryland law correctly noted that equitable subrogation operates automatically, as a matter of law, at the very moment of payment. The lack of diligence or prudence of the lender is not the determining factor.

As the law of the land, we expect ongoing efforts by intervening lien holders to chip away at the automatic application of equitable subrogation by urging courts to more closely examine the relative lack of diligence or prudence of the lender.

How to beat a bank for a quarter million bucks.

Maryland’s law of equitable subrogation is fairly settled.  Where a lender has advanced money for the purpose of discharging a prior lien, and the disbursement is in reliance upon the lender receiving a security equivalent to the discharged lien (payoff of a first lien to obtain first lien position), without actual knowledge of the junior lien then the new lender is deemed subrogated to the prior lien. Decisions by our appellate courts now add nuance to this rule based on a limitless supply of neglectful or honestly mistaken loan transactions.

 On October 9, 2014 Maryland’s Court of Special Appeals decided National Institutes of Health Federal Credit Union v. BAC Home LoansServicing, LP (Sept. Term, 2011, No. 2103). This unreported decision addressed the relative lien priority of a Home Equity Loan (known as an “HELOC”) when compared to a later recorded refinance deed of trust. For Maryland lenders and title folks, the decision applies well known equitable subrogation law to a slightly re-ordered timeline of events. For those not familiar with equitable subrogation it is an excellent primer.

An HELOC loan is most commonly an open ended line of credit secured to real property.  The recorded lien instrument will describe a maximum amount, and will also commonly include a statement that the credit line must remain open unless and until the borrower signs a formal request to close the account. The lien is released only after the credit line is closed. And so, in a Maryland real estate settlement involving payoff of an HELOC, the payoff must be accompanied by the borrower’s request to close out the account.  And if the settlement officer fails to obtain authorization to close the account, the borrower is free to run the HELOC back to its maximum limit even after the refinance. The risk to the refinance is obvious-- the new HELOC balance will prime the refinance deed of trust.

In our title insurance practice, we have experienced home sellers who drew on their unreleased HELOC to gamble in Atlantic City or invested in failing business concerns, leaving the new owners, their title insurers and lenders to sort through the wreckage.

In this case, the borrower took a $1 Million Dollar loan from BAC to refinance a prior $800,000 purchase money loan, and a HELOC. But in a twist not seen in prior cases, the refinance deed of trust was immediately. The HELOC, however, had been funded one year earlier but was not recorded in the land records until one month AFTER the refinance deed of trust.  Predictably, after the refinance the borrower ran the HELOC right back to its limit to bolster his failing business interests.  And just as predictably, the borrower defaulted on all his loans and drifted into bankruptcy.  The court case grew from the refinance lender’s attempt to foreclose, and the HELOC lender’s attempt to establish priority. The HELOC lender lost at trial before the Circuit Court.

It was very important to the intermediate appellate court that the HELOC lien instrument was not yet recorded at the time of the refinance loan. The refinance lender received the borrower’s application, which disclosed the existence of a line of credit, but a title search confirmed there was no recording in the land records---the search showed what is commonly called “clear title.”

It was also very important to the appellate court that the HELOC lender used a standard payoff statement that made reference to a “release fee” to be submitted with the payoff. And since the title report showed no recorded lien, the refinance lender did not include a lien release fee with the payoff disbursement for the full amount listed in the payoff statement.

The evidence was that the HELOC lender did not communicate a single thing to the refinance lender to suggest a secured lien.  After the refinance lender’s best efforts, it could only reasonably conclude that the payoff was going toward an unsecured debt. And it was on this basis that the trial court was affirmed. 

The HELOC lender thus took nothing from the foreclosure sale, and was effectively wiped out by a sale price that covered only the first secured lien of the refinance lender. The failure to record timely cost this HELOC lender over $250,000.

Equitable subrogation is a powerful tool, as demonstrated in this decision, but we have seen instances where trial courts dig deep into a refinance lender's files to impute "actual knowledge" of the unrecorded or late recorded interest of another lender. For example, in one recent trial, the court looked to a prior loan file for the same borrower that contained a credit report making reference to the other lender's "mortgage loan." Even though the refinance loan described in the file did not close, and it was one year before the refinance loan at issue, the court ruled that possession of this information in the refinance lenders business records was enough to impute "actual knowledge" to the entire corporation. The case settled quickly, so we do not know what the court of special appeals would have done on that set of facts.

So, get yourself some equitable subrogation--it's better than a gun.

A bit of banking leap-frog.

On December 7, 2012, the Maryland Court of Special Appeals issued it's opinion affirming a trial court decision in favor of our client, Bank of America, N.A., protecting it's $201,000 lien from attack by another lender. 

The Bank of America building, in Baltimore, MD

The other lender, Dominion Financial, loaned about $200,000 to the prior owner of a home, but just did not get around to recording a deed of trust for several months.  Meanwhile, the house was sold to a young single mom, who borrowed money from BOA to finance her purchase.  Most of this borrowed money was spent paying off the seller's open mortgage loan. BOA then won the race to the land records, and recorded it's deed of trust, first. Dominion may have made it's loan before BOA, but it recorded second.

In the Circuit Court for Baltimore City, Dominion sued for a court order declaring that it's lien on the property was in the first position, entitling it to take all of the proceeds in the event of a foreclosure sale. On behalf of Bank of America, we argued that the law of "equitable subrogation" allowed BOA to leap-frog over Dominion to the first lien position because BOA had paid of an earlier lien owed by the seller.

This case took two years to wind through the court system. First, there was discovery in the Circuit Court, and the parties followed with cross-motions for summary judgment.  The case then went to trial, before the Hon. Evelyn Cannon.  At the end of the case, Judge Cannon found in favor of BOA, and Dominion appealed. This appellate decision ends the matter.

The path to a just result is long. In this case it was a two year journey!

But this is not just a "feel good" story of bank-versus-bank. The finality of this decision benefits the single mom who needs to discuss a loan modification or refinance. Open disputes between lenders often prevent borrowers from getting relief from their bank simply because the lender's situation is unsettled.