Shifting Values In Subordination: Where Are Your Priorities?

Terry Jessop & Bitner Newsletter

Issue 31, March 2016

For lenders who want to ensure that their loans have first-position priority, and for title companies who wish to avoid claims on lender's policies, it is crucial to understand who claims what interest in the property at issue. This is especially true when a loan is refinanced and a subordination agreement is required.

Here's the situation: John Doe purchases a home with a loan for $250,000 from Big Bank. At the same time, John Doe obtains a second loan from Big Bank for $50,000. Both loans are secured By John's property, and the larger loan has first priority, as it should. Ten years go by. John makes regular payments on both loans, and he accumulates some equity. He needs more money, but he doesn't have the means or desire to pay off either of the first two loans. So he gets a third loan for $25,000 from Hard Money Lender.

Five years later, John is ready to refinance Big Bank's $250,000 trust deed. He contacts Credit Union Lender, who agrees to issue a $200,000 loan to Mr. Doe (which is the amount owed to Big Bank on its first-position loan), on the condition that Big Bank subordinate its remaining $50,000 trust deed, which would otherwise be in first position. Big Bank agrees to subordinate its smaller loan to Credit Union Lender's larger loan. The refinance closes, Big Bank's $250,000 first-position trust deed is reconveyed, and Credit Union's trust deed is recorded together with an appropriate subordination agreement, signed by Big Bank. Credit Union Lender doesn't worry about getting a subordination agreement from Hard Money Lender, because Credit Union Lender is swapping positions with Big Bank, who has priority over Hard Money Lender.

While Credit Union Lender's assumption about priority over Hard Money Lender is logical, the Credit Union Lender's position is in jeopardy. Indeed, if Hard Money Lender forecloses, he will cut off all but $50,000 of Credit Union Lender's interest in the property, according to a recent decision from the Utah Supreme Court.

In VCS Inc. v Countrywide Home Loans, et.al., 2015 UT 46, 349 P.3d 704, the court adopted the doctrine of "partial subordination" in cases with circular lien priorities, like the one described above. In short, the court enforces the parties' intentions, insofar as possible. In our example, Big Bank intended to be in first position with its two trust deeds. Credit Union Lender also intended to be in first position with respect to its $200,000 refinance, which is why it required Big Bank to subordinate its remaining $50,000 trust deed. But Credit Union Lender is junior in time to Hard Money Lender, who intends to have priority over all encumbrances which are junior to him. According to the VCS case, Credit Union Lender steps into first position, ahead of Hard Money Lender, but only in the amount of Big Bank's $50,000 trust deed. Consequently, if Credit Union Lender forecloses, it gets the first $50,000 from the proceeds of the sale, but Credit Union Lender must give the next $25,000 (plus interest and attorneys fees) to Hard Money Lender, and then the balance to itself and Big Bank, if there is enough to go around.

To avoid this quagmire, a lender providing new money must obtain subordination agreements from every other lender that is otherwise ahead of it. Unsure about the priority of your lien? Give us a call. We can help.

© Terry Jessop & Bitner March 2016