By: Edward L. Kelly
The doctrine of subrogation enables a party discharging another’s debt to step into the shoes of the creditor who held the discharged debt. Subrogation plays a significant role in the mortgage context, as the concept acts as an exception to a state’s recording statute, enabling one creditor to replace another creditor and obtain the latter’s lien priority. In the event of a foreclosure, creditors need to understand where they fall on this lien hierarchy and how subrogation may benefit a mortgagee who would otherwise be subordinate to an intervening lien. This article focuses on one form of subrogation available in Florida, equitable subrogation, and details the common law conditions that must be satisfied to step into the shoes of a senior lienholder under this doctrine.
Conventional versus Equitable Subrogation
Florida courts recognize two general subrogation categories: conventional subrogation and equitable (or “legal”) subrogation. Conventional subrogation requires a lawful contract whereby a party having no interest or relation to a matter pays another’s debt, and by agreement assumes the position of the original creditor. This new creditor now enjoys all of the original creditor’s security and rights in the matter. Equitable subrogation, on the other hand, arises in the absence of a contract or agreement from a balancing of equities to protect the relative lien position of parties to a transaction.
Five-Prong Approach to Equitable Subrogation
Although there is no “bright line” rule upon which a creditor may rely to invoke the doctrine, the Florida Supreme Court has held that assuming the position of a senior lienholder via equitable subrogation generally requires satisfaction of five conditions:
- The subrogee (party seeking subrogation) must pay the debt to protect its own interest;
- The subrogee must not act as a volunteer;
- The subrogee must not be primarily liable for the debt;
- The subrogee must pay off the entire amount of the debt; and
- Subrogation must not harm the rights of any third party.
Satisfying the First Four Prongs
One scenario that satisfies the first prong involves a creditor that agrees to extend a loan to a homeowner and the creditor’s title search revealed a single existing mortgage on the property. The creditor directs a portion of its loan to pay off the first mortgage in full, believing that it will assume the senior lien position, but then later discovers there is a second mortgage recorded between the first mortgage and the creditor’s mortgage. Under Florida’s recording statute, the second mortgage takes priority over the creditor’s mortgage. In the event of foreclosure, however, equitable subrogation may be available to the subsequent creditor, enabling the creditor to assume first position lienholder status, but only to the extent of the balance on the first mortgage paid by the creditor. This means that the creditor (now the subrogee) cannot increase the balance owed on the original first mortgage. For example, if the creditor extended a loan of $200,000, using half the amount to pay off the first mortgage, the creditor assumes first position lienholder status up to the amount of $100,000. The above example also applies where a first position lienholder refinances its loan after a junior lienholder has entered the picture unbeknownst to the first position lienholder.
The second prong ties in with the first; equitable subrogation is not available to an uninterested party or stranger to the transaction (typically referred to as a “volunteer”), but rather is reserved for those with an interest in the subject matter. A mortgagee that disburses a portion of its loan to pay off an existing first-position mortgage in ignorance of an intervening junior mortgage has an interest sufficient to avoid volunteer-status. The third and fourth prongs are clear-cut; the subrogee must not be primarily liable for paying off the debt (e.g., the subrogee could be a guarantor or could be paying the debt to clear the existing lien from its collateral), and if the subrogee wants to assume the senior lienholder’s position, it must pay the debt in full.
Avoiding Harm to Third Parties
The fifth and final prong, lying at the crux of the doctrine of equitable subrogation, receives significant attention by the courts. The prong focuses on whether an intervening junior lienholder would face any injustice by another lienholder jumping in priority through satisfaction of a senior lien. In the scenario described above, where the subsequent creditor pays the debt due the first position lienholder, the second position lienholder experiences no prejudice to its position. As far as the second position lienholder is concerned, its interest is still subject to the senior lien; only the name of the senior lienholder has changed. The same principle applies where the senior lienholder refinances its own original loan.
Suppose, however, that the second position lienholder includes a due-on-sale clause in its loan providing that if the property is ever sold or transferred, the lienholder may declare any remaining balance owed on its loan immediately due and payable. If the property is sold, and the new owner executes a note and mortgage in favor of a new lender, equitable subrogation may not be available to the new lender if it pays the debt owed the first position lienholder and distributes any remaining funds to the new owner. To permit subrogation in this scenario would harm the second position lienholder, as the second position lienholder expressly conditioned its loan upon the right to immediately recall the debt following the property’s sale or transfer. By providing the new owner funds that could be used to satisfy the second position lienholder’s mortgage, the new lender has deprived the second position lienholder of funds it rightfully expected to receive when originally extending its loan.
Lingering Issues of Notice
Florida opinions continue to discuss whether it matters if the subrogee knows that there is a junior lienholder whose interest will be subordinate to the subrogee when the subrogee pays off a senior lienholder’s security interest. Recent court opinions suggest that whether or not the subrogee is aware of an intervening lienholder has no bearing on the doctrine’s application. These opinions focus most intently on whether allowing equitable subrogation prejudices an intervening lienholder.
