Arizona Supreme Court Holds That (1) A.R.S. § 33-992(A) Does Not Preclude Assignments by Equitable Subrogation of a Lien That Attached Before Construction Began on the Project at Issue and (2) When a Single Mortgage Burdens Multiple Parcels, a Third Party May Be Entitled to Equitable Subrogation When That Party Has Paid a Pro Rata Amount of the Obligation and Obtained a Full Release of the Parcel at Issue from the Mortgage.

First National Bank of Arizona (“First National”) loaned approximately $62 million over time to The Summit at Copper Square, LLC (“Summit”) to construct a high-rise commercial and condominium project in Phoenix.  First National secured its loans by recording two deeds of trust but agreed to release condominium units from both deeds of trust upon payment of release prices set forth in the parties’ loan agreements as third parties purchased completed units.

The Weitz Company, LLC (“Weitz”) was the general contractor for the project and began construction in November 2005.  Beginning in September 2007, Summit sold ninety-one completed condominium units to buyers who either financed their purchase or paid cash.  Some of the purchase money for these units was applied to the construction loan, resulting in First National releasing these units from both its deeds of trust.  Deeds of trust securing the owners’ purchase money loans were then recorded against the condominium units. 

In May 2008, after Summit sold eighty-five of the ninety-one units at issue, Weitz recorded a mechanics’ lien against the project.  Six months later, Weitz sued to foreclose its lien against Summit, the unit owners, and their lenders. 

The owners and lenders contested the foreclosure and moved for partial summary judgment, asserting that they were equitably subrogated to First National’s deeds of trust, and had priority over Weitz’s mechanics’ lien, because they had paid the portions of the construction loan allocated to their units.  Weitz filed a cross-motion for partial summary judgment, arguing that A.R.S. § 33-992(A)—which provides that mechanics’ liens are preferred to all liens, mortgages or other encumbrances upon the property attaching subsequent to the time the labor was commenced or the materials were commenced to be furnished except any mortgage or deed of trust that is given as security for a loan made by a construction lender—precludes equitable subrogation or, alternatively, that the Owners and Lenders were not eligible to invoke the doctrine because they did not fully discharge Summit’s obligations to First National. 

The trial court agreed with Weitz’s alternative argument and ruled that, because Weitz commenced work on the project before any units were sold, A.R.S. § 33-992(A) gave Weitz’s mechanics’ lien priority.  The court of appeals agreed that Weitz’s lien had priority, but for a different reason.  It held that § 33-992(A) precludes application of equitable subrogation to give the owners and lender’s lien priority over Weitz’s lien.

The Arizona Supreme Court overturned the Court of Appeals’ decision, holding that§ 33-992(A) does not preclude equitable subrogation of a lien that is superior to a mechanics’ lien.  Arizona applies “equitable subrogation” as set forth in the Restatement (Third) of Property:  Mortgages § 7.6(a) (1997).  Under the Restatement, one who fully performs an obligation of another, secured by a mortgage, becomes by subrogation the owner of the obligation and the mortgage to the extent necessary to prevent unjust enrichment.  The Arizona Supreme Court rejected the court of appeals’ conclusion that A.R.S. § 33-992(A) precludes equitable subrogation for several reasons.

First, the court of appeals’ reasoning that subrogation would grant lien priority to an encumbrance recorded after laborers and material men had begun work on the property misapprehends how equitable subrogation operates. Second, nothing in § 33-992(A) suggests that the legislature intended to preclude equitable subrogation in the mechanics’ lien context.  Third, permitting equitable subrogation of a lien that is superior to a mechanics’ lien is consistent with the legislature’s treatment of junior lienholders’ interest in foreclosure actions. 

The Supreme Court also rejected the trial court’s conclusion that the owners and lenders were not eligible to invoke the doctrine because they did not fully discharge Summit’s obligations to First National.  Although partial subrogation to a mortgage is generally not permitted, the Court agreed with the owners and lenders that a prospective subrogee is required to discharge only the portion of an obligation that is secured by the property at issue and that the complexities associated with dividing security between the original obligee and the subrogee do not exist when the original obligee has released its lien against the property.  The Court concluded that equitable subrogation of a mortgage is prohibited when it would divide security between the original obligee and a payor who discharges part of the obligation but is permitted when the obligation is secured by a single mortgage on multiple properties and the obligee releases the property at issue from the mortgage lien in return for discharge of the entire obligation allocated to that property.

Justice Timmer authored the opinion of the Court, in which, Vice Chief Justice Pelander, Justice Berch, and Justice Brutinel joined.