Carmine Russo used a $716,000 secured loan from First Magnus Financial Corp. to purchase property in 2004. In 2005, Russo obtained a $400,000 home equity line of credit; the line was secured by a deed of trust. The next month, Russo executed a $700,000 revolving loan in favor of another entity, D’Esprit Profit Sharing Plan, and recorded a related deed of trust. Then, in 2006, Russo borrowed $1 million from First Magnus on a promissory note for which BAC Home Loans Servicing would eventually become the beneficiary.
The proceeds of the $1 million loan were applied to the 2004 First Magnus loan and the 2005 equity loan. Russo also used some personal funds to settle the 2005 equity loan. First Magnus did not notify D’Esprit of the new loan. First Magnus recorded the new loan and sometime after that D’Esprit released the $350,000 that was remaining on its revolving loan agreement. Finally, the D’Esprit loan was re-recorded to fix a technicality and was then assigned to Semper.
Russo defaulted, prompting Semper to initiate a trustee’s sale. In response, BAC sued for an injunction to prevent Semper’s trustee’s sale and to declare that BAC’s loan had priority position. The trial court granted summary judgment in favor of BAC, concluding that BAC’s loan had first priority under the doctrine of equitable subrogation and that Semper’s loan was second. Semper appealed.
In a unanimous opinion, the Court of Appeals held that equitable subrogation applied and that Semper failed to identify any genuine issue of material fact to preclude summary judgment.
Under the doctrine of equitable subrogation, a subsequent lender who applies funds to a “primary and superior encumbrance” can be substituted “in the priority position of the primary lienholder, despite the recording of an intervening lien.” The doctrine may apply if, among other requirements, intervening claimants do not suffer prejudice.
Semper argued that subrogation would cause it prejudice because the new loan with BAC had a different interest rate than the earlier 2004 First Magnus loan and the 2005 equity loan; the BAC loan had a fixed interest rate and the subrogated loans had variable rates which could be lower than the fixed rate. In addition, other differences in loan terms and conditions increased the cost of the new loan. Thus, argued Semper, Russo was more likely to default under the new BAC loan than the original loans, thereby prejudicing Semper’s ability to be repaid.
The Court explained that higher interests rates for the later loan could affect subrogation. For example, a much higher rate would increase the amount of the first-priority loan at a trustee’s sale, thus reducing the amount the intervening, second-priority lienholder could recover from the sale. But, citing the Restatement, the Court held that because the original loans here had a variable interest rate and the new loan’s fixed-rate is within the variable range, there is no prejudice sufficient to overcome subrogation. As BAC argued, the Semper (or its predecessor) had considered and accepted the risk of a higher rate because the variable rate of the original loan could be substantially higher than the new fixed rate.
The Court also affirmed that “notice is not an element of equitable subrogation under Arizona law.” Lamb Excavation, Inc. v. Chase Manhattan Mortgage. Corp., 208 Ariz. 478, ¶ 20, 95 P.3d 542, 548 (App. 2004). The relevant inquiry is whether there was “actual prejudice to an intervening lienholder,” not whether notice may have caused the intervening lienholder to behave differently.
Finally, the Court rejected Semper’s argument that it was prejudiced because Russo used personal funds that could have been applied to Semper’s loan to repay the 2005 equity loan. As the Court explained, that payment was not relevant because “BAC’s priority under equitable subrogation extends only insofar as BAC supplied funds to satisfy the priority liens, and funds paid toward those liens from other sources cannot be credited to BAC.”
Judge Espinosa authored the unanimous opinion in which Judges Vásquez and Kelly concurred.
Posted by: Joseph Roth