Is Equitable Subrogation Dead for Lenders in Missouri?
|August 31, 2010
By Scott B. Mueller [T]he broad doctrine, as a doctrine of equity, that so far as an innocent purchaser for a valuable consideration without notice of any infirmity . . . has . . . added to the permanent value of the estate, he is entitled to a full remuneration. . . This is the clear result of the Roman law; and it has the most persuasive equity, and, I may add, common sense and common justice, for its foundation.
Discounting the Remedy Absent Wrongdoing and the Volunteerism Bar
The Meaning of Equitable Subrogation
In short, lender’s equitable subrogation is a tool by which real property lenders, or lienors, may replace the prior, senior lien position of an earlier in time lender by paying off that prior lender’s loan. This result could soften the blow dealt by Missouri’s notice-based recording statutes or the impropriety of deceitful borrowers or other lenders. A lender could seek equitable subrogation in many different circumstances, but always due to one of two possible scenarios: either the new lender was mistaken as to the intended collateral’s title; or the new lender was tricked into thinking it would hold a first priority lien.
Likewise, Missouri courts, in determining whether to apply the doctrine, historically chose one of two policy perspectives: either that the new lender should have known better as to previous lienors’ interests and thus equitable subrogation is denied; or that the new lender gave value with an expectation and inherits the same position as the prior, satisfied lender, so long as no junior lender suffers. Missouri’s current approach, though, adopts the former position to limit the remedy to only those instances where a lender or insurer falls prey to egregious fraud.
The standard definition or understanding of subrogation (often found in lender/borrower or insurer/insured relationships) springs when a party pays an obligation or incurs debt which should be borne by another. It is, then, “a principle of equity, [that] an insurer, upon payment of the loss, acquires the legal right to be subrogated pro tanto to the insured’s right of action against the person responsible for the loss. The conventional legal wisdom was that the payor could recover from the beneficiary of the satisfied debt as a matter of equity. This logic was often reduced to contractual terms and thus became what could be described as “conventional” or “legal” subrogation. Historically, when no such contract right existed, but the circumstances were such as to warrant subrogation, courts would use “equitable subrogation” in lieu of a contractual subrogation right.
Development of the Remedy for Lenders
The First 100 Years: From Reluctance to Acceptance
Missouri’s early 19th century cases looked critically at the new lender’s motivation to pay another’s debt despite early legal scholars’ advocacy for the broad use of equitable subrogation in a “great variety” of circumstances. These cases sought to limit equity’s ability to compromise prior creditors’ legal rights.
Valle’s Heirs – Missouri’s First Equitable Subrogation Case
In Missouri’s first reported case of equitable subrogation, Valle’s Heirs v. Fleming’s Heirs, the court looked abroad for guidance on the novel remedy. In Fleming’s Heirs a decedent’s heirs wished to reclaim property sold at a statutorily botched estate sale – despite the fact that the sale proceeds satisfied the property’s. The equitable subrogation doctrine preserved the purchasers’ interest from the risk of losing their money and collateral due to a statutory technicality. The Court thought it unjust for the heirs to take clear title to the property, but then deny the purchasers’ interest simply because of technical noncompliance and thereby create a windfall. Valle’s Heirs referenced Maine’s warm introduction of the doctrine to America in Bright v. Boyd.
In Bright v. Boyd, like Valle’s Heirs, an invalid estate sale prompted a purchaser to extend new funds to retire preexisting liens. Yet, in Boyd the subsequent purchaser sued for a refund after his substantial improvements created equity. Maine’s Judge Story first balked at the idea of applying equity to a case where the new purchaser volunteered to pay off existing creditors. But after examining ancient European legal traditions, Judge Story imported the doctrine “founded in the highest . . . and clearest natural equity.” Valle’s Heirs echoed Judge Story’s opinion:
After a strong start in Missouri, the Supreme Court of Missouri and lower state courts dealt equitable subrogation a series of setbacks in cases which all involved mishandled estates or judicial sales. In the 1879 case of Wooldridge v. Scott,
unlike Valle’s Heirs, the court denied the plaintiff estate’s equitable subrogation plea because the loan transaction between the senior lender and borrower failed to satisfy the statute of frauds. Thus the prior loan at issue which the plaintiff retired was unperfected, unattached and immune to subrogation.
The Wooldridge court, as opposed to Valle’s Heirs, saw technicality as precluding the equitable remedy, not justifying it. This pensive approach to the novel remedy disfavored those who make legal, technical mistakes and became a recurrent theme in Missouri. Wooldridge’s lasting legacy, though, is found in its last sentence: “[i]f the vendee had . . . a fraudulent purpose . . . we might be disposed to afford relief.” Wooldridge’s clairvoyance came to fruition in later Missouri decisions and became the standard for the doctrine’s use.
Equitable subrogation’s tribulations continued in early 19th century estate cases where Missouri courts limited or restricted the use of equitable subrogation for thematic reasons. One such theme was volunteerism, as espoused in Norton v. Highleyman, where the court denied a misinformed plaintiff equitable subrogation after trying to purchase property at a postponed estate sale. The court held that “a mere mistake purely of law does not afford any ground for relief in a court of equity. In making . . . payment plaintiff was a mere volunteer.
Norton saw mistakes of fact as operative in determining whether to apply equitable subrogation. The Norton court also established a firm limitation:
[B]efore a third party, making payment of a debt secured by mortgage, can be subrogated to the rights of the mortgagee, he must show either that he made the payment at the request of the mortgagor, or to protect some interest he had of his own . . .
Norton recognized Wooldridge’s limitation that equity will not rectify mistakes of law absent misdeeds, and yet another estate sale case, Bunn v. Lindsay, refused to consider mistaken volunteers as candidates for equitable subrogation altogether. Bunn denied equitable subrogation to its plaintiff who paid off a debtor’s lien only after a third party recorded a judgment against the debtor. Since the plaintiff had no legal interest in the property, he, like the plaintiff in Norton, was “a stranger to any interest in the land up to the time he voluntarily made the payment.” A new lender’s failure to consult land records in Oldham v. Wade, also precluded subrogation and together these early Supreme Court cases created a precedent which enforced Missouri’s recording statutes, but did not prevent unjust enrichment.
Berry v. Stigall – Debtors’ Opportunism Triggers Equitable Subrogation
It took another estate sale case, Berry v. Stigall, to finally laud the doctrine’s ability to thwart unjust enrichment of opportunistic borrowers. Berry involved debtors who both consciously allowed a new (but technically unauthorized) mortgage to satisfy prior liens, but then sought to enjoy their resultant unencumbered property free of an unauthorized mortgage which they self-servingly rebuked. The court likened the plaintiffs’ situation to that of the heirs in Valle’s Heirs and Boyd who sought to void a subsequent purchaser’s interest, but still retain the benefits thereof. The complicit “approval of [Plaintiffs’] silence” irked the court and this complicity tipped the chancery scales in favor of equitable subrogation.
State Savings Expands the Doctrine
State Savings provided an opportunity to examine equitable subrogation in relation to a non-negligent lender who loaned funds to a debtor with a contractual expectation of senior priority. In State Savings, a lender agreed to satisfy the borrower’s three preexisting loans to succeed to a first lien position. The borrower’s forgery of the promised lien subordination prompted litigation, though.
State Savings contained the essential elements that warranted equitable subrogation and pitted seemingly equally innocent parties in a priority dispute created by a fraudulent borrower. The plaintiff sought to preserve a promised expectation, while the prior lienor sought the legal fruit of the superior interests’ release.
Unlike previous Missouri cases which protected first-in-time lenders, the creditor in State Savings displayed neither negligence nor altruism, but simply fell victim to fraud. State Savings found in favor of the new lender, though, in part because the junior lienor would enjoy the same collateral position as if no funds had been extended. State Savings held that the unaffected “status” of a lienholder, though, would never dispositively “entitle one…to be subrogated.”
The facts of State Savings aligned with the intended purpose of equitable subrogation and helped present the doctrine in a new light, apart from strict Supreme Court holdings, and presented a glowing review of the doctrine - especially when junior lienors did not suffer. Yet another 1918 Missouri case codified the doctrine’s elements and Missouri’s highest court validated State Savings as a “wholesome” doctrine 37 years later in Anison v. Rice. However, one feature of the State Savings decision - the borrower’s complicit fraud – provided a platform for future courts to marginalize the doctrine’s applicability.
1918 also saw Frazier v. Cook’s use of equitable subrogation to prevent the defendant’s windfall when the plaintiff wrongfully inserted of a post-execution insurance clause, which, it was held, voided the instrument, but did not vitiate the lien in equity. In Frazier, all parties intended for the plaintiff to hold a first-priority lien, so the lien’s preservation harmed no one. So preventing the borrower’s unjust enrichment trumped the rules of construction-based technicality.
The 1926 case of Baker v. Farmers’ Bank of Conway further endorsed State Savings’ view of equitable subrogation when lenders have senior-lien intent, but no “culpable and inexcusable neglect.” Baker held that lending funds to satisfy preexisting liens at the borrower’s contractual behest is non-voluntary for subrogation purposes and thus protectable.
Anison v. Rice and Validation of the Supreme Court of Missouri
The Supreme Court of Missouri revisited the substantially matured doctrine in Anison v. Rice; increased the doctrine’s reach; and discounted some of its technicality-based detractors. Anison discussed the prototypical subrogation scenario – a lender’s expectation of seniority upon a debtor’s solicitation - as well as a potentially fatal reliance on an oral promise.
In Anison two joint tenants asked a new lender to satisfy their foreclosing creditor in exchange for a new note and new deed of trust, ostensibly to replace the to-be-foreclosed first. Anison’s plaintiff advanced funds to retire the default loan, but never received his promised collateral interest.
The Supreme Court ruled that equitable subrogation entitled the plaintiff to the secured lien position formerly held by the foreclosing creditor, despite a failure to observe the formalities at which Wooldridge balked. Anison drew extensively from earlier Missouri cases and national treatises to present a comprehensive and positive review of the merits of equitable subrogation. Anison’s extensive analysis, reasoning and historical treatment of the doctrine emphatically established the validity of equitable subrogation in Missouri.
Seceding Appellate Courts and a Fraud-Based Limitation
Three decades after Anison, an attempted exploitation of equitable subrogation’s capability prompted an appellate abandonment of the doctrine. An over-aggressive perversion of the doctrine led the appellate courts to apply equitable subrogation only so as to punish wrongdoing, not to prevent unjust enrichment. These appellate decisions trended away from equitable subrogation until 2007’s landmark - Ethridge v. Tierone.
Sage, Landmark, Metmor, and Thompson Vault Wrongdoing Over Unjust Enrichment
Frago v. Sage introduced a renewed distrust of equitable subrogation because the party seeking subrogation stood to reap a windfall. In Frago, the plaintiffs paid off their own senior debt to avoid foreclosure, but then boldly sought subrogation as to their own junior debt. Frago’s plaintiffs sought to appoint themselves, like Napoleon’s self-anointment as emperor, as first priority lienors as to their own collateral.
This potential exploitation of the doctrine drew the court’s ire and the Frago court even cited insurance based conventional subrogation standards to limit the doctrine’s future application. Frago placed the “burden . . . upon the party seeking subrogation to substantiate by clear and convincing evidence that . . . the other party, in equity, should endure the loss.”
In Landmark Bank v. Ciaravino the Eastern District continued its anti-equitable subrogation crusade and resuscitated the line of cases hostile to equitable subrogation, like Bunn, which limited the doctrine to “only extreme cases bordering on fraud.” The Landmark decision entirely overlooked the unjust enrichment prevention goals of State Savings and Anison and regressed to Bunn’s harsh reliance on Missouri’s recording statutes.
In Landmark the plaintiff sought subrogation as to a discoverable senior lien, but the court opined that the lien’s detectability imputed negligence and precluded equity. This sentiment was quickly echoed in Gateway Center which held that only Missouri’s recording statutes act to protect new lenders. Most importantly, though, Landmark conclusively held that fraud - not unjust enrichment – is the true condition precedent to equitable subrogation which applied in “only extreme cases bordering on . . . fraud”. Only Landmark’s Anison-based dissent recognized the doctrine’s utility to prevent such egregious unjust enrichment.
The court’s focus on fraud became acute in Metmor v. Landoll, where a recorder of deeds did not reflect a prior lienor’s interest, but electronic recordation made the instrument theoretically discoverable. According to the court, only the “nuances of the Platte County recording system” kept Plaintiff from discovering it. Despite the court’s concession that the new lender could not have possibly discovered the senior lien, it held that absent fraud, equitable subrogation was unavailable. Metmor and Gateway Center now subverted Anison’s policy that technical mistakes should not yield windfalls at a lender’s expense, but bafflingly used technicalities to justify the denial equitable subrogation.
Thompson v. Chase continued Missouri’s purge of equitable subrogation despite the presence of each of the doctrine’s requisite elements. In Thompson, the plaintiff quitclaimed her marital interest to facilitate her ex-husband’s refinance their marital property and pay her divorce award. But once the new lender’s funds satisfied the lion’s share of her judgment, she still sought to attach and levy the property to satisfy the remaining balance of her first-in-time judgment. The defendant lender now faced foreclosure and the extinguishment of its interest and sought subrogation as a defense to the plaintiff’s execution. Thompson, then, presented a mirrored image of Frago.
Even Missouri’s anti-equitable subrogation courts could justify the doctrine based on Thompson’s facts. A court seeking to prevent windfalls per Frago could validate equitable subrogation since the plaintiff would hold property worth twice as much as the balance of her judgment lien. Thompson, however, read Frago to mean that windfalls are discouraged only if the lender benefits and embraced the contra-positive, that equitable subrogation should be denied if the remedy would prevent the borrower’s windfall.
Thompson’s other available justification for equitable subrogation involved the plaintiff’s complicity per Landmark. Thompson’s plaintiff also induced the new lender’s refinance loan by waiving her interest in the property to bait a new first lien. However, despite the holdings of State Savings, Anison, Holland, and Frasier, Thompson found no indicia of the now-imperative fraud and thus refused to prevent the plaintiff’s self preserved windfall.
Thompson and Frago display an untenable position as to equitable subrogation. Thompson denied equitable subrogation even though the debtor stood to gain a windfall while the potential windfall to the creditor, in Frago’s view, precluded equitable subrogation. These irreconcilable decisions contradict earlier Missouri equitable subrogation cases which sought to avoid unjust enrichment and instead suggest that courts protect borrowers at lenders’ expense.
The Supreme Court Completes the Cycle in Ethridge
In 2006, the Southern District heard an equitable subrogation case replete with equitable subrogation’s hallmark features: technicalities, mistakes and unjust enrichment. In Ethridge v. Tierone , a widow sought to void her husband’s refinance of their marital property because the deed of trust included only the husband as “borrower” and failed to recite her marital interest.
The lender sought reformation to reflect both parties as the borrowers, since both benefitted from the refinance loan and the attendant satisfaction of the prior deed of trust. Alternatively, the widow’s potential windfall supported a claim for equitable subrogation. The Southern District, per Anison, ruled that Mrs. Ethridge benefitted from the earlier lien’s discharge and equitable subrogation would rightfully prevent a windfall at the lender’s expense.
However, the Supreme Court of Missouri, on review of the Southern District’s Ethridge decision, abandoned its prior holdings in favor of the new equitable subrogation modes created by the Eastern and Western Districts. Favoring Metmor and Thomson, the Court noted the “extreme” nature of equitable subrogation and brandished the doctrine to cases involving fraud and held that Mrs. Ethridge “must” have acted in fraud for equitable subrogation to apply. The Supreme Court of Missouri became an adherent to the appellate courts’ revisionist approach to equitable subrogation and Ethridge finalized this new fraud-based paradigm.
The heightened standards of Ethridge have yet to be tested in Missouri
In Howard v. Turnbull, another post-Ethridge case which asserted a claim for equitable subrogation, the plaintiff guarantor sued a debtor’s bank after satisfying the debtor’s obligation. The guarantor was not involved in the debtors’ business which utilized the bank’s loan and therefore reached an “agreement” which held that if the guaranty was ever called by the bank, the bank would assign other collateral to the guarantor in exchange. However, despite the guarantor’s eventual payment of the entire balance, no such collateral reached the plaintiff and he asserted claims for, among other things, unjust enrichment as to the debtors, equitable subrogation as to the bank, and fraud as to all parties. However, the fraud claim was voluntarily dismissed and all claims, including equitable subrogation, were dismissed by the trial court. On appeal, the Western District did not take the opportunity to discuss whether the plaintiff guarantor would have a claim in equity for the lender’s other collateral vis a vis equitable subrogation. One may only speculate as to whether the voluntary dismissal of all fraud claims by the plaintiff, in the court’s mind, precluded a claim for equitable subrogation per Ethridge.
The only other reported Missouri state court case involving equitable subrogation is equally silent as to the new standards of equitable subrogation. In Sutton Funding, LLC v. Mueller, the Eastern District considered a case in which involved a judgment lienor sought priority over a subsequent, but purchase-money deed of trust. The court ruled that such a situation did not involve equitable subrogation, but rather the priority of purchase money liens as against earlier judgment liens. The court side-stepped any discussion of equitable subrogation despite the remarkable familiarity to cases like Bunn, Landmark Bank and Metmor, which held against equitable subrogation as to lenders who failed to discover previous liens against their intended collateral.
So it remains to be seen whether the pendulum of equitable subrogation will swing back into favorability in Missouri. Undoubtedly, the recent mortgage crisis and foreclosure glut will push the equitable remedy to the forefront again. Other states’ contrasting views on equitable subrogation may also cast sway over Missouri’s current harsh stance toward equitable subrogation. One thing is certain, though: Such a powerful remedy so prevalent in American legal history will not long remain dormant.
Scott B. Mueller, Esq. graduated from Saint Louis University School of Law in 2006 and is an associate in the law firm of Danna McKitrick, P.C. in St. Louis, Missouri and concentrates his practice in the areas of real estate and title litigation, creditors’ rights and commercial litigation.
This article originally appeared in the
Journal of the Missouri Bar and is reprinted with permission.
Ohio Supreme Court Decision
Look for a report in TitleNews online regarding a decision by the Ohio Supreme Court to strike down a lender's attempt to obtain priority via the doctrine of equitable subrogation. The case is ABN-Amro Mortgage Group, Inc. v. Kangah, 2010 WL 3272260 (Ohio), 2010-Ohio-3779.