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Equitable Subrogration Doctrine Applied - Investors S.B. v. Keybank, N.A.
Where a party supplies the funds to pay off an existing mortgage in the belief that no junior liens encumber the subject premises, and it later appears that intervening liens existed, the courts may apply the doctrine of equitable subrogation to avoid an unfair result.

For example, assume that A holds a first mortgage on Blackacre, and that the owner ("X") seeks to refinance by obtaining a new mortgage from B. However, X also applies for a mortgage loan from C, which is recorded the day before the mortgage to B. B advances the funds to pay off A's mortgage, believing he will have a first lien. Had B known of C's mortgage, he could have obtained an assignment from A, thereby stepping into A's shoes and achieving priority over C. The Court may elect to treat the transaction as if B had in fact obtained an assignment from A. (For this reason, The concept is sometimes referred to as equitable assignment.) This is not unfair to C; to the contrary, C has unfairly benefitted from B's pay-off of A's mortgage. Thus, application of this doctrine merely restores the parties to the positions they had bargained for. See Weinstein on Mortgages, §13.9 (2d Ed. 2001).

Nevertheless, courts have sometimes refused to apply this principle where the party invoking it is chargeable with actual or constructive notice of the intervening lien. Thus, in the example given above, if the intervening mortgage held by C could have been disclosed by a search, but erroneously failed to do so, the court may decline to hold that B’s mortgage has priority over C’s. See, e.g., First Union v. Nelkin, 354 N.J. Super. 557 (App. Div. 2002). Such decisions overlook the fact (as noted above) that the doctrine simply places the parties where they intended to be, so notice of the intervening lien should be irrelevant. They are also contrary to the position taken by the Restatement (Third) of Property: Mortgages, §7.6 (1997), which suggests that actual or constructive knowledge is “not necessarily relevant”.

In Investors S. B. v. Keybank, N.A., 424 N.J. Super. 439 (App. Div. 2012), a mortgage lender sought a declaration that its lien enjoyed priority over that of a judgment creditor whose lien had been previously recorded. The Chancery Division held for the mortgagee, and the Appellate Division affirmed, because the lender’s funds had been applied toward the pay-off of a pre-existing mortgage. The panel concluded that “such as refinancing mortgagee is ordinarily entitled to the same priority as the original mortgagee even though it negligently failed to discover the lien of the intervening judgment creditor before closing”. 424 N.J. Super. at 441. Thus, the opinion is consistent with the approach adopted by the Restatement and prior decisions such as U.S. Bank v. Hylton, 403 N.J. Super. 630 (Ch. Div. 2008) and UPS Capital v. Abbey, 408 N.J. Super. 524 (Ch Div. 2009).

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