Subrogation and Liens
Subrogation is the substitution of one party for another whose debt the party pays, entitling the paying party to rights, remedies, or securities that would otherwise belong to the debtor. Subrogation simply means substitution of one person for another. Subrogation seeks to prevent the unearned enrichment of one party at the expense of another by creating a relation similar to a constructive trust, prevention of merger, or equitable liens, in favor of the party making payment, in all legal rights held by the creditor.
Subrogation can be defined as the substitution of one party in the place of another regarding a lawful claim, demand or right, so that the substituted party succeeds to the rights of the other in relation to the debt or claim, and its rights, remedies or securities thereof. For example, a surety who has paid a debt is by subrogation entitled to any rights, remedies, or securities for the debt held by the creditor and the benefit of any judgment the creditor has against the debtor, and shall proceed against the debtor as the creditor would.
In Universal Forest Prods. E. Div., Inc. v. Morris Forest Prods., LLC, 558 F. Supp. 2d 893 (E.D. Wis. 2008), the court held that a party who is subrogated to a second party’s rights against a third party “steps into the shoes” of the second party and may bring all claims which the second party could have brought against the third party.
The principle of subrogation is applied in insurance policies where an insurer who has paid a loss under an insurance policy is entitled to all the rights and remedies belonging to the insured against a third party in relation to any loss covered by the policy. Subrogation is an equitable assignment. When the surety becomes obligated, the right comes into existence and such right of subrogation does not become a cause of action until the debt is fully paid.
Generally, the sum that a party pays to discharge the mortgage measures the extent to which s/he may be subrogated to the mortgage lien. In Taylor v. Furnace Assocs. (In re Taylor), 2008 Bankr. LEXIS 2687 (Bankr. D. Md. Sept. 10, 2008), the court stated that the doctrine of equitable subrogation provides that one who pays the lien of another and takes a new lien as security will be subrogated to the rights of the first lien holder as against any intervening lien holders. Based on principles of natural reason and justice, equitable subrogation is a highly favored doctrine and widely applied. Equitable subrogation is a state law doctrine and therefore, its usage differs from state to state.
A lien is a charge imposed upon specific property and is a claim, encumbrance, or charge on property for payment of some debt, obligation or duty and a tie that binds the property to a debt or claim for its satisfaction. A lien transfers all or part of one’s property, interest, or rights to another. One who pays off a mortgage or encumbrance of a principal debtor may be entitled to subrogation if the entire mortgage debt is paid.
The doctrine of subrogation holds that where a person, other than the principal obligor, pays the mortgage indebtedness on land in which he has an interest equity will substitute him in place of the original mortgagee with the mortgagee’s rights, and therefore he may keep alive and enforce the lien insofar as is necessary for his protection.
In Mortgage Elec. Registration Sys. v. Church, 2009 U.S. Dist. LEXIS 99595 (W.D. Mich. 2009), it was stated that in Michigan, a party with no preexisting interests in real property, who loans money to another to pay off an existing mortgage, is not entitled to the application of equitable subrogation. The doctrine of equitable subrogation does not allow a new mortgagee to take the priority of the older mortgagee merely because the proceeds of the new mortgage were used to pay off the indebtedness secured by the old mortgage.
Where a third person advances money to discharge an existing lien and takes a new lien for his own security, some courts permit subrogation to an intervening lien, especially where the person advancing the money to discharge the original lien was ignorant of the intervening lien. In Taylor v. Furnace Assocs. (In re Taylor), 2008 Bankr. LEXIS 2687 (Bankr. D. Md. Sept. 10, 2008), the court stated that for purposes of equitable subrogation, “intervening lien holder” means intervening in the sequence presented when there has been a prior lien and then the intervening lien, followed by the release of the prior lien and the creation of a new lien in favor of the party who paid for the release of the prior lien. Excluded from the concept of intervening lien holder is the sequence when there has been a prior lien, a release of the prior lien, a lien in favor of some third party, and then the creation of a lien in favor of the party who paid for the release of prior lien. The definition does not require that the new lien must be filed before the prior lien is released. Indeed, equitable subrogation is applied where the party seeking subrogation failed to even file a lien.
In Fulton v. Fulton, 2008 U.S. Dist. LEXIS 40789 (N.D. Ohio May 21, 2008), the court stated that equitable subrogation arises in situations where a lien holder pays a prior lien without discovering a subsequent intervening lien. In such a situation, the lien holder who paid the prior lien is not guilty of such negligence as will prevent his being subrogated to the prior lien as against the intervening lienor, especially where subrogation leaves the latter no worse off than he would have been had the prior lien not been paid. In order to recover under a theory of unjust enrichment, a plaintiff must prove by a preponderance of the evidence that:
- the plaintiff conferred a benefit upon a defendant;
- the defendant had knowledge of such benefit; and
- under circumstances where it would be unjust for him to retain the benefit without payment.
Mere constructive notice, imputed from the existence of recordation, is not sufficient to preclude subrogation, in the absence of culpable negligence. In some cases, subrogation has been denied because of the lender’s negligence in discharging the prior lien and taking a new mortgage as security without using proper precautions to discover the existence of an intervening lien, especially where the holder of the latter would be prejudiced by allowing subrogation. When money is advanced to pay a senior lien with an express agreement that the lender will be subrogated and if the holder of the intervening lien is not placed in any worse position by the transaction, then actual or constructive knowledge of the intervening lien will not defeat the right of subrogation to which the debtor agreed.