The Journal of The DuPage County Bar Association

Back Issues > Vol. 22 (2009-10)

Winning the Race to the Recorder’s Office – The Downfall of First in Time
By Timothy M. Hughes

Lakeshore Decaro v. M. Felix Inc1. has changed the landscape of recording laws in Illinois, with the Appellate Court of Illinois’ decision to extend equitable subrogation to new real estate buyers. The decision has far-reaching ramifications on property rights in Illinois, particularly when foreclosure sales account for a larger number of property conveyances in the state.

Conventional subrogation was succinctly defined in LaSalle Bank, N.I. v. First American Bank2, which stated: "in terms of real property, the doctrine of conventional subrogation holds that when a refunding mortgage is made, the lien of the old mortgage continues in effect without interruption and the refunding mortgage does not become subordinate to an intervening lien or interest attaching between the time the old mortgage was recorded and the effective date of the refunding mortgage, even though the old mortgage has been released."

But according to Appellate Court Judge Sheila M. O’Brien’s decision in Decaro v. Felix, the doctrine does not apply only to refinancing mortgages. O’Brien’s opinion states that a property buyer’s mortgagee may step into the shoes of the seller’s mortgagee, giving the new mortgagee priority over lienors who recorded prior to the new mortgagee.3

Prior to O’Brien’s opinion, Illinois recording law followed a more traditional "first in time, first in right" approach to recording and priority. A seller had to provide clean title to convey a property. And a buyer took a property subject to remaining liens attached to the property prior to conveyance. While that approach created its own difficult situations (such as buyers of new-construction housing taking title to property subject to the mechanics liens of the contractors and subcontractors who built the home for the seller), priority was seldom an issue. The law left priority to be determined by recording date: the earlier the recording date, the higher the priority. But now, the highest priority may sometimes outlive the duration of the original property owner’s actual interest.

In the present case, Felix owned real property with two existing mortgage liens, timely recorded, totaling $82,746.924. Subsequently, Lakeshore Decaro obtained an arbitration judgment against Felix for $80,000 and recorded a memorandum of judgment against the property.5 Felix then sold the property to Burke Cheney Builders6, which obtained a $104,800 mortgage loan from First National Bank of Brookfield. Burke Chaney used a portion of that proceeds to pay off the existing mortgages.7

When Lakeshore Decaro instituted post-judgment proceedings against Felix and sought a sheriffs levy sale of the property, Burke Cheney sought a determination from the court that its mortgage with First National Bank was superior in right to Lakeshore Decaro’s judgment lien.8 It claimed that the fact that its mortgage loan had paid the balance of the two existing mortgages on the property entitled it to equitable subrogation.9 In other words, the Bank’s mortgage stepped into the shoes of the two mortgages it had paid off.

Citing two Illinois cases where a third-party buyer’s mortgage was given priority over existing liens, O’Brien ruled in favor of the third party buyer in Felix v. Decaro, finding that equity favors subrogation.10 Although the cases cited are arguably analogous, neither involved an outright mortgage.

O’Brien cited Young v. Morgan11, a 130-year-old case involving a buyer who repaid a trust deed and stepped into the shoes of the original trust deed beneficiary. The Supreme Court of Illinois found that the buyer’s repayment of the trust deed allowed the buyer to take the beneficiary’s priority over subsequently recorded judgment liens against the property.12 The court held that because the buyer had purchased the property subject to the trust deed, the buyer was entitled to equitable subrogation.

O’Brien also cited Cochran v. Cutler,13 in which the Appellate Court of Illinois Second District awarded subrogation rights to third party purchasers of land who used their mortgage loan to pay a vendors’ lien on the purchased property owed by the property sellers under their original purchase contract.

Both LaSalle and Home Savings Bank v. Bierstadt14 detailed that conventional subrogation may only be granted "where the payment of incumbrances is necessary to protect rights of the payor, or where they are paid pursuant to an agreement with the debtor that the payor shall hold them as security for the money advanced."

Despite the subrogation agreement requirement outlined in LaSalle and Bierstadt," O’Brien’s opinion makes no mention of any such agreement to reserve the right of subrogation for Burke Chaney. It appears there was none.

The result is that Lakeshore Decaro was unable to enforce its judgment lien right against the property because of a loan never recorded — or even in existence — at the time Lakeshore Decaro recorded its judgment. The Court ruled that Lakeshore Decaro was entitled to a mere fraction of the $83,000 it received from Burke Chaney’s title company in the redemption that followed a sheriff’s sale of the property. The court found that the remainder of the $83,000 redemption proceeds should have gone to the title company, which became Burke Chaney’s substitute plaintiff. It held that awarding the entire redemption proceeds to Lakeshore Decaro would amount to unjust enrichment.15

O’Brien’s opinion extends the equitable subrogation right to the common closing table transaction many attorneys perform at on a daily basis, where a seller’s mortgage is repaid by a buyer’s mortgage. While O’Brien’s opinion pays no recognition to the policy shift created by this application of equitable subrogation, another opinion by a The Supreme Judicial Court of Massachusetts does. In East Boston Savings Bank v. Toner16, citing the Restatement (Third) of Property, the Court ruled that "Because … the equities are substantially similar in refinancing and sales transactions…we hold that equitable subrogation applies."

In East Boston, the Massachusetts Court outlines a five-part test for the application of the equitable subrogation doctrine: (1) the subrogee made the payment to protect his or her own interest; (2) the subrogee did not act as a volunteer (3) the subrogee was not primarily liable for the debt paid; (4) the subrogee paid off the entire encumbrance and (5) subrogation would not work any injustice to the rights of the junior lienholder.17 It also notes that equitable subrogation may be appropriate where one or two of these factors is not present.18

In that case, two owners of a condominium had two mortgage loans on the condominium property at the time they sold it to a buyer.19 The buyer used his mortgage loan to repay the sellers’ first mortgage, but the buyer’s attorney and mortgage lender failed to discover the sellers’ second mortgage.20 Following the sale, the property was subject to the previous owner’s second mortgage and the buyer’s mortgage.21 The court ruled that the buyer’s mortgage took first priority because by repaying the seller’s first mortgage, it stepped into the shoes of the original first mortgage at first priority.22

The East Boston court reasoned that if it did not apply equitable subrogation, the holder of the judgment lien "will be unjustly enriched because she will ascend to first priority through no act of her own."23 That logic, of course, ignores the act of recording itself as entitling the holder of a lien to rise to first priority.

If the principle of equitable subordinations laid out in O’Brien’s opinion and in the East Boston decision, the assumptions of lien holders will be turned on their head. As stated before, the principle of first in time, first in right is the assumed law in Illinois. If that changes on a broad basis, there will be many surprised practitioners. For those who now know of its applicability, like mechanics lien enforcement attorneys, this new reading of priority law could provide a boon to collections. Either way, every practitioner needs to understand how the law is applied in their locality.

1 Lakeshore Decaro v. M. Felix, Inc., 371 Ill.App.3d 1103 (1st Dist. 2007).

2 LaSalle Bank, N.I. v. First American Bank, 316 Ill.App.3d 515, 521 (1st Dist. 2000).

3 Decaro, 371 Ill.App.3d at 1109.

4 Decaro, 371 Ill.App.3d at 1105.

5 Id. at 1104.

6 Id. at 1105.

7 Id.

8 Id. at 1105-06.

9 Id.

10 Id. at 1109.

11 Young v. Morgan, 89 Ill. 199 (1878).

12 Id. at 2.

13 Cochran v. Cutler, 39 Ill.App.3d 602, 350 N.E.2d 59 Ill.App. 1976.

14Home Sav. Bank v. Bierstadt, 168 Ill. 618, 624 (1897).

15 Decaro, 371 Ill.App.3d at 1110.

16 East Boston Sav. Bank v. Ogan, 428 Mass. 327 (Mass. 1998).

17 Id. at 330.

18 Id.

19 Id. at 328.

20 Id.

21 Id.

22 Id. at 333.

23Id. at 334.

Timothy M. Hughes is a partner at Lavelle Law, Ltd. where he concentrates his practice in the area of Federal & State Tax Controversies, Bankruptcy, Civil Litigation and Business Law.

 
 
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