I found this article following a conversation with some of my clients and
felt it had to be posted. Many people misunderstand the concept of an
equitably subrogated claim or motions for equitable subrogation. This
article by Edward L. Kelly and Karl R. Gruss, I certainly hope will help
clarify any misconceptions.
The doctrine of subrogation enables a party discharging another’s
debt to step into the shoes of the creditor who held the discharged debt.
Subrogation plays a significant role in the mortgage context, as the concept
acts as an exception to a state’s recording statute, enabling one
creditor to replace another creditor and obtain the latter’s lien
priority. In the event of a foreclosure, creditors need to understand
where they fall on this lien hierarchy and how subrogation may benefit
a mortgagee who would otherwise be subordinate to an intervening lien.
This article focuses on one form of subrogation available in Florida,
equitable subrogation, and details the common law conditions that must
be satisfied to step into the shoes of a senior lienholder under this doctrine.
Conventional versus Equitable Subrogation
Florida courts recognize two general subrogation categories: conventional
subrogation and equitable (or “legal”) subrogation. Conventional
subrogation requires a lawful contract whereby a party having no interest
or relation to a matter pays another’s debt, and by agreement assumes
the position of the original creditor. This new creditor now enjoys all
of the original creditor’s security and rights in the matter. Equitable
subrogation, on the other hand, arises in the absence of a contract or
agreement from a balancing of equities to protect the relative lien position
of parties to a transaction.
Five-Prong Approach to Equitable Subrogation
Although there is no “bright line” rule upon which a creditor
may rely to invoke the doctrine, the Florida Supreme Court has held that
assuming the position of a senior lienholder via equitable subrogation
generally requires satisfaction of five conditions:
- The subrogee (party seeking subrogation) must pay the debt to protect its
- The subrogee must not act as a volunteer;
- The subrogee must not be primarily liable for the debt;
- The subrogee must pay off the entire amount of the debt; and
- Subrogation must not harm the rights of any third party.
Satisfying the First Four Prongs
One scenario that satisfies the first prong involves a creditor that agrees
to extend a loan to a homeowner and the creditor’s title search
revealed a single existing mortgage on the property. The creditor directs
a portion of its loan to pay off the first mortgage in full, believing
that it will assume the senior lien position, but then later discovers
there is a second mortgage recorded between the first mortgage and the
creditor’s mortgage. Under Florida’s recording statute, the
second mortgage takes priority over the creditor’s mortgage. In
the event of foreclosure, however, equitable subrogation may be available
to the subsequent creditor, enabling the creditor to assume first position
lienholder status, but only to the extent of the balance on the first
mortgage paid by the creditor. This means that the creditor (now the subrogee)
cannot increase the balance owed on the original first mortgage. For example,
if the creditor extended a loan of $200,000, using half the amount to
pay off the first mortgage, the creditor assumes first position lienholder
status up to the amount of $100,000. The above example also applies where
a first position lienholder refinances its loan after a junior lienholder
has entered the picture unbeknownst to the first position lienholder.
The second prong ties in with the first; equitable subrogation is not available
to an uninterested party or stranger to the transaction (typically referred
to as a “volunteer”), but rather is reserved for those with
an interest in the subject matter. A mortgagee that disburses a portion
of its loan to pay off an existing first-position mortgage in ignorance
of an intervening junior mortgage has an interest sufficient to avoid
volunteer-status. The third and fourth prongs are clear-cut; the subrogee
must not be primarily liable for paying off the debt (e.g., the subrogee
could be a guarantor or could be paying the debt to clear the existing
lien from its collateral), and if the subrogee wants to assume the senior
lienholder’s position, it must pay the debt in full.
Avoiding Harm to Third Parties
The fifth and final prong, lying at the crux of the doctrine of equitable
subrogation, receives significant attention by the courts. The prong focuses
on whether an intervening junior lienholder would face any injustice by
another lienholder jumping in priority through satisfaction of a senior
lien. In the scenario described above, where the subsequent creditor pays
the debt due the first position lienholder, the second position lienholder
experiences no prejudice to its position. As far as the second position
lienholder is concerned, its interest is still subject to the senior lien;
only the name of the senior lienholder has changed. The same principle
applies where the senior lienholder refinances its own original loan.
Suppose, however, that the second position lienholder includes a due-on-sale
clause in its loan providing that if the property is ever sold or transferred,
the lienholder may declare any remaining balance owed on its loan immediately
due and payable. If the property is sold, and the new owner executes a
note and mortgage in favor of a new lender, equitable subrogation may
not be available to the new lender if it pays the debt owed the first
position lienholder and distributes any remaining funds to the new owner.
To permit subrogation in this scenario would harm the second position
lienholder, as the second position lienholder expressly conditioned its
loan upon the right to immediately recall the debt following the property’s
sale or transfer. By providing the new owner funds that could be used
to satisfy the second position lienholder’s mortgage, the new lender
has deprived the second position lienholder of funds it rightfully expected
to receive when originally extending its loan.
Lingering Issues of Notice
Florida opinions continue to discuss whether it matters if the subrogee
knows that there is a junior lienholder whose interest will be subordinate
to the subrogee when the subrogee pays off a senior lienholder’s
security interest. Recent court opinions suggest that whether or not the
subrogee is aware of an intervening lienholder has no bearing on the doctrine’s
application. These opinions focus most intently on whether allowing equitable
subrogation prejudices an intervening lienholder.