In an action regarding lien priority between two lenders, the Court of Appeals of Arizona recently affirmed the trial court’s application of the replacement doctrine and concluded that plaintiff’s deed of trust takes priority over defendant’s deed of trust, but reversed the trial court’s application of the doctrine of equitable subrogation in favor of plaintiff, on the grounds that plaintiff’s predecessor in interest had actual knowledge of defendant’s junior lien but failed to take the proper steps to ensure it was satisfied and released. See US Bank, N.A. v. JPMorgan Chase Bank, N.A., 398 P.3d 118 (Ariz. Ct. App. 2017). In the case, non-party borrowers obtained a $200,000 home equity line of credit (the “HELOC”) from defendant’s predecessor in interest in 1997, which was secured by a deed of trust on the borrowers’ home (the “HELOC Deed of Trust”). In 2004, the borrowers executed a note and deed of trust in favor of plaintiff’s predecessor in interest in the amount of $387,000 (the “2004 Note” and “2004 Deed of Trust”). At that time, defendant’s predecessor in interest executed and recorded a subordination agreement, waiving the HELOC Deed of Trust’s priority in favor of the 2004 Deed of Trust. In 2005, the borrowers executed a new note and deed of trust for $682,000 in favor of plaintiff’s predecessor in interest (the “2005 Note” and “2005 Deed of Trust”), using $384,040.34 from the loan proceeds to pay off the 2004 Note. The 2004 Deed of Trust was released. Another portion of the loan proceeds ($211,148.30) was used to pay off the HELOC; however, the payment was $3,452.13 short of what was required to pay off the HELOC, which remained open. The borrowers continued to take advances on the HELOC, resulting in an unpaid balance of more than $203,000 by 2013. The borrowers subsequently defaulted on the 2005 Note and the trustee began non-judicial foreclosure proceedings. Plaintiff, as holder of the 2005 Note and 2005 Deed of Trust, filed a complaint seeking lien priority pursuant to the doctrines of replacement and equitable subrogation, as well as unjust enrichment and estoppel. Plaintiff subsequently moved for summary judgment on its replacement and equitable subrogation claims. Defendant opposed, arguing that its HELOC Deed of Trust was recorded before the 2005 Deed of Trust and not subordinated, and should be granted priority. The court granted plaintiff’s motion, concluding that “equity favors subordinating [defendant’s] lien to [plaintiff’s] lien” and defendant appealed.
On appeal, the Court of Appeals acknowledged that, while previously-recorded deeds of trust normally take priority over later deeds of trust, the equitable doctrines of replacement and subrogation may permit a later-recorded deed of trust to assume priority over an earlier deed of trust. Analyzing each argument in turn, the Court first rejected defendant’s argument that the HELOC Deed of Trust is superior to the 2005 Deed of Trust under the rule of “first in time, first in right.” The Court found that the borrowers used the 2005 Note proceeds to satisfy and replace the 2004 Note and 2004 Deed of Trust and, therefore, application of the replacement doctrine is appropriate. Accordingly, the 2005 Deed of Trust retained priority over the HELOC Deed of Trust to the extent of $384,040.34 – the amount paid on the 2004 Note from the proceeds of the 2005 loan. The Court further noted that defendant suffers no prejudice from the application of the replacement doctrine because the HELOC Deed of Trust maintains the same position it occupied before the 2005 Deed of Trust replaced the 2004 Deed of Trust. Second, the Court agreed with defendant’s argument that equitable subrogation does not apply because plaintiff’s predecessor was aware of defendant’s lien “and failed to take proper steps to ensure that it was satisfied and released.” Equitable subrogation generally only applies when one fully discharges a debt secured by a mortgage; here, because the Court found that plaintiff’s predecessor in interest did not fully discharge the obligation secured by the HELOC Deed of Trust, equitable subrogation does not apply and the HELOC Deed of Trust retained priority over the 2005 Deed of Trust for any amount above $384,040.34.