What You Need to Know

• Equitable Subrogation Doctrine: MidFirst reaffirms the principle that a lender who pays off a prior mortgage may be subrogated to the rights of the original lender, effectively stepping into their shoes in terms of lien priority.
• Court's Focus on Facts: This case underscores that decisions about equitable subrogation depend on the facts of the case. The Court remanded the case to the trial court to determine whether Nationstar was "culpably negligent" by failing to notice the recorded judgment lien
• Importance of Due Diligence: The Court highlighted that the refinancing lender failed to provide evidence of performing a title search or obtaining a credit report. This raised concerns of negligence, which could potentially impact the application of equitable subrogation.

Introduction

In a decision from the Supreme Court of North Carolina, the Court considered the principle of equitable subrogation in the context of a pre-existing, unrelated judgment against a mortgager that attested to there being no outstanding liens at the time of the mortgage. The issue considered by the Court was whether the mortgagee’s successor was entitled to equitable subrogation following an execution sale to satisfy the prior judgment. MidFirst Bank v. Brown, 386 N.C. 103 (2024).

Background

In 2000, Brown took title to the subject property in Charlotte, North Carolina (the “Property”). In 2004, Brown obtained a loan from First Horizon Home Loan (the “First Horizon Loan”) in the amount of $265,100.00 secured by a recorded deed of trust. In 2010, an unrelated judgment in South Carolina was entered against Brown, and subsequently domesticated by United General Title Insurance Company (“United”) and recorded in Mecklenburg County, North Carolina.

In 2016, Brown refinanced the First Horizon Loan by mortgaging the Property with Nationstar Mortgage LLC (“Nationstar”). Under the terms of this agreement, Nationstar paid off the remainder of the First Horizon Loan in the amount of $219,873.01, and Brown affirmed that there were no outstanding liens. The deed of trust for the Nationstar loan was subsequently recorded. Plaintiff MidFirst Bank was Nationstar’s successor in interest for the 2016 loan.

In 2019, United began enforcement proceedings against Brown to collect the South Carolina judgment. The Mecklenburg County Sheriff’s Office seized the Property and held an execution sale. Brown’s daughter successfully bid $102,900 in satisfaction of the United judgment. Brown continued to reside at the subject property.

MidFirst Bank filed a complaint seeking to quiet title via declaratory judgment, alleging that the Nationstar deed of trust continued to encumber the subject property after the execution sale. Alternatively, MidFirst Bank argued that the doctrine of equitable subrogation applied to subrogate Nationstar to the rights and priorities of the First Horizon deed of trust.

Defendant and MidFirst Bank filed cross motions for summary judgment. The trial court granted MidFirst Bank’s motion. On appeal, the Court of Appeals held that equitable subrogation was not available to MidFirst Bank, and the Bank filed a petition for discretionary review with the Supreme Court seeking review of this issue.

The Decision

In its discretionary review, the Supreme Court noted that the rule of equitable subrogation was “settled”:

[W]here money is expressly advanced in order to extinguish a prior encumbrance, and is used for this purpose, . . . the lender or mortgagee may be subrogated to the rights of the prior encumbrancer whose claim he has satisfied .... Also, if the money is advanced to a debtor to discharge an existing first mortgage upon his property, and in pursuance of an agreement that the lender is to have a first lien upon the property for the repayment of the sum loaned, the lender is entitled, as against a junior encumbrancer, to be treated as the assignee of the first mortgage which has been paid off and discharged with the money loaned, whenever it becomes necessary to do so to effectuate the agreement with the lender, and to prevent the junior encumbrance from being raised accidentally to the dignity of a first lien, contrary to the intention of the parties.

Additionally, the Supreme Court noted three exceptions that exist to the general rule, where equitable subrogation will not be granted to: (1) a “volunteer”, and (2) a party “guilty of culpable negligence”, and (3) where it would prejudice the junior lien holder.

Since it was undisputed that the Nationstar loan was provided to Brown on the condition that it be used to pay off the First Horizon Loan and Nationstar in fact did so, equitable subrogation clearly applied. Therefore, the Supreme Court considered whether any of the aforementioned exceptions applied.

Since payoff of the First Horizon Loan was a condition of the refinancing loan, Nationstar was not a volunteer. Concerning the third exception, the Court noted that in this instance, the lower court should consider that United’s lien had been satisfied. Thus, the only party prejudiced would have been the debtor Brown’s daughter if MidFirst Bank’s lien was sustained up to the amount paid to satisfy the prior mortgage.

Regarding the second exception, the Supreme Court noted it was “extremely concerning” that Nationstar failed to produce any evidence that a title search was conducted or that a credit report was obtained. However, (1) Brown had attested to there being no other liens encumbering the Property, (2) his daughter purchased the Property at the execution sale for an amount substantially less than the amount owed under the Nationstar loan, and (3) Brown still lived on the Property. Ultimately, however, the Court held that a determination of whether Nationstar was culpably negligent for failing to be aware of the recorded United lien and the resulting displacement of their intended first lien priority, was a fact-intensive inquiry and remanded it to the trial court for reassessment. As framed by the Supreme Court, the critical question on remand was whether Nationstar acted with the degree of care of a lender of ordinary prudence under the circumstances.

Takeaways

This highlights the application of equitable subrogation in property disputes and a trial court's role in balancing equities when conducting the required fact-sensitive analysis. Per the North Carolina Supreme Court, the equitable subrogation doctrine clearly applied, subject to application of exceptions on remand. The Court also guided the lower court’s analysis on remand; noting that it should take into account that the mortgagor’s application failed to disclose the existence of a prior lien and that his own daughter purchased the property at a discounted price at the subsequent execution sale, but also that the plaintiff failed to produce evidence of having conducted a title search. Accordingly, the case confirms the obvious: the importance of searching the underlying record for preexisting liens or encumbrances not voluntarily disclosed. At the same time, it signals that courts will not allow a debtor to willfully fail to disclose liens in loan applications and then seize on mistakes made by the lender based on that non-disclosure.

For a copy of the decision, please contact Michael O’Donnell at modonnell@riker.com, Matthews Florez at mflorez@riker.com, Kori Pruett at kpruett@riker.com or Shelley Wu at swu@riker.com.