Mortgages

Gibson v Neu, 867 NE2d 188 (In Ct App 2007).

Facts: John Nowak executed a first-priority mortgage on his residence in favor of Irwin Mortgage Corp. (Irwin). Subsequently, Nowak bought stock from Brett Gibson. Nowak executed a promissory note of $350,000 and a second mortgage on Nowak's residence in Gibson's favor. Gibson recorded the mortgage. The note required Nowak to pay Gibson $7,000 each month. It provided that if Nowak defaulted on a payment, then Gibson could immediately foreclose on the mortgage. The mortgage documents stated that Gibson was required to release the mortgage if Nowak decided to sell his residence and had not defaulted on his payments.

Nowak defaulted on several payments. When he was $500 behind on payments, he sold his residence to Thomas and Elizabeth Neu. The Neus borrowed $200,000 from Washington Mutual Bank (Washington Mutual) and executed a mortgage on the property in Washington Mutual's favor so that they could pay Nowak $600,000 for the residence. Of that, $506,016.34 was used to satisfy the Irwin mortgage. A title company performed a title search on the property before the sale but did not discover Gibson's mortgage. Nowak did not inform Gibson of the sale and continued to default on his payments after it occurred.

Gibson then sought to foreclose on his mortgage, and Nowak filed for bankruptcy. The trial court found that Gibson should have released his mortgage when Nowak sold the residence to the Neus because Nowak was in substantial compliance with the terms of the parties' contract at that time. In addition, the court held that the Neu mortgage was a first-priority lien on the property under the doctrine of equitable subrogation.

Holding: Affirmed in part, reversed in part, and remanded. Gibson was not required to release his mortgage when Nowak sold the residence. The parties agreed that Gibson could foreclose on the mortgage without notice if Nowak defaulted on his loan payments. Nowak repeatedly defaulted on the loan and was behind in his payments at the time of the sale. It is irrelevant whether Nowak was in substantial compliance with the contract's terms because the doctrine of substantial performance applies only when a party fails to perform a nonessential condition to a contract. Nowak's payments to Gibson were an essential condition of the parties' agreement.

However, the Neus have a first-priority lien on Nowak's property under the doctrine of equitable subrogation. The doctrine allows a mortgagee to assert the rights of a prior lien-holder whose debt the mortgagee satisfies. In Indiana, equitable subrogation applies when the refinancing mortgagee satisfies the entire debt of the prior lien-holder and certain other conditions are met. First, the mortgagee must not be acting in the capacity of a mere volunteer. Rather, the mortgagee must have a direct interest in discharging the debt. The Neus had a direct interest in satisfying the Irwin mortgage "to protect their rights to [] [Nowak's] property." Thus, they did not act as mere volunteers.

Second, equitable subrogation applies only when application would be equitable. Courts consider a number of factors, none dispositive, to determine whether application would be equitable. One such factor is whether the mortgagee expected to obtain a security interest in the property when the mortgagee satisfied the prior lien. Both parties concede that although Washington mutual had such an expectation, the Neus did not. However, another factor courts consider is whether any intervening lien-holders would be prejudiced by application of the doctrine. If the doctrine were applied in this case, then Gibson would remain in the same position that he was in before Nowak sold the property to the Neus. At that time, his mortgage was junior to the Irwin mortgage. Thus, Gibson would not be prejudiced by application of the doctrine. In fact, if the doctrine were not applied, then Gibson would receive a windfall. It should be noted that yet another factor courts consider is whether the mortgagee was "culpably negligent in failing to learn" of an intervening lien.

Third, equitable subrogation may not apply if the mortgagee had actual knowledge of an intervening lien at the time the mortgagee satisfied the prior lien. The Indiana Supreme Court has suggested that such knowledge may be relevant in situations, such as the present one, not involving a traditional refinancing. However, in this case the Neus had only constructive notice of the Gibson mortgage. Such knowledge is never a bar to equitable subrogation.

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