Subrogee entitled to priority up to the amount actually paid to the prior lienholder and not just the principal amount of the prior lien.

AS1, LLC v. Celtic Home Solutions, LLC, et al., 2022 IL.App (1st) 220485 (December 23, 2022)

This case involved a dispute between competing lienholders regarding the application of conventional and equitable subrogation to the priority of their respective liens.

TruProperty Investments (TruProperty) and Celtic Homes Solutions (Celtic), two limited liability companies, purchased property from Paffrath, the titleholder, and executed a purchase-money mortgage to Paffrath. A year later, TruProperty conveyed its interest to Celtic, who executed a mortgage to AS 1, which mortgage was used to pay off the original mortgage to Paffrath, who issued a release. Concurrently, Celtic also executed a junior mortgage to Paffrath. All the documents from this refinance transaction were recorded a month after the closing.

Just prior to the recording of the refinance documents but after the recording of the original Paffrath mortgage, two judgments totaling approximately $135,000 were recorded against TruProperty. Several months later, Celtic defaulted on its loans from AS 1 and Paffrath, and AS 1 filed foreclosure proceedings, naming Celtic, Paffrath, and the two judgment creditors as defendants and claiming priority over all other interests.

The AS 1 mortgage contained a provision that upon payment of any lien or encumbrance on the property, AS 1 would be subrogated to "…any rights, equal or superior titles, liens and equities, owned or claimed by any owner or holder of said outstanding liens, charges and indebtedness…" whether acquired by assignment or that are released of record upon payment thereof. AS 1 claimed priority based upon both this conventional subrogation and under equitable subrogation.

The court set forth the requirements to obtain conventional subrogation:

A new lender seeking to be subrogated in lien priority when refinancing must demonstrate (1) there is an express agreement providing that the new lender will be able to assert the rights of the original creditor, (2) the previous debt was in fact paid off by the new lender, (3) no harm will come to an innocent party if priority is granted to the lender, and (4) there was no gross negligence.

After finding that the subrogation to AS 1's mortgage satisfied these requirements, the court then addressed the judgment creditors' argument that AS 1 was subrogated to only the principal amount of the original Paffrath mortgage. Citing Aames Capital Corp. v. Interstate Bank of Lake Forest, 315 Ill,App.3d 700 (2000), the creditors argued that the Aames court's language that the refinancing mortgagee is entitled to priority "…up to the amount that the original mortgage secured at the time of its perfection" meant that priority is granted for only the principal amount stated in the original mortgage, i.e., "at the time of its perfection" meant the amount of the lien at the date the original mortgage was recorded. AS 1 countered that the "time of its perfection" meant the time that the refinance mortgage was recorded.

Acknowledging that the Aames decision on this point is ambiguous, the AS 1 court noted that the value of a mortgage lien is fixed "…for only the fleeting moment when it is executed," and that even a day later, interest has accrued, thereby increasing the amount of the lien; likewise, over time, payments made by the borrower will reduce the amount of the lien. Reviewing decisions from other courts, the AS 1 court concluded that in order to give the refinance lender the benefit of its bargain, it must be given priority for the amount due on the prior lien at the time of the refinancing.

Finding that its decision regarding conventional subrogation was sufficient to resolve the priority issue, the AS 1 court found it unnecessary to determine whether equitable subrogation applied to the facts of the case.