Replacement and Equitable Subrogation for Lienholders

There are two notable exceptions to the general rule of priority for deeds of trust, “first in time, first in right.” Both exceptions were discussed in US Bank, N.A. v. JPMorgan Chase Bank, N.A.,  242 Ariz. 502, 398 P.3d 118 (June 29, 2017).

The Loepers had both a home equity line of credit (“HELOC”) and a deed of trust from First Magnus Financial Corporation (“FMF Deed of Trust”). The HELOC was first in time, but the lienholder agreed to subordinate their interest to the FMF Deed of Trust. Therefore, the FMF Deed of Trust had priority.

The Loepers later executed a new note and deed of trust in favor of FMF, using the proceeds to pay off the old FMF note. They also used proceeds from this loan to pay off the HELOC. However, the $211,148.30 allocated to pay off the HELOC was short of the full amount required to pay off the loan by $3,452.13. The holder of the HELOC deed of trust notified the title company of the shortfall, but no action was taken to correct it, and the HELOC Deed of Trust was not released. The Loepers then continued to take advances on the HELOC.

After the Loepers defaulted on the FMF note, both lienholders sued to determine lien priorities. The court stated that the replacement doctrine was used when the senior mortgage is released and replaced with a new mortgage. The new mortgage retains the same priority as the old mortgage, but only to the extent of the balance of the old mortgage. The junior lienholder is not prejudiced because they retain the same position they were in previously.

Here, the new FMF note replaced the old FMF note, and retained its priority to the extent of the balance of the old note.

Equitable subrogation could also apply in this case because the proceeds from the new FMF note were used to pay off the HELOC balance. This would effectively give the FMF Deed of Trust priority beyond the balance of the old FMF note. However, the court would only apply equitable subrogation if the entire obligation of the HELOC was discharged. Because the full balance was not paid off, the court would not apply equitable subrogation and divide the lienholder’s rights. Equitable subrogation is therefore an all-or-nothing doctrine, and the HELOC retained priority beyond the balance of the original FMF Deed of Trust.

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