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Who’s on First: Mortgage Priority in Refinancing Situations

by Natalie Lorenz, Associate

A scenario that often arises when a bank refinances a customer’s mortgage from a different lender is that intervening liens have been placed on the mortgaged property.  For example, a customer purchases property for $200,000 with a loan from Bank A, which obtains a mortgage on the property in the same amount.  Then the customer obtains a second loan for $50,000 from Bank B to pay for her son’s education, and gives Bank B a lien on the same property as collateral.  After a few years, the customer decides to go to Bank C to refinance the loan from Bank A.  Bank A’s loan is paid off, and its mortgage is released, and Bank C then obtains a mortgage on the property instead.  However, Bank B’s lien remains on the property.

In this scenario, what happens if the customer defaults on Bank C’s loan, and foreclosure proceedings begin?  Will Bank B or C have priority over the proceeds once the property is sold?

The general rule is that the first-recorded lien has priority, and therefore, Bank B would be first in line to receive foreclosure proceeds (up to the amount of its lien).  Bank C must either pay off Bank B’s loan or obtain a subordination agreement from Bank B in order to achieve priority over Bank B.

In a case titled PBEI Holdings v. First National Bank of Dieterich, the attorneys at Mathis, Marifian & Richter recently represented a bank in the same position as Bank B (FNB Dieterich) before the Illinois Appellate Court.  Another bank in a similar position to Bank C in the above scenario (PBEI) attempted to gain priority over FNB Dieterich after it refinanced a mortgage, without first having paid off FNB Dieterich’s intervening loan and without having obtained a subordination agreement from FNB Dieterich.

PBEI argued that it could “step into the shoes” of Bank A and claim priority over foreclosure proceeds, even though FNB Dieterich’s lien came before PBEI’s.  PBEI argued that under the doctrines of conventional and equitable subrogation, it took over Bank A’s priority position simply because PBEI refinanced  Bank A’s loan.  The appellate court, however, agreed with Mathis, Marifian & Richter that refinancing by itself is not enough.  The court held that PBEI could not step into Bank A’s shoes because PBEI knew of FNB Dieterich’s intervening lien, yet did not take any steps to achieve priority over it, nor demonstrate any intention or expectation that it would achieve priority over it.  You can read the court’s opinion here: http://www.illinoiscourts.gov/R23_Orders/AppellateCourt/2015/4thDistrict/4140850_R23.pdf.

The attorneys at Mathis, Marifian & Richter have banking law experience, and look forward to helping your company avoid disputes such as this one with careful planning and drafting.  We are also here to help your company defend its interests in the event a dispute arises.

Natalie Lorenz is an associate in the Belleville office.  She specializes her practice in commercial litigation, wrongful discharge, premises liability, worker's compensation, medical malpractice, personal injury, appellate practice, civil litigation, employment law, administrative law, discrimination, construction law.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.

 

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