November 24, 2015
by Richard M. Leibert
Hunt Leibert – USFN Member (Connecticut)
In an important ruling, the Connecticut Appellate Court has affirmed the trial court’s application of the doctrine of equitable subrogation in reordering the priority of interests, despite the defendant bank having had constructive notice of the plaintiff’s recorded mortgage. [AJJ Enterprises, LLP v. Herns Jean-Charles, AC 36838 (Conn. App. Ct. Oct. 13, 2015)].
Facts — As sellers, Pascarelli and Bartolo, dba AJJ Enterprises LLP (AJJ), entered into a purchase and sale agreement with Jean-Charles (J-C) to sell 18 Monroe Street, Norwalk, Connecticut for a price of $675,000, with a first mortgage of $500,000 provided by First County Bank. The balance of the price (as well as closing costs advanced by the sellers) was paid through a secured promissory note in the amount of $195,000 to AJJ. The AJJ note was to be secured by a “blanket mortgage on properties that [J-C] owns.” At the time, J-C owned his residence at 10 Carlin Street, Norwalk.
On May 24, 2002 the transaction closed, and the AJJ mortgage was recorded on 18 Monroe and 10 Carlin that same day. AJJ had not done a title search on 10 Carlin; AJJ believed that its mortgage was a second mortgage, as reflected in the promissory note from J-C — ‘“secured by a second mortgage on real property known as 18 Monroe … and 10 Carlin …’” (In fact, at the time the mortgage from J-C to AJJ was recorded, it was subsequent to two mortgages that encumbered 10 Carlin: a first mortgage in the face amount of $288,000 and a second mortgage in the face amount of $30,300.)
At the time of closing with AJJ, J-C had undertaken to refinance his mortgage on 10 Carlin. There were two mortgages being paid off through this 10 Carlin refinance, requiring $314,156.49. Aegis Mortgage Corporation (Aegis) provided the refinancing funds in the amount of $348,000. Aegis intended to hold a first mortgage position. The initial title search carried out by Aegis on May 16, 2002 could not have discovered the AJJ blanket mortgage recorded on May 24, 2002. Aegis closed the loan and its refinancing mortgage was recorded on June 11, 2002 — subsequent to the recording of the AJJ mortgage. The Aegis loan paid off the first and second mortgages, enabling the AJJ mortgage to move into first lien position. This was not discovered until J-C defaulted and a foreclosure was commenced.
Foreclosure as to 18 Monroe — First County commenced a foreclosure on 18 Monroe, with a sale date set for August 16, 2008. Pascarelli and Bartolo, who had personally guaranteed payment, formed JP Asset Management LLC to purchase the First County note and mortgage. JP Asset obtained a judgment of strict foreclosure on 18 Monroe August 2, 2010 (two years later).
Foreclosure as to 10 Carlin — AJJ brought a foreclosure action on 10 Carlin, claiming first position. Aegis (which had assigned its mortgage to Bank of New York Mellon, as trustee for the Amortizing Residential Collateral Trust, mortgage pass-through certificates, series 2002-BC7) defended, claiming by the theory of equitable subrogation that it had a first mortgage. AJJ contended that Aegis had constructive knowledge of the AJJ mortgage when Aegis recorded its mortgage on June 11, 2002 and that Bank of New York Mellon, Trustee (substitute defendant bank in the case), was precluded from obtaining the benefit of equitable subrogation.
The trial court ruled in favor of Bank of New York Mellon, Trustee, and placed its mortgage in first position; AJJ appealed. The appellate court found that the trial court did not abuse its discretion in applying the doctrine of equitable subrogation despite the defendant bank’s constructive knowledge of the plaintiff’s lien. The Connecticut Appellate Court specifically cited to the Restatement (Third), Property, Mortgages § 7.6, comments (e) and (f), (1997):
“‘Under [the] Restatement … subrogation can be granted even if the payor had actual knowledge of the intervening interest; the payor’s notice, actual or constructive, is not necessarily relevant. The question in such cases is whether the payor reasonably expected to get security with a priority equal to the mortgage being paid. Ordinarily, lenders who provide refinancing desire and expect precisely that, even if they are aware of an intervening lien … A refinancing mortgagee should be found to lack such an expectation only where there is affirmative proof that the mortgagee intended to subordinate its mortgage to the intervening interest.’ … “The Restatement is careful to emphasize that the court considering equitable subrogation must be convinced that no injustice will result to the intervening lienholder before applying the doctrine[.] … ‘In virtually all cases in which injustice is found, it flows from a delay by the payor in recording his or her new mortgage … The delay may lead the holder of an intervening interest to take detrimental action in the belief that that interest now has priority.’”
There were no circumstances reflecting that AJJ changed its position in detrimental reliance; moreover AJJ did not bargain for first mortgage position, while Aegis did. The fact that AJJ found itself in first position was due to windfall and not anything for which it negotiated.
The significance of this holding is its effective restatement of three Connecticut Supreme Court holdings, reversing a trend that had occurred at the appellate court level, which — in a series of decisions — appeared to claim that constructive notice of an intervening interest in property served as a per se bar to the application of the doctrine of equitable subrogation.
Editor’s Note: The author’s firm represented the Bank of New York Mellon, as trustee for the Amortizing Residential Collateral Trust, mortgage pass-through certificates, series 2002-BC7 (substitute defendant bank) at the trial and appellate levels in the case summarized in this article.
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