RPLR March 2018

                                                                                Uncertain Recording Act Priority

                                                                                          Roger Bernhardt

Introduction

Our real estate recording act makes priority depend not only on the objective question of which of two rival interests was recorded first, but also on the subjective consideration of the equities of one of the parties (usually the one who took second but recorded first)—i.e., on whether she gave value or was without notice of the other (was “in good faith”). Thus, CC §1214 provides “[e]very conveyance of real property ... is void as against any subsequent purchaser or mortgagee of the same property ... in good faith and for a valuable consideration, whose conveyance is first duly recorded.” (Emphasis added.) Thus, in California, for B to prevail over A, she must show not only that she recorded before A, but also that she took without notice of A’s unrecorded mortgage. (She must also show that she gave valuable consideration, but since that was not an issue in the case I will be discussing, I will stop referring to that feature.) Just recording first is not enough; under our race-notice statute, B must not only win the race against A but must also be without notice of A. We are willing to permit only good guys (those who took without notice) to win prizes for winning their races.

This extra qualification has costs. Requiring a party to show not only that he won the race (recorded first), but also that he was without notice (including possible actual notice, constructive notice, and inquiry notice) forces a trier of fact to decide not only a simple question (Who got to the finish line first?), but also a more complicated one: Did B have the requisite virtues? Such a requirement also often generates uncertainty (as to the sufficiency of these virtues) and makes it harder for a decider (or an advisor) to assure a party of the certainty of outcome. One has to hedge. Finally, the combination of two such distinct standards causes its own complications, as was revealed in MTC Fin., Inc. v Nationstar Mortgage (2018) 19 CA5th 811 (MTC) (reported at p 44).

MTC

In MTC, one of the secured creditors (Mellon) was the assignee of a $15,000 home equity line of credit (HELOC) that had been executed 10 years earlier by Sparrow, and the other secured creditor (Nationstar) was the assignee of a $205,000 mortgage on the same property. (I will refer to these as the HELOC and the mortgage, to keep them separate. There was also another third party holding a homeowner’s association (HOA) lien, but its rights can be ignored for our purposes here.) Both the HELOC and the mortgage had been executed by the property owner (Sparrow) in favor of the original lender (Countrywide) on the same day.

After the HELOC was in default, its holder, MTC (as trustee under Mellon’s deed of trust), had taken it to trustee sale, selling the property (perhaps to Mellon) for $105,000. After paying Mellon the amount owed to it on the HELOC, and costs of sale, this high bid of $105,000 left MTC with a $73,085 surplus, and it petitioned the court for instructions as to its distribution. The surplus came down to about $59,500 when the court awarded the holder of the HOA lien, as a proper junior, its $13,573 claim. Both Sparrow, as trustor, and Nationstar, as assignee of the mortgage, claimed the $59,500 surplus.

Nationstar’s claim to the surplus from the HELOC sale required that its mortgage be inferior to the HELOC, and thus extinguished by its foreclosure. (Under CC §2924k, Nationstar could not support a claim to the surplus if its mortgage had priority over that HELOC.) Thus Nationstar had to claim that its mortgage was inferior to the HELOC, not prior to it. (More facts are at p 44.)

(Nationstar’s posture was rather counterintuitive. If it had, instead, contended that its mortgage was superior to the HELOC, that position would certainly have destroyed its claim to the $59,500 surplus, but would also have entitled it to recover all or most of the larger amount it was owed on the $205,000 mortgage as a lien that was superior to the HELOC, and therefore unaffected by its foreclosure. It is hard to guess what Nationstar it had in mind with its peculiar strategy.)

Nationstar supported its odd claim of inferiority to the HELOC by showing the following:

·       Sparrow had previously refinanced with Countrywide and had executed both the HELOC and mortgage to it on the same day, without designating the priority either instrument was to have.

·       When the title company had sent both documents to the recorder’s office, on the next day, both were there opened, stamped, and recorded at 8 a.m., but the recorder had entered the HELOC in its books and indexed it first (as document #057), putting it in front of the mortgage (which became document #058).

·       That meant that, technically, the HELOC had been recorded “first.”

If Mellon’s HELOC was prior, then Nationstar’s mortgage was a junior lien, and Nationstar was better entitled to any surplus from the (senior) HELOC trustee sale under CC §2924k than was the trustor, Sparrow (who would only be entitled under that section after all junior liens had been satisfied). On the other hand, if Nationstar’s mortgage was superior to Mellon’s HELOC, then Nationstar could not claim the surplus from an inferior trustee sale under the HELOC that had no effect on its mortgage. So who was the better loser?

How to Determine Priority?

The opinion persuades readers that the court of appeal really wanted to favor Nationstar, probably because HELOCs are always put below their companion mortgages, and the recorder’s ordering of the documents in the records appears to be a fluke. But how to justify rectifying such a mistake? There appeared to be no equities to justify offsetting what the records showed (as is often done when the race has been won by the wrong contestant). Countrywide had recorded both instruments and thus did not look like a competitor who had taken with notice of a rival unrecorded first lien. Being second appeared to be what Countrywide wanted, at least for one of its liens; nor was it still around to testify to the contrary or now able to correct a claimed mistake. Countrywide’s successors—Mellon and Nationstar—were different parties, but both of them were merely assignees of instruments already recorded, and thus with priorities that were already settled. That feature appeared to require any conclusion that the mortgage have priority over the HELOC to be justified on grounds of race rather than of notice or equity. The mortgage would have to be treated as recorded before the HELOC even though appearing after it in the records.

Thus, the court’s explanation for its outcome was that the two instruments had the same “time of creation” of the two liens (relevant under CC §2897) because both had been executed on the same day (although it is unclear why time of creation should matter at all for documents already recorded). Nor were the “dates of recording” of the documents determinative, since both had been deposited at the recorder’s office at the same time, 8 a.m. (This is a very common problem, arising out of our use of overnight and electronic delivery tools, an issue I discussed in my column Living With Tied Priority, 35 CEB RPLR 11 (Jan. 2012), also available on my website, RogerBernhardt.com. Despite the phenomenon of uncertainty as to which envelope should have been opened first, it remains possible to say which was opened before the other, and which could have been found by the one depositing the envelope later opened or the document later indexed, if that were to be made relevant.)

As for the fact that different numbers had been assigned to the two documents (with the HELOC showing a lower (i.e., prior) number over the mortgage), the court advised readers that courts “have consistently held, however, that if two deeds of trust are submitted at the same time for recording, the order in which they are indexed is not determinative of priority.” 19 CA5th at 815 (emphasis added). Even if one likes this result, this is a puzzling explanation. Our supreme court arguably did make a statement something like that in Phelps v American Mtg. Co. (1936) 6 C2d 604, 609, but then took it back in Firato v Tuttle (1957) 48 C2d 136, 138. There is no consistency of holdings that indexing order is irrelevant when documents are submitted together, and I doubt that there is such a rule. Indeed, how would outsiders know whether instruments sequentially numbered had been submitted together or separately? (In First Bank v East W. Bank (2011) 199 CA4th 1309, reported at 35 CEB RPLR 26 (Jan. 2012), when mortgages were left separately in the recorder’s overnight bag by two different lenders, were they “submitted together” so as to fall under this rule?)

Finding those factors (time of creation, date of recording, time of submission, or order of indexing) to be unhelpful, the MTC court held that that result depended on the “apparent intent” of the original parties. “Apparent” seemed to mean that no evidence of any actual intent by Countrywide was necessary, and led to a conclusion that no lender taking two deeds of trust would likely ever want its open-ended HELOC to have priority over its fixed, usually larger, other mortgage. Under such conditions, Nationstar’s mortgage would have been apparently intended to be prior to Mellon’s HELOC, and thus Nationstar would have no claim to any surplus from MTC’s HELOC sale, which would all go to Sparrow.

A BFP?

Nationstar also claimed to have concerns that its mortgage might fail against the purchaser at MTC’s trustee sale—who might later successfully claim to have taken as a bona fide purchaser (BFP) without notice, if a court concluded that the Nationstar mortgage had been extinguished by the HELOC trustee sale. But the court held that such a worry was baseless, because the trustee’s sale guaranty for the HELOC sale had warned potential buyers of other liens, including the Nationstar mortgage, thus depriving such a purchaser of BFP protection. However, that HELOC sale purchaser was not a party to the MTC/Nationstar litigation. The court said (19 CA5th at 817): “Had Nationstar feared inconsistent rulings, it could join the purchaser in these proceedings but it failed to do so,” thus blaming Nationstar for its quandary of “losing” to both MTC and MTC’s purchaser, when one was below it and the other above it.

Omitting an Important Party

Although that quoted sentence about joinder of the trustee sale purchaser came from the final paragraph of the court’s opinion, almost as a throwaway, I do wish the court had said more about the status of that MTC purchaser, as well as other third parties. This might have mattered. The outcome, or at least the logic supporting it, might have changed had the MTC purchaser been a party defending itself in this litigation, or had more attention been paid to the effect of this decision on the rest of the world.

Had the trustee sale purchaser been a party, we might have seen better arguments for the priority of the HELOC, or at least more serious concern as to the ways to correct recording mistakes. There might have been legitimate concern as to how outsiders (all the rest of us) should behave when records appear skewed. These records were designed to create a system on which we all are to rely, such reliance being a value no less important than fairness in a particular case. (Indeed, that is one of the reasons that the UCC prefers a system in which equities do not trump race outcomes; see UCC §9–322.)Every time a court decides that equitable reasons justify ignoring technical priority—e.g., that being without notice is more important than winning the race—the system gets a little weaker and less reliable. A title company or attorney has to tell a client that the records might absolutely show priority in one direction, but equities may dictate going the other way. What position does a searcher take after having unearthed, in the same chain, two material instruments, with each one bearing a same-day recorder’s stamp: Should she trust the recording sequence or must she seek to ascertain the apparent intent of the depositor?

The omission of the trustee sale purchaser from the MTC litigation made it easy for the court to rule as it did. Nationstar probably concluded that it could survive such partial litigation. But I think outside observers would have felt significantly more confident about any new rule regarding same-day (same-hour?) recording priority had that issue been disposed of in a richer context in which all affected parties had participated.

 

41 Real Property Law Reporter 36 (Cal CEB March 2018), © The Regents of the University of California, reprinted with permission of CEB.

 

 

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