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June 4, 2018

Lien Priority Matters

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Lien Priority Matters

When it comes to liens, California has adopted a "first in time, first in right" system of priorities. As authors Miller and Starr, the widely-acknowledged gurus of California real estate law, put it, liens, "have relative priorities among themselves according to the time of their creation." California Civil Code 2897 says, "Other things being equal, different liens upon the same property have priority according to the time of their creation." That is why people who make private loans, secured by trust deeds, are encouraged to record that instrument ASAP. Someone who waits a month, a week, or even a day to record a trust deed may find that someone else has recorded another, on the same property, during that intervening time. The second person now has lien priority over the first. If the second person ever had to foreclose, the first person could be wiped out.

Though, as we can learn from a recent appellate case (MTC Financial v. Nationstar Mortgage, First Appellate District Court of Appeal, Jan. 22, 2018) it can still get complicated.

In 2003 a borrower obtained two loans from Countrywide Home Loans, Inc. Each loan was secured by the same residential property. One loan was a standard residential mortgage in the principal amount of $205,080. The other was a home equity line of credit (HELOC) for $15,000. This transaction was done as a refinance of an existing Countrywide first trust deed in the amount of $173,000.

The two new loans were secured by deeds of trust. Those two instruments were recorded the same day, Dec. 16, 2003. As is quite common, they were both stamped as deposited in the Recorder's office at 8:00 A.M. on that day. (As, no doubt, were a number of other documents unrelated to this transaction.) The only difference between the Recorder's Office treatment of the two was that the equity line was indexed as number 2003-0603657 and the mortgage was indexed as 2003-0603658.

Subsequently, the equity line was assigned to Bank of New York Mellon and the mortgage was assigned to Nationstar. Alas, the borrower ultimately defaulted on the equity line. The Bank of New York Mellon foreclosed. Apparently, by then, the value of the home had increased. After payment of all the funds due the Bank, plus the fees and costs of the foreclosure auction, there was a remaining surplus of $73,085. So, who should get that?

California Civil Code 2924 spells out how the proceeds of a trustee's auction foreclosure sale are to be distributed. First, to the cost and expenses of conducting the sale; second, to payment of the obligations which were the subject of the sale; third, to the outstanding balance of any junior liens in the order of their priority; and, finally, if there's anything left, to the borrower.

Three parties made claim to the surplus: the borrower, a homeowner association (a junior lien holder), and Nationstar. The trial court ordered distribution of $13,572 to the HOA, and the balance to the borrower. Nationstar appealed.

Nationstar argued that, according to the indexing numbers, it was junior to the equity line and, per the distribution priorities listed above, it was first in line to receive any of the surplus. But the appellate court said "no". In its decision it pointed to a 1936 California Supreme Court case where the Court said, if deeds of trust "were filed at the same time or in their proper order and the reverse order of recordation was an inadvertence, that mistake … should not be permitted to alter the intended relation of the parties … where an examination of the recorded documents would provide notice of the true priorities." In 2011 another appellate court held it "would disrupt the statutory scheme to make priority turn on the random act of indexing … especially where banks and title insurers have no influence over when the recorder indexes trust deeds."

It's really curious. Nationstar took the position that it deserved the $73,000 surplus because its $205,000 mortgage had been wiped out due to the equity line's seniority. The Court said, "No, you were in senior position. You weren't wiped out. Your loan is still secured. The buyer at auction is taking the property subject to your mortgage." Nationstar should be happy with that result.

The foreclosure auction buyer, on the other hand, may be less than happy. We don't know. The buyer was not a party to any of these legal actions. We just have to hope he wasn't relying on a real estate agent telling him that the Nationstar loan would be gone.

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