Eric E. Lenzen
Friday, November 02, 2007

Equitable Subrogation – You Can’t Always Get What You Want

Equitable Subrogation is a doctrine whereby one who pays off the mortgage obligation of another is treated as the beneficial owner of that original obligation. The doctrine of equitable subrogation, which is based upon principles of equity and objective fairness, is often employed to preserve the priority rights of a first lien holder. The general rule is simple: when the proceeds from one mortgagee’s loan are utilized to satisfy the outstanding obligations under an earlier mortgage, equitable subrogation affords such second mortgagee the right to be substituted into the position of the earlier mortgagee and afforded priority over subsequent liens and creditors, to the extent it satisfied the earlier debt.
Until recently, decisions of Wisconsin Courts applying the doctrine of equitable subrogation have been reasonably predictable. On October 10, 2007, the Wisconsin Court of Appeals issued an opinion in the case of Countrywide Home Loans v. Schmidt et al. The outcome and rationale advanced in Countrywide calls into question the future consistency of application of this doctrine.

The pertinent facts of Countrywide are as follows: In February 2004, Countrywide, a residential mortgage lender, lent Schmidt $360,000 secured by a mortgage on Schmidt’s residence. Unbeknownst to Countrywide, in September 2003, prior to the date of the Countrywide loan, Schmidt entered into a contract to sell the residence to Mayer for $300,000. Schmidt attempted to rescind his contract with Mayer, but Mayer brought an action for specific performance of the contract and thereafter filed a lis pendens on the property. After receiving the proceeds of the Countrywide loan, but nonetheless during the pendency of Mayer’s court action, Schmidt used a portion of the $360,000 borrowed from Countrywide to satisfy two older existing mortgages on the property from 2002, with principal balances totaling approximately $260,000 in the aggregate.

Eventually, when the dust settled and Countrywide regained consciousness, Countrywide realized that because Mayer had entered into a contract with and brought a civil action against Schmidt prior to Schmidt entering into the mortgage arrangement with Countywide, Mayer’s claim on the property held a priority position vis-à-vis its own claim as a mortgagee. Naturally, Countrywide argued the doctrine of equitable subrogation. Countrywide argued that because the proceeds of its loan to Schmidt were used to satisfy two existing first lien mortgages on the property, it should hold the pole position in the lien race for a minimum of $320,000 of the $360,000 loan (the $260,000 principal balance of the existing mortgages plus interest, taxes, and insurance also paid with the Countrywide loan proceeds). Unfortunately for Countrywide, both the Circuit Court and the District II Court of
Appeals disagreed.
The Court concluded that, under the doctrine of equitable subrogation, Countrywide was entitled to recoup from Mayer only the $260,000 expended to satisfy the existing mortgages. The Court focused on the fact that, in essence, Mayer, through her purchase of the property, would be the party satisfying Countrywide’s lien on the residence and, as such, thoughtfully weighed the inequity of allowing Countrywide to recover $320,000 when Mayer had contracted to purchase the property for only $300,000. The Court did, however, grant Countrywide the cold comfort of being able to pursue Schmidt for the deficiency. According to the Court, “equitable subrogation is a creature of equity, the object of which is to do substantial justice independent of form or contract relation between the parties.”
In furtherance of its quest to do substantial justice, the Court disregarded the details of the loan agreement between Countrywide and Schmidt. Perhaps this was a result of Mayer’s apparent blamelessness in the situation? Perhaps it was to teach a lesson in basic pre-loan due diligence to Countrywide? Whatever the true reasoning behind the decision, the Court, after weighing the conflicting interests of Mayer and Countrywide, elected to split the baby, and Countrywide ended up with the undesirable half.
The general proposition remains true in Wisconsin that an equitable subrogee “steps into the shoes” of the original lien holder and is therefore entitled to receive whatever that original lien holder would have received had the original debt not been satisfied; however, Countrywide demonstrates that Wisconsin Courts will not hesitate to reach conclusions by balancing what they perceive to be the attendant equities and rendering judgments anchored in large measure by objective fairness. As Countrywide learned, you can’t always get what you want. While a legally operative contract may afford a party a solid foundation for its position in a civil action in law, equitable subrogation is an action in equity and, in equity, courts have significant discretion to determine the specific manner in which they “do substantial justice.”
This article appeared in the Fall 2007 Edition of The Real Deal, Presented by the Real Estate Practice Group at Whyte Hirschboeck Dudek S.C.

Related Practice Areas:

Commercial Real Estate