• December 12, 2009

In Minnesota, as in many states nationwide, the priority of loans secured by mortgages on real property is normally determined by the order in which the mortgages are recorded.

But what if the first-in-time mortgage is recorded second through some foul-up or delay for which the first-in-time mortgage is perhaps not completely blameworthy (or worse, if the first-in-time mortgage is not recorded first through some kind of trickery foisted upon it)?

As old as the rule of priority under the recording act, the doctrine of equitable subordination has evolved — that is, a rule that the normal rule does not apply.

Pending before the Minnesota Supreme Court and argued on December 8, is Citizens State Bank (“CSB”) vs. Raven Trading Partners, LLC, (“RTP”) et al., Respondents – Case No. A08-1560. CSB’s mortgage was first in time but, due to an error in the recording process and related delay, RTP’s mortgage would, according to the recording statute, have priority.

The district court issued an order equitably subordinating the mortgage in favor of RTP to the mortgage in favor of CSB. The court of appeals reversed. On appeal to the Minnesota Supreme Court, the question is whether the RTP mortgage should be equitably subordinated to the CSB mortgage.

At oral argument, the Minnesota Supreme Court was tough on Michael Brutlag, counsel for CSB asking at length, in essence, “What kinds are screw-ups should the lender be held to, versus what kind should we let them off the hook for?”

The Court was as or more tough on Daniel Stauner, counsel for RTP, focusing intensely on how RTP would be harmed by the application of equitable subordination in this case because, apparently, the CSB loan refinanced to two prior mortgages so RTP knew or should have known its mortgage was junior to a lien in the same dollar amount, just not the CSB loan. RTP counsel argued that there would have been a meaningful distinction between the CSB lien (a “new” refinance) and the preexisting two liens (two “seasoned” loans).

An underlying issue: what degree of deference, if any, is owed to the district court in its exercise of discretion in circumstances such as these?

The case is very close.  A bright-line priority rule and placing the cost of error on the dilatory party (CSB discovered an error the delayed recording but took about two months to fix it), has obvious advantages and would support affirmance of the Court of Appeals.  On the other hand, RTP’s not entirely compelling explanation of how RTP would be prejudiced by the application of equitable subordination in this case plus deference owed to the trial court in its exercise of discretion could result in reversal of the intermediate court’s decision.

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