Subordination of Liens

Generally, a lien upon real property (commonly referred to as a mortgage or deed of trust) has priority according to the date and time of recording of the document with the county recorder of the county where the property is located. The issue of priority is critical, since in the event of a foreclosure of a deed of trust the foreclosure has the effect of extinguishing junior liens, mortgages, and deeds of trust upon the real property. A junior lien means a lien recorded later in time than the first priority or senior lien.

The general rule of “first in time, first in priority” can be altered by use of a subordination agreement. A subordination clause or subordination agreement is used to lower the priority of a first recorded deed of trust or mortgage in favor of a later or junior recorded deed of trust or mortgage. A subordination agreement is typically used when a developer wishes to acquire land and construct improvements, but is unable to obtain a loan from a lender on the security of the land to pay for both the purchase of the land and construction costs. The seller of the land might agree with the developer to subordinate its deed of trust for the unpaid portion of the purchase price to a junior loan to finance construction of the proposed development. There are various statutory requirements for subordination clauses/agreements. (Civil Code §2953.1)

California court decisions have given guidance on the minimum requirements for an enforceable subordination agreement. The agreement must at least specify the maximum principal, maximum interest rate, maximum term, and the mode of repayment of the subordinating loan. A subordination agreement must generally contain terms that define and limit the seller’s risk and do not leave any material terms to a future agreement by the parties.

Other factors may also bear upon the priority of recorded liens; for example, liens for unpaid property taxes are given priority over a deed of trust. (Revenue & Taxation Code §2192.1) Further, under the recording laws, a lien recorded later in time may be given priority if it was recorded before the earlier mortgage or trust deed was acquired, for a valuable consideration and in good faith, without notice of the existence of the unrecorded mortgage or deed of trust. (Civil Code §1214)

Another factor affecting the priority of liens is that the lien created by a mortgage or deed of trust does not come into existence and attach to the real property until the later of (a) the performance of the last act required to make the obligation secured by the mortgage or deed of trust binding on the lender or (b) the recording and delivery of the mortgage or deed of trust to the beneficiary. (Western Loan & Bldg. Company vs. Scheib (1933)) Hence, if a mortgage or deed of trust is given to secure future advances and is recorded before the advances are actually loaned to the borrower/trustor, and if the future advances are required on the part of the beneficiary pursuant to the loan documents, then the lien is deemed to attach to the real property as of the date the deed of trust or mortgage was recorded or delivered. On the other hand, if the making of future advances by the beneficiary is completely optional, then the effect of the lien does not attach to the real property until the date the advances are actually made to the borrower. (Fickling vs. Jackman (1928))

Another exception to the “first in time, first in priority” rule is provided in the case of a purchase-money loan. (Civil Code §2898)  The purpose of the exception is to prevent a deed of trust or mortgage signed by the purchaser, and recorded before delivery of the grant deed from the seller to the buyer, from having priority over the deed of trust or mortgage for the unpaid purchase price of the real property. However, the purchase-money rule is subject to the operation of the recording laws. Therefore, a purchase-money mortgage may not have priority over a later deed of trust given to a lender that gave value, in good faith, without notice of the unrecorded purchase-money lien. (Middlebrook-Anderson Co. vs. Southwest Savings & Loan Association (1971))

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