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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Priority of Mortgage Liens and Mortgage Fraud

California law incorporates a “race–notice” system of recording liens against real property. Simply stated, the general rule is that the first person to “race” to the county recorder’s office and record his mortgage or conveyance has superior legal title to a person who records an instrument later. California Civil Code §1213 states that recorded documents provide constructive notice to third parties of the interest conveyed by the recorded instrument, thereby preventing anyone with a subsequently recorded interest from obtaining better title to the property from the holder of the current title. The importance of the constructive notice statute is enforced by California Civil Code §1107, which provides that every grant of an estate in real property is conclusive against the grantor, also against everyone subsequently claiming under him, except a purchaser or encumbrancer who in good faith and for a valuable consideration acquires a title or lien by an instrument that is first dully recorded. Civil Code §1214 provides every conveyance of real property is void as against any subsequent purchaser or mortgager of the property in good faith and for valuable consideration whose conveyance is first dully recorded. The importance of Civil Code §1214 is that even an earlier conveyance may not be enforceable against a later conveyance, where the holder of the later conveyance races first to the county recorder’s office to record the mortgage or deed.

A type of fraud sometimes occurs when a property owner applies for multiple loans secured by the same parcel of real property in order to receive loan proceeds that exceed the value of the real property, without each lender knowing about the other prospective loan. The property owner commits fraud by failing to inform each lender that he is in the process of obtaining loans from other lenders secured by the same property. This type of fraud can be difficult to detect due to the delay between the time when the borrower signs a deed of trust placing a lien on his land and the time that the deed of trust is finally processed, delivered to the county recorder, and recorded in the public record of the county recorder.

The innocent lender or the innocent purchaser of the later recorded documents then finds himself in a dispute over which conveyance is valid and enforceable. If a title company conducted the transaction, then a policy of title insurance may provide coverage for the loss to the innocent party. However, often in interfamily transactions or transactions handled informally between persons who are acquainted with one another, an escrow might not be used, and title insurance might not be purchased. The best practice is to engage an attorney or use a reputable escrow holder and obtain an appropriate policy of title insurance in every transaction that involves real property, even as between family members and close business associates.

If you have questions concerning your particular situation, then please call our Salinas office at 831-757-5426 during business hours to schedule a telephone conference or office visit, or complete the adjacent form and we will contact you.

An attorney-client relationship is not created between the client and the law firm until the attorney and client execute a written retainer agreement describing the legal work to be performed.