Lienholders can partially subordinate by contract

Mortgagee Wells Fargo could subordinate its first-priority lien to its third-priority lien on secured property, without thereby moving the second-priority lien to first position, the court held.

Defendant Milton H. Cortez obtained two loans to purchase a home in 2005. The first loan was with Wells Fargo for $415,000 (deed of trust recorded September 23, 2005), and the second was with SunTrust for $220,000 (deed of trust recorded September 30, 2005). About a year later, Cortez took out a third loan secured by the property, again with Wells Fargo and this time for $252,007.  Immediately after the third loan was recorded, Wells Fargo executed a Subordination Agreement providing that its second lien would have a prior and superior right to its first lien.

Cortez defaulted on payments to SunTrust, and the property was sold at a public auction to Cross-Claimant Futuri Real Estate Inc. for $468,000. The SunTrust loan was paid in full, but Futuri now contends that the property it purchased is not encumbered by either of Wells Fargo’s liens.

Lien subordination

This case seems to present an issue of first impression in Virginia, namely whether a lienholder can subordinate its first-priority lien to one of its subsequent liens without waiving such priority with respect to any other liens or as to third-party claims. This court holds that partial subordination clauses in agreements are permitted and enforceable in Virginia and do not have the unintended effect of waiver of priority or security with respect to other liens.

Virginia is a “race-notice” jurisdiction. Thus, a first-priority lien statutorily survives foreclosure by an inferior lienholder to whom it is not subordinated. Foreclosure dislodges only inferior liens from their secured position. But a subordination clause or agreement may change the order of priority. Virginia courts have held that it is inappropriate to follow the order of recording if doing so contradicts the parties’ intentions as to priority as evident in their contract.

Here, the Subordination Agreement makes it clear that is it an agreement between and for the benefit of Wells Fargo. Contrary to Futuri’s argument, the Agreement does not provide a basis to argue that Wells Fargo intended to subordinate its interest in the property to SunTrust. The Agreement provides, in relevant part: “Now, therefore, for good and valuable consideration, the receipt of which is hereby acknowledged, [Wells Fargo] hereby agrees that the lien of the Original Security Instrument is subordinate and junior to the lien of the Subsequent Security Instrument and that the lien of the Subsequent Security Instrument shall also have a prior and superior right over the lien of the Original Security Instrument.” No other liens are mentioned. The intent of the parties in the Agreement is clear.

The purpose of Wells Fargo subordinating its first-priority to its third-priority lien is to enhance the collectability of its loans by ensuring that, in the event of a foreclosure of the SunTrust (second-priority) loan, both Wells Fargo loans would remain secured by the subject property. Thus, the Agreement prevents the deficiency of Wells Fargo’s second loan from becoming unsecured in the event of foreclosure, while maintaining full recourse against the property for the entire amount of both outstanding unsatisfied loans. The second Wells Fargo loan amount thus gains first-priority position.

The court rejects Futuri’s view that, after foreclosure, both Wells Fargo liens are now unsecured. This view would make Futuri the third-party beneficiary of a windfall of the discharge of the secured liens totaling $465,353.29, a circumstance for which there is no evidence the loan-contracting parties intended.

Although a more careful drafting of the Agreement could have made Wells Fargo’s intentions clearer, imperfect drafting does not provide a reason for the court to overlook the obvious intent of the parties to the Agreement. It was plainly meant to impact only the two liens it expressly references.

As to whether Wells Fargo waived the priority of its original lien with respect to third-party liens, the rule of partial subordination is followed in a majority of states. Partial subordination means that the alteration of the lien priority between the first and third lienholders has no effect on the second priority lienholder. As SunTrust has already been paid in full via foreclosure proceeds, applying the partial-subordination approach to this case will impact only whether liens remain on the property Futuri purchased (and the order of distribution of remaining proceeds).

The court holds that Virginia law is in harmony with the majority view of other states. The Wells Fargo Subordination Agreement thus resulted in only a partial subordination of its first-priority lien to its own inferior lien, did not result in subordination to any other lien, and did not waive the secured status of Wells Fargo’s first lien by tis subordination to its second lien. The court will not give an unintended windfall to Futuri in overlooking the obvious intent of the parties.

Atlantic Trustee Servs. LLC v. Cortez, Case No. CL-2017-8414, Jan. 10, 2018; Fairfax Cir. Ct. (Bernhard). VLW No. 018-8-001, 22 pp.