The Court of Appeals last month in BAC HOME LOANS SERVICING LP v SEMPER INVESTMENTS (March 22, 2012), gave additional guidance on the rules and boundaries of equitable subrogation where lienholders dispute each other’s priority position to be paid,

Russo defaulted on a loan from Semper, triggering that lender’s trustee’s sale. BAC sued for an injunction to prevent Semper’s trustee’s sale and for a declaration that BAC’s loan had priority position. The trial court granted summary judgment in favor of BAC, concluding that BAC’s loan had first priority under the doctrine of equitable subrogation and that Semper’s loan was in second place. Semper appealed. The Court of Appeals held that equitable subrogation applied and that Semper failed to identify any genuine issue of material fact to merit a different result.

Under the doctrine of equitable subrogation, a subsequent lender who applies funds to a “primary and superior encumbrance” can be substituted “in the priority position of the primary lienholder, despite the recording of an intervening lien.” The doctrine may apply if, among other requirements, intervening claimants do not suffer prejudice. Semper argued all sorts of factors would cause it prejudice if BAC was declared senior to its lien, but to no avail. First, Semper argued that subrogation would be prejudicial because the new loan with BAC had a different interest rate than the earlier 2004 First Magnus loan which was assigned to Semper and the 2005 home equity loan. The Countrywide/ BAC loan had a fixed interest rate, and the subrogated loans had variable rates which could be lower than the fixed rate.

Second, other differences in loan terms and conditions increased the cost of the new loan. Semper claimed that in these circumstances, Russo was more likely to default under the new BAC loan than the original loans, thereby prejudicing Semper’s ability to be repaid. The Court explained that higher interest rates for the later loan could affect subrogation. For example, a much higher rate would increase the amount of the first-priority loan at a trustee’s sale, thus reducing the amount the intervening, second-priority lienholder could recover from the sale. But, citing the Restatement Third of Property dealing with mortgages, the Court held that because the original loans to Russo had a variable interest rate and the new loan’s fixed-rate is within the variable “range,” there was no prejudice sufficient to overcome the doctrine of subrogation.

BAC reminded the Court that Semper (its predecessor, really) had considered and accepted the risk of a higher rate because the variable rate of the original loan could be substantially higher than the new fixed rate.

The Court also affirmed that “notice is not an element of equitable subrogation under Arizona law” citing Lamb Excavation, Inc. v. Chase Manhattan Mortgage. Corp., 208 Ariz. 478, 95 P.3d 542, 548 (App. 2004). The relevant inquiry for the Court was whether “actual prejudice to an intervening lienholder” occurred, not whether notice might have caused the intervening lienholder to behave differently. Interestingly, the Court said that BAC’s priority under the equitable subrogation doctrine extended only to those funds BAC supplied “to satisfy the priority liens,” and any funds reducing those liens obtained from other sources were not to be used to BAC’s credit.