In a case of first impression, the California Court of Appeal addressed the priority of liens when there is an intervening subordination agreement. [Bratcher v. Buckner, (2001) 90 Cal.App.4th 1177].
The case involved four liens, three of which were deeds of trust and one of which was a judgment. Also, two of the lienholders entered into subordination agreements with another lienholder, giving the latter lien priority.
|Homestead exemption filed in February 1996.|
|Deed of trust in favor of Buckner’s attorneys, filed in March 1976.|
||Deed of trust in favor of Buckner’s parents, filed in March 1976.|
|Abstract of judgment in favor of Bratcher, filed in May 1976.|
||Deed of trust in favor of the SBA, filed in September 1979.|
|Two subordination agreements between lienholders 2 and 3, in which the beneficiaries under Liens 3 and 4 agreed to subordinate in favor of the SBA deed of trust (Lien 5).|
Eventually, Bratcher attempted to enforce lien 4 by forcing a sale of the encumbered property. The property owner, Buckner, objected to the sale, arguing that, because of the subordination agreements, the value of the property was not enough to satisfy Bratcher’s lien. Bratcher in turn argued that the effect of the subordination agreements was to raise his lien to the first position subject only to the homestead exemption. The trial court granted the order to sell and Buckner appealed.
To determine lien priority, the Court reviewed the concept of “circuity of liens” and the general rules governing the interpretation of contracts. The Judge observed that “circuity of lien results because the prior mortgage is displaced by the subordinating lien while apparently retaining its priority of the intervening liens.” This contradictory position is created by the subordination agreement. The lien is superior in that the recording statutes place it in higher priority than Bratchers’ judgment lien, but contractually subordinate to the lien which Bratcher claimed priority over.
First, the Court noted that the subordination agreements stated that Liens 2 and 3 were only to be subordinated to the rights of Lien 5; Lien 4 was not mentioned in either agreement. By applying general rules of interpretation of contracts, the Court looked to the objective intent of the parties. The Court concluded that, by virtue of the subordination agreements, Liens 2 and 3 switched priority places with Lien 5, but only to the extent of the total amount of Liens 2 and 3. Under this rule, Lien 4 would retain its original priority position and Bratcher would not be adversely or beneficially affected by the subordination agreements.
Under this scenario, the Court determined that, when the property is sold, the liens will be satisfied as follows:
To the extent that any money is left over, payment of the remainder of Liens 1 and 2.
This case explains how subordinate lienholders can protect themselves and how to prevent higher priority lienors from doing an “end run” around their lien. The case also demonstrates the risks when secured lenders subordinate to less-than-all lower priority debt. If Bratcher had prevailed, the other lenders would have lost their priority as to Bratcher.