ArrowPoint Federal Credit Union v. Bailey

Second real estate case of the year rejects replacement mortgage doctrine

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SC Supreme Court discards arguments of ALTA and PLTA

Real estate cases can be absent from our Advance Sheets for months, but we have seen two cases already in 2023. In ArrowPoint Federal Credit Union v. Bailey* our Supreme Court was asked to adopt a novel replacement mortgage doctrine, but the Court deflected the question, deferring to the legislature, even though American Land Title Association and Palmetto Land Title Association filed amicus briefs in favor of the doctrine.

This is a real estate mortgage priority dispute between two institutional lenders concerning a residential property in Winnsboro.  Jimmy and Laura Bailey mortgaged their residence at 247 Morninglow Drive to Quicken Loans in the amount of $256,500. The mortgage was recorded on October 20, 2009. One week later, the Baileys closed an equity line of credit with ArrowPoint Federal Credit Union in the amount of $99,500. The second mortgage was recorded on November 4. ArrowPoint had record notice of the Quicken mortgage. On November 23, the Baileys refinanced the Quicken mortgage with Quicken, this time in the amount of $296,000.

In connection with the refinance, the Baileys executed an interesting document entitled “Title Company Client Acknowledgment”, which stated the only outstanding lien on the property was the prior Quicken mortgage. This statement was false. The Court stated that there was no clear explanation as to whether Quicken had the title searched at this point.

The Baileys used $257,459 from the refinance to pay off the first mortgage. On December 15, Quicken released the first mortgage and recorded the refinance mortgage. Quicken assigned the mortgage to U.S. Bank, the petitioner in this case.

(If these facts make you break out into a cold sweat, then you were around doing real estate closings at the break-neck speed we suffered during this time frame.)

The Baileys defaulted on the line of credit, and ArrowPoint filed this action seeking a declaration that its line of credit had priority over the Quicken refinance mortgage. Both lenders moved for summary judgment. U.S. Bank claimed it had priority under the replacement mortgage doctrine. The special referee and Court of Appeals agreed with ArrowPoint, and the Supreme Court affirmed. Both appeals courts concluded that adopting the replacement mortgage doctrine is a question for the General Assembly.

Dirt lawyers are intimately familiar with South Carolina’s race-notice statute (S.C. Code §30-7-10) which prioritizes liens based on notice and the recording date.

The Supreme Court recited that it had recognized the equitable subordination doctrine as an exception to the race-notice statute. The Court noted the right of subrogation is essentially a creation of the court of equity, which allows a person who is secondarily liable for a debt, upon paying the debt, to assume by law the place of the creditor whose debt is paid.  Decades later, the Court declined to recognize the doctrine for a lender that refinanced its own mortgage but failed to discover an intervening mortgage. The Court said in the case at hand that it had previously warned lenders of their duty to search titles!**

The Court noted that the replacement mortgage doctrine is another exception to the race-notice statute, and many jurisdictions either recognize the doctrine or follow its logic. Cases from other jurisdictions were cited, and the Restatement (Third) of Property was quoted. According to the Restatement, the replacement mortgage doctrine provides:

  • If a senior mortgage is released of record and, as a part of the same transaction, is replaced with a new mortgage, the latter mortgage retains the same priority as its predecessor, except
  • To the extent that any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest in the real estate, or
  • To the extent that one who is protected by the recording act acquires an interest in the real estate at a time that the senior mortgage is not of record.

The Court said that it was required to respect the authority of the legislature on public policy matters and declined to sit as a “superlegislature” to second-guess the General Assembly’s decisions. The Court differentiated the equitable subrogation doctrine from the replacement mortgage doctrine by saying that the “race” begins with the original mortgage in the equitable subrogation situation, and the intervening lender suffers no loss. Under the replacement mortgage doctrine, on the other hand, the original first mortgage is satisfied of record and replaced with a new mortgage that is recorded after the intervening mortgage.

The Court also criticized the replacement mortgage doctrine because it dilutes the importance of title examinations. Lenders who seek to refinance their own mortgages, as Quicken did in this case, can easily search the title to discover the intervening lien. The last words of the case state, “Finally, we emphasize parties must conduct diligent title searches to protect their interests under the race-notice statute.”

I, for one, will not argue with that final statement. It now appears that if ALTA and PLTA want a replacement mortgage doctrine in South Carolina, they need to approach the legislature.

*South Carolina Supreme Court Opinion 28129, January 11, 2023.

**All the citations are omitted but are set out in detail in the subject case.  

SC Court of Appeals rejects “replacement mortgage” doctrine

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Our Court of Appeals issued an opinion* on November 25 addressing and rejecting a novel foreclosure theory in South Carolina. Let’s look at the facts.

Jimmy and Laura Bailey owned a residence located at 247 Morninglow Drive in Winnsboro. They obtained a $256,500 mortgage loan from Quicken Mortgage in 2009. Later that year, the Baileys obtained an equity line of credit from ArrowPointe in the amount of $99,000. Next, the Baileys obtained a loan from Quicken in the amount of $296,000. The proceeds of this loan were used to pay off the first Quicken mortgage, which was satisfied of record.

At the time of the second Quicken loan, Quicken did not have actual knowledge of the ArrowPointe mortgage, but that mortgage was recorded. The Baileys signed an owner’s affidavit stating there were no outstanding mortgages.

The Baileys defaulted on the ArrowPointe line of credit, and ArrowPointe filed the subject foreclosure action. U.S. Bank (a successor to Quicken) and ArrowPointe filed competing motions for summary judgment, both claiming priority. U.S. Bank first asserted an equitable subrogation argument but abandoned that argument before the hearing and argued the replacement mortgage doctrine instead.

The special referee denied U.S. Bank’s motion, concluding that the replacement mortgage doctrine is not the law of South Carolina and that ArrowPointe’s mortgage had priority. U.S Bank appealed.

The Court of Appeals began its analysis by stating that South Carolina is a race-notice state, that is, the recording statute determines the priority of mortgages, and a mortgage is valid from the date of recording without notice. A subsequent creditor who records first, without notice, is protected by the recording statute.

One exception to the race-notice statute, the Court stated, is the doctrine of equitable subrogation. That doctrine allows a subsequent creditor to obtain priority if it meets the following elements: (1) the lender claiming subrogation has paid the prior debt; (2) that lender was not a volunteer but had direct interest in the discharge of the prior debt; (3) that lender was secondarily liable for the prior debt or for the discharge of the lien; (4) no injustice will be done by allowing the equity; and (5) that lender must not have actual notice of the prior mortgage.

The doctrine of replacement mortgage is also an exception to the race-notice statute, the Court stated. This theory, according to the Restatement (Third) of Property (Mortgages), is described as follows: (a) If a senior mortgage is released of record and, as a part of the same transaction, is replaced with a new mortgage, the latter mortgage retains the priority of the predecessor, except (1) to the extent that any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest, or (2) to the extent that one who is protected by the recording act acquires an interest in the real estate at a time that the senior mortgage is not of record.

Courts have adopted three different approaches to equitable subrogation: (1) the majority position holds that a party with actual knowledge of an intervening lien cannot seek equitable subrogation; (2) the minority position holds that a party with actual or constructive knowledge of an intervening lien cannot seek equitable subrogation; and (3) the Restatement approach states that actual or constructive knowledge of an intervening lien is irrelevant and does not bar equitable subrogation.

The Court indicated it is cognizant of a trend toward adopting some form of replacement mortgage doctrine in other states and of our Supreme Court’s dicta in Matrix Financial Services Corp. v. Frazer.** In Matrix, our Supreme Court stated that a lender that refinances its own debt is not entitled to equitable subrogation but specifically did not decide whether a lender that refinances its own debt could succeed under the theory of replacement mortgage.

The Court held that ArrowPoint has priority under our race-notice statute because U.S. Bank had constructive notice of ArrowPointe’s mortgage.

Changing our rule is a matter for the legislature, according to the Court of Appeals. My guess is that our Supreme Court may have the opportunity to weigh in on this issue.

* ArrowPoint Federal Credit Union v. Bailey, South Carolina Court of Appeals Opinion No. 5784 (November 25, 2020).

** 394 S.C. 134, 714 S.E.2d 532 (2011).