Texas Supreme Court Rules Fair Subrogation Not Prohibited By Failure To Timely Foreclosure
In a per curiam decision, the Texas Supreme Court recently ruled that the holder of a trust deed has the right to seize by equitable subrogation, even after failing to timely seize his trust deed.
Responding to a certified question presented by the United States Court of Appeals for the Fifth Circuit, the Texas Supreme Court has ruled that a lender is entitled to equitable subrogation when it has failed to correct a curable constitutional defect in loan documents under § 50 of the Texas Constitution in Fed. Mortgage real estate loan Corp. vs. Zepeda, 601 SW3d 763, 764 (Tex. 2020).
Application Zepeda on the facts of this case, the Texas Supreme Court held that the mortgagee maintained his equitable rights of subrogation to assert a pre-existing lien which had been repaid with the proceeds of his loan, and his failure to timely foreclose under the trust deed did not exclude its rights of subrogation.
A copy of the notice in PNC Mortgage v. Howard is available on: Link to Opinion.
In 2003, husband and wife borrowers purchased a home with loans secured by two purchase privileges on their property. Two years later, the borrowers refinanced the mortgages with a new loan from another lender and paid off the purchase price mortgages. The note and deed of trust securing the loan were subsequently assigned and acquired by a new lending entity (“mortgagee”).
After the borrowers stopped making payments on the loan, in January 2009, the mortgagee informed the borrowers of their default and their intention to accelerate the loan, and five months later, accelerated the note. Meanwhile, the original lender initiated foreclosure proceedings against the borrowers despite the assignment of the loan to the mortgagee, resulting in a foreclosure sale of the property to the original lender.
The borrowers brought an action against the original lender seeking to reverse the foreclosure sale on this basis, while adding the mortgagee as an interested defendant. After the trial court declared the foreclosure void ab initio against the original lender, in January 2015, the mortgagee asserted counterclaims against the borrowers seeking to foreclose the trust lien deed or, failing that, a judgment declaring its right to foreclosure by fair subrogation if the trial court determined that the four-year limitation period for foreclosure after acceleration had expired. The mortgagee also filed a separate lawsuit against the borrowers alleging breach of the loan, which was consolidated with the underlying action.
Ruling on the parties’ joint motion for judgment based on stipulated facts, the trial court pronounced judgment against the mortgagee, declaring the loan note and the lien on the trust deed unenforceable. The mortgagee appealed.
On appeal, the mortgagee argued that because the borrowers had used the loan proceeds to pay off the two pre-existing purchase price mortgages, he held an equitable lien on the borrowers’ property.
Noting that the mortgagee failed to take corrective action after the borrowers’ action informed the mortgagee that the wrong entity had foreclosed on the property, the appeals court upheld the trial court’s judgment, ruling that the mortgagee’s negligent failure to timely seize the trust lien deed barred his subrogation rights.
The decision of the court of appeal was based in part on the opinion of the Supreme Court in Zepeda v. Federal Home Loan Mortgage Association, which presented similar facts: the applicant borrower purchased a home with a mortgage lien loan and then refinanced the debt, using its proceeds to pay off the first loan balance.
The borrower in Zepeda subsequently notified the refinance lender that its loan documents contained a constitutional defect and asked it to remedy the defect, but failed to do so before selling the loan. After the new noteholder has failed to remedy the default in the same manner, the borrower Zepeda filed a claim for quiet title in the Federal Court, which ruled that the noteholder was not entitled to equitable subrogation because it negligently failed to remedy the constitutional defect in its loan documents.
Two months after the decision of the court of appeal in this case, the lender in Zepeda appealed to the United States Court of Appeals for the Fifth Circuit, which certified whether “ a lender [is] entitled to a fair subrogation, where he has not corrected a curable constitutional defect in the loan documents under § 50 of the Texas Constitution? To the Texas Supreme Court, which replied in the affirmative. Zepeda v. Fed. Mortgage real estate loan Company., 935 F.3d 296, 301 (5th Cir. 2019); Fed. Mortgage real estate loan Corp. vs. Zepeda, 601 SW3d 763, 764 (Tex. 2020).
In answering the certified question of the Fifth Circuit, the Texas Supreme Court held that the equitable subrogation rights become fixed the moment the proceeds of a subsequent loan are used to discharge a prior lien, and the negligence of a lender to preserve its rights under its own lien does not deprive the lender of its equity rights to assert a prior lien that was released using the proceeds of the subsequent loan. Zepeda, 601 SW3d to 766.
Based on this decision, the mortgagee filed a petition for review with the Texas Supreme Court, claiming that the notice in Zepeda annulment of the judgment of the court of appeal.
Application Zepeda in that case, the Texas Supreme Court agreed that the mortgagee’s failure to timely seize under the trust lien deed did not preclude his rights of subrogation, holding that the subrogation functions as a cover Against the risk of refinancing the unpaid amount of an existing loan, allowing a lender to assert rights under a lien that his loan has satisfied when the lender’s own lien is invalidated. Zepeda, 601 SW3d to 768.
The Court rejected attempts by borrowers to distinguish Zepeda arguing that this case involved mortgages for the purchase of money rather than a home equity loan at issue in Zepeda, and their argument that a breach of law – the mortgagee’s failure to take timely action on the trust lien deed – prohibits subrogation when a constitutional defect is not. Because the borrowers’ additional arguments – that the mortgagee’s rights of subrogation were time-barred and not permitted under the trust lien deed – were not considered by the court of appeal, these issues were remanded. to the court of appeal for review.
Accordingly, the Court set aside the judgment of the Court of Appeal declaring the hypothecary creditor’s equitable rights of subrogation to be unenforceable and remanded for new proceedings in accordance with its opinion.