Lamb Excavation v. Torrejon

IN THE COURT OF APPEALS
STATE OF ARIZONA
DIVISION TWO

LAMB EX CAVATION , INC., an Arizona ) 2 CA-CV 2002-0139
corporation, ) DEPARTMENT B
)
Plaintiff/Appellee, ) O P I N IO N
)
v. )
)
CHASE MANHATTAN MORTGAGE )
CORPORATION, )
)
Defend ant/Appe llant, )
)
and )
)
INTEG RA W INDOW & DOO R, INC.; )
ATKO BU ILDING MAT ERIALS, INC.; and )
U.S. CO MPON ENTS L .L.C., )
)
Defendants/Cross-Claimants/Appellees. )
)

APPEAL FROM THE SUPERIOR COURT OF PIMA COUNTY

Cause No. C-20010928

Honorable Jane L. Eikleberry, Judge

REVERSED AND REMANDED
Durazzo & Eckle, P.C.
By Patric E. Durazzo Tucson
Attorneys for Plaintiff/Appellee

Snell & Wilmer, L.L.P.
By Marc G. Simon and Wade R. Swanson Tucson
Attorneys for Defendant/Appellant
Chase Manhattan Mortgage
Corporation
Slutes, Sakrison & Hill, P.C.
By James M. Sakrison Tucson
Attorneys for Defendant/Cross-
Claimant/Appellee
Integra Window & Door, Inc.

Norman R. Freeman II, P.C. Tucson
Attorney for Defendant/Cross-
Claimant/Appellee
U.S. Com ponents L.L.C .

Anderson, Brody, Levinson, Weiser & Horwitz, P.A.
By Jeffrey H . Levinso n & Janessa E. Koenig Phoenix
Attorneys for Defendant/Cross-
Claimant/Appellee
ATKO Building Materials, Inc.

E S P I N O S A, Acting Presiding Judge.

¶1 In this mechanics’ lien foreclosure action, appellant Chase Manhattan Mortgage

Corporation (Chase) a ppeals from the trial court’s g rant of summary judgment in favor of

appellee Lamb Excavation, Inc. (Lamb). Chase contends the court erred in declining to apply

the doctrine of equitable subrogation in its favor, which would have placed Chase in the

primary lien position occupied by the construction lender after Chase provided permanent

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financing for the subject project and satisfied the construction loan. We agree and reverse the

grant of summary judgment in favor of Lamb and remand the case to the trial court for further

proceedings consistent with this decision.

Facts and Procedural Background

¶2 The essential facts are undisputed. In February 2000 Edwin and Catherine

Torrejon obtained a construction loan from Commercial Federal Bank (CFB) to build a house

on a parce l of prop erty they ha d purch ased. T he loan was se cured b y a deed of trust. The

Torrejons employed several subcontractors during construction, including Lamb, ATKO

Building Materials (ATKO), U.S. Co mponents, and Integra Window & D oor (Integra). Those

four subcontractors subsequently served on CFB and the Torrejons preliminary twenty-day

notices of mechanics’ and materialmen’s liens pursuant to A.R.S. § 33-992.01. In

November 2000, the Torrejons obtained permanent financing from Chase to satisfy the CFB

construction loan, executing a promissory note and deed of trust to the property, which Chase

recorded on December 15, 2000.1 Shortly thereafter, Lamb, ATKO, Integra, and U.S.

Compo nents (collectively referred to as mechan ics’ lienholde rs), who h ad not bee n fully paid

for their w ork, all recorde d mech anics’ lie ns against the p roperty.

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The construction loan and th e permane nt financing differed in their terms: the CFB
loan, by its temporary nature, had a one-year term, while the Chase loan was for thirty years;
the CFB interest rate was 8.25% a nd the Ch ase financin g, an adju stable rate note, carried an
11.275% interest rate; and the CFB loan was for the amount of $240,000, while the Chase n ote
listed $248,000 as the principal balance.

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¶3 In February 2001, Lamb filed an action to foreclose its lien, naming as

defendan ts the Torrejons, CFB, Chase, and the three other mechanics’ lienholders.2 The three

answered and filed cross-claims asserting lien priority positions identical to L amb’s. In

November 2001 C hase mov ed for summ ary judgme nt, arguing its lien should be subrogated

to the extent of the CFB lien. Lamb filed a countermotion for summary judgment, which the

other three mechanics’ lienholders j oined, contending th at Chase w as not entitled to equitable

subrogation because the CFB lien had been extinguished and thus there was no agreement or

intent to subrogate. Lamb also argued that subrogation “would work a substantial injustice” on

the lienholders. The trial court denied Chase’s motion and granted the lienholders’ motion

instead.

¶4 In granting Lamb’s motion for summary judgment, the trial court rejected

Chase’s argument that it was entitled to equitable subrogation, finding that Chase was “a

sophisticated lender” an d had “c onstructive notice of the potential for the filing of a

mechanic’s liens [sic] against the property when it made the loan.” Citing Mosher v. Conway,

45 Ariz. 463, 46 P .2d 110 (1935 ), the trial court also found that the decisio n to apply eq uitable

subrogation depends on the particular circumstances of each case and that applying the

doctrine here would produce an “inequitable result” and be contrary to public policy. In

2
In addition to the lien-foreclosure claim, Lamb’s complaint and the subsequent
amended complaint contained three additional counts for breach of contract, unjust enrichment
and equita ble lien, and quantum meruit.

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addition, the court rea soned that subrogation did not ap ply because the terms of the CFB and

Chase loans were “not identical.” This appeal followed.

Standard of Review

¶5 A trial court properly grants summary judgmen t if the moving party is entitled

to judgmen t as a matter of la w. Ariz. R. Civ. P . 56(c)(1), 1 6 A.R. S., Pt. 2; Orme School v.

Reeves, 166 Ariz. 301, 802 P.2d 1000 (1990). Because determining whether Chase was

entitled to equitable s ubrogation involves a question of law, we review de novo the issue of

whether that relief is appropriate. See Johnson v. Hispanic Broadcasters of Tucson, Inc., 196

Ariz. 597, 2 P.3d 687 (App. 2000) (entry of summary judgment reviewed de novo); see also

Andrews v. Blake, 205 Ariz. 236, 69 P.3d 7 (2003) (availability and propriety of equ itable

relief reviewed de novo).

Equitable Subrogation

¶6 The doctrine of equitable subrogation permits the substitution of one lienholder

into the lien-priority position of a prior lienholder. Subrogation is “an equitable remedy

designed to avoid a person’s receiving an unearne d windfall at the expen se of another.”

Restatement (Third) of Property (Mortgages) (hereinafter “Restatement”) § 7.6 cmt. a. In

general, previously recorded liens have priority over subsequent mechanics’ liens recorded

after labor has begun or materials have been furnished. The mechanics’ liens then have

priority over later-recorded encu mbrances. See A.R.S. § 33-992; E. Sav. Bank v. Pappas, 829

A.2d 953 (D.C. 2003); see generally Restatement § 7.6. But application of the doctrine of

equitable subrogation allows a subsequent lender who sup plies funds used to pay off a p rimary

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and superior encumbrance to be substituted into the priority position of the primary lienholder,

despite the recordin g of an intervening lien. See Mosher; Peter man-D onnelly Eng’rs &

Contractors Corp. v. First Nat’l Bank of Ariz., 2 Ariz. App. 3 21, 408 P.2d 841 (1965); see

also Mort v. United States, 86 F.3d 890 (9th Cir. 1996).

¶7 On appeal, Chase co ntends it w as entitled to eq uitable subrogation based on the

two-part test enunciated in Peterma n-Donn elly, which considers (1) whether an express or

implied agreement to subrogate existed and (2) wheth er any prejudice to the lien claimants

resulted. Conversely, Lamb u rges us to up hold the trial co urt’s ruling, asserting the trial co urt,

in denying subrogation, properly considered factors such as Chase’s actual or constructive

notice of the interve ning liens, its sta tus as a soph isticated lender, and public policy issues.

Thus, the parties disagree on the appropriate legal stand ard for asses sing whe ther equitab le

subrogation should apply. In order to clarify the Arizona standard, we first review the

approaches taken by other jurisdictions.

Majority Approach

¶8 The four primary elements of equitable subrogatio n are as follow s: (1) the party

claiming subrogation has paid the debt; (2) the party was not a volunteer; (3) the party was not

primarily liable for the debt; and (4) n o injustice w ill be done to the other party by allowing

subrogation. See Kuznik v. Bees Ferry Assocs., 538 S.E .2d 15 (S .C. Ct. A pp. 2000 ); accord

St. Paul Fire & Marine Ins. Co. v. Murray Guard, Inc., 37 S.W.3 d 180 (A rk. 2001); County

v. Jensen, 83 P.3d 405 (Utah Ct. Ap p. 2003); cf. Mosher. A majo rity of jurisdictions apply

the doctrine of e quitable subrogation when the subsequent mortgagee had no actual knowledge

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of an existing lien, reasoning that the subsequent mortgagee, having paid the preexisting

obligation, reasonably had expected to step into the shoes of the previous creditor. Houston

v. Bank of Am. Fed. Sav. Bank, 78 P.3d 71 (Nev. 2003) (characterizin g, though declining to

adopt, majority approach viewing equitable subrogation as defeated only by actual, but not

constructive, knowledge of existing lien ; adopting in stead more liberal appro ach); Osterman

v. Baber, 714 N.E.2d 735 (Ind. Ct. App. 1999) (same); see, e.g., Han v. United States, 944

F.2d 526 (9th Cir. 19 91); Smith v. State Sav. & Loan Ass’n, 223 Cal. Rptr. 298 (Cal. Ct. App.

1985). 3

Minority Approach

¶9 A minority of states, however, consider, in addition to the primary eleme nts

considered by the majority, such things as whether the subsequent mortgagee had constructive

notice of intervening liens, the lender’s sophistication, and the lender’s negligence in failing

to discover an existing encu mbrance. See, e.g., Bankers Trust C o. v. United States, 25 P.3d

877 (Kan. Ct. App. 2001) (denying equitable subrogation to negligent sophisticated lender);

Carl H. Peterson Co. v. Zero Estates, 261 N.W.2d 346 (Minn. 1977) (equitable subrogation

denied because o f sophistication of party seekin g subroga tion); see also Landmark Bank v.

Ciaravino, 752 S.W .2d 923 (M o. Ct. Ap p. 1988) (equitable su brogation a llowed on ly in

extreme cases bordering on fraud); Richards v. Sec. Pac. Nat’l Bank, 849 P.2 d 606 (U tah Ct.

3
Indeed, an “increasing trend” is to allow subrogation notwithstanding actual knowledge
of intervening liens, if the parties had intended that subrogation occur. Osterman, 714 N.E.2d
at 739.

7
App. 1993) (constructive notice of mechanics’ lien defeats claim of e quitable subrogation);

Kim v. Lee, 31 P.3d 665 (Wash. 2001 ) (constructive notice bars equitable su brogation).

Restatement Approach

¶10 The Restatement sets forth an even more liberal ru le concern ing equitab le

subrogation than that of the majority of jurisdictions. Section 7.6 of the Restatement states:

(a) One w ho fully performs an obligation of an other, secured by
a mortgage, becomes by subrogation the owner of the obligation
and the mortgage to the extent necessary to prevent unjust
enrichment. Even though the performance w ould otherwise
discharge the obligation and the mortgage, they are preserved and
the mortgage retains its priority in the hands of the subrogee.

(b) [S]ubrogation is appropriate to prevent u njust enrich ment if
the person seeking subrogation performs the obligation:

....

(4) upon a request . . . to do so, if the person performing was
promised repayment and reason ably expecte d to receive a
security interest in the real estate with the priority of the
mortgage being discharged, and if subro gation will n ot materially
prejudice the holders of intervening interests in the real estate.

Thus, under the Restateme nt, a subsequent mortgagee’s negligence in failing to discover an

existing lien does not preclude application of the doctrine so long as the intervening

lienholders are not prejudiced. And, notice is not a consideration. Rather, the question is

whether a subsequent mortgagee reasonably expected a security interest w ith the same p riority

as that of the mortgage being discharged. See Restatement § 7.6(b)(4) and cmt. e; see also

Houston.

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¶11 The rationale behind the Restatement’s approach is that the intervening

lienholder suffers no prejudice because its lien maintains the same position it occupied before

the subsequent lender satisfied the pre-existing obligation. Restatement § 7.6 cmt. a. (“The

holders of intervening interests can hardly complain about this result, for they are no worse

off than before the senior obligation was discharged. If the re were no subrogation, such junior

interests would be promoted in priority, giving them an unwarranted an d unjust windfall.”); see

also Pappas (focus of Restatement is on whether intervening lienholders prejudiced).

Arizona Approach

¶12 As this court stated in Herberman v. Bergstrom, 168 Ariz. 587, 590, 816 P.2d

244, 247 (App. 1991), “[f]o r equitab le subro gation to apply, there must be an agreement, either

express or implied, tha t the subseq uent lender w ill be substituted for the holder of the prior

encumbrance.” See also P eterman -Donne lly. In addition, the subsequent mortgagee must

not be a volunteer. Id. Becau se subrogation is a creature of equity, “its application may be

defeated by intervening rights wh ich wou ld be prejudiced by the substitution.” Id. at 326, 408

P.2d at 846. As an equitable construct, “[i]t rests upon the principle that substantial justice

should be attained, regardless of form.” Mosher, 45 Ariz. at 468, 46 P.2d at 115.

¶13 Arizona’s approach to equitable subrogation appears consistent with the

Restateme nt: the doctrine will apply w hen there is a n express o r implied agre ement to

subrogate, which is concordant with a party’s having a reasonable expectation of receiving a

security interest, and when an intervening lien claimant suffers no prejudice . See Peterman-

Donnelly; see also Wetherill v. Basham, 197 Ariz. 198, ¶ 13, 3 P.3d 1118, 1123 (A pp. 2000),

9
quoting Ramirez v. Health Partners of So. Ariz., 193 Ariz. 325, ¶ 26, 972 P.2d 658, 665

(App. 1998) (A rizona cou rts usually follow Restateme nt absent controlling authority, provided

its application “is logical, furthers the interests of justice, is consistent with Arizona law and

policy, and has been g enerally acknowledg ed elsewhere.”).

¶14 Although expressly declining to set forth a general rule for the future

applicability of equitable subrogation, our supreme court in Mosher nonetheless stated, “when

one, being himself a creditor, pays another creditor, whose claim is prefera ble to his, it is held

that the person so paying is subrogated to the rights of the other creditor.” 45 Ariz. at 469, 46

P.2d at 116. Th e court determined that whether the doctrine applies “depends upon the

particular facts and circumstances of each case as it arises,” id. at 468, 46 P.2d at 115, but

equitable subrogation will not be applied when the subsequent creditor is a mere volunteer. Id.

¶15 Peterma n-Donn elly, this court’s most recent interpretation of Mosher, includes

the following observation:

Although the Mosher case indicates that an a d hoc app roach is
required, the following statement . . . approxim ates a ge nerality:

“[A] third person , having agreed to ad vance mo ney to
discharge an encumbrance on proper ty of another, where he [or
she] is not a volunteer, and where payment is made under an
agreement that he [or she] will be substituted in place of the
holder of the encumbranc e, is entitled to subrogation, whether
such agreement is express or whether such agreement is
implied.”

Peterman-D onnelly, 2 Ariz. App. at 325, 408 P.2d at 845 (citing what is now 83 C.J.S.

Subrogation § 50, p. 583-4). Although the parties dispute the import of this language, which

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Lamb characterize s as mere dic ta, we find it persuasive when viewed in combination with the

remainder of the court’s analysis. Moreover, we do not find the two cases incompatible.4 In

considering whether to apply subrogation, the court in Peterman-Donnelly focused p rimarily

on the parties’ express or implied understanding and intent to subrogate and on whether any

intervening rights would be prejudiced by subrogation. N either Mosher nor Peterman-

Donne lly requires that subrogation be denied where a subsequent creditor has actual or

constructive notice of intervening liens; nor does either contain any language suggesting

subrogation is inappropriate when a sophisticated lender is involved . Furthermore, Mosher’s

dictate, were we to apply it, that courts must consider the facts and circumstances of each

individual case,5 seems mere ly to state the obv ious, that, in evaluating an equitable subrogation

claim, a court mus t necessarily consider the factual and procedural framework in which the

case developed. Lamb’s protestations notwithstanding, nothing in Peterman-Donn elly

contradicts the general language in Mosher.

¶16 Having identified the appropriate parameters for applying equitable subrogation,

we now examine whether the trial court failed to properly apply it here. We find that it did.

First, as Chase maintains and Lamb does not dispute, there existed at least an implied

4
Interestin gly, the trial court in its decision cited Mosher for the proposition th at the
applicability of equitable subrogation depends upon the particular facts and circumstances of
each individual case, bu t made no mention o f Peterma n-Donn elly.
5
We note that, immediately after refusing to promulgate a general rule, the Mosher
court remarked that “the modern tendency is to extend [equitable subrogation’s] use rather than
to restrict it” and that “it now has a very liberal application, its principle being modified to
meet the circumstances of ca ses as they arise.” 45 Ariz. at 468 , 46 P.2d at 115.

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agreement to subrogate, reflected in the form of the loan documents and escrow closing

instructions. For exam ple, the closing instructions provide that “[the] title insurance policy

. . . must show [Chase’s] mortgage to be a valid first lien against the property.” In addition, one

of the conditions in the closing instructions specifically stated that the loan was to “payoff the

following: comm fed-$231100.” It is clear and undisputed that Chase was not acting as a

volunteer in paying off the CFB loan, and nothing in the record suggests its motivation was

anything oth er than com mercial.

¶17 Second, we agree with Chase that the trial court erred in finding that the

mechanics’ lienholders would be prej udiced by su brogation. In so finding , the court sim ply

stated, without elaboration, that equitable subrogation would “defeat the rights of other

creditors who w ould be prejud iced by its application” and that applying the doctrine would be

“inequitable.”

¶18 We fail to comprehend the nature of the perce ived preju dice or ineq uity, as it

appears the lienholders would re main in the same position they occupied before subrogation

if that doctrine were applied. To the contrary, without subrogation, the lienholders w ould

receive a windfall if elevated to a higher priority status. See Restatement § 7.6 cmt. a. The

record establishes that when the lienholders agreed to perform work on the property they

understood that CFB, not they, had a superior position. They therefore accepted the risk that

the Torrejons would not pay them and would not pay the first lienholder, thereby defeating

their liens. See E. Boston Sav. Bank v. Ogan, 701 N.E.2d 331 (Mass. 1998). Furthermore,

although the lienholders e mphasize C hase’s allege d negligen ce, they offer n o concrete

12
example of how subrogation would prejudice their interests other than characterizing

themselves as “truly innocent intervening lienholders” who, if subrogation is denied, “will be

paid for the wo rk they have already performed and nothing else.” Lamb’s contentions rest

solely on theoretical policy arguments and fail to demonstrate how applying the criteria stated

in Mosher and Peterma n-Donn elly supports the trial court’s gran t of summary judgmen t in

its favor.

¶19 In denying equitable subrog ation, the trial court cited the difference in terms

between the CFB and Chase loans as an “important” factor in its decision, suggesting that, from

the court’s perspective, the lien claimants would have been prejudiced by the implementation

of the Chase loan terms, w hich differed from the terms of the o riginal CFB financing.

Howeve r, it is well settled in A rizona that, w hen equita ble subrogation is ap plied, its

application is limited to the extent of the prior lien only. See Mosher; Restateme nt § 7.6 cm t.

e. Peterma n-Donn elly does not suggest otherwise. The Mosher court recog nized the limits

of subrogation, stating, “the doctrine . . . cannot give any greater rights to the subrogee than a re

held by the person to whose rights he is subrogated.” According to the Restatement, “[t]he

payor is subrogate d only to the ex tent that the funds disbursed are ac tually applied toward

payment of the prior lien. There is no right of subrogation with respect to any excess funds.”

Restatement § 7.6 cmt. e. The Restatement also recognizes that when a lender, such as Chase,

demands a higher inte rest rate than that under the prior loan, the intervening lienholders may

be jeopardized. In this situation, “[s]ubrogation should be granted only to the extent of the debt

balance that would have existed if the interest rate had been unchanged.” Id. While

13
emphasizing that the terms of the two loans differed, Lamb has failed to explain precisely how

it is prejudiced by that difference. Indeed, Chase readily concedes that “its lien can only be

subrogated to the extent of the [CF B lien].” Thus, if Chase is only subrogated to the extent of

the original loan, the lien claima nts can hard ly claim they will be prejudiced. We see no reason

to deny equitable subroga tion on this basis.

¶20 Finally, we briefly address the trial court’s statement that “Chase had

constructive notice of the potential for the filing of a mechanic ’s lien[] again st the property

when it made the loan.” (Emphasis added.) Significantly, when Chase recorded its deed, no

mechanics’ liens had yet been recorded. Thus, in addition to imposing an improper

constructive-notice requirement, the trial court also impliedly charged Chase with notice of

mechanics’ liens not then in existence, based purely on the future possibility of such liens. Cf.

Richards (commencemen t of visible work imparts constructive notice of lien). Regardless,

the court’s findin g is irrelevant, given our determination that constructive notice is not an

element of equitable subrogation under A rizona law . This con clusion is also consistent w ith

those of the majority of jurisdictions that have addressed the issue. See, e.g., Han; Smith;

Osterman; Dodge City of Spartanburg, Inc. v. Jones, 454 S.E.2d 9 18 (S.C. Ct. A pp. 1995).

Disposition

¶21 We reverse the grant of summary judgment in favor of Lamb and remand the case

to the trial court for further proceedings consistent with this opinion. Both parties have

requested attorney fees on appeal, and Chase also has requested attorney fees incurred at the

trial level. In view of Chase’s failure to provide any substantive basis for an award of fees, we

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decline to grant its requests. See In re Wilcox Revocable Trust, 192 Ariz. 337, 965 P.2d 71

(App. 1998 ).

¶22 Reversed and remanded for further pro ceedings.

PHILIP G. ESPINOSA, Acting Presiding Judge

CONCURRING:

PETER J. ECKER STROM, Judge

JOSEPH W. HO WARD, Judge

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