• Q&A: Thursday evening, Dec. 3, at 7:00 pm in Room 5
• Q&A: Monday, Dec. 14, at 7:00 pm in Room 5
• Exam: Wednesday, Dec. 16, at 1:30pm (1:30 to 5:00)
– Exam consists of MC, short answer, and essay
– Exam will be in “open laptop” mode (no network access)
– You may bring an outline that you prepared or contributed to in
a study group (no other materials)
– I will post sample essay questions from prior exams on class
website
Purchase Money Mortgage Defined
• A mortgage is a “purchase money” mortgage if it:
– Is retained by a seller of land as security for the buyer’s
subsequent payment of part/all of the purchase price of the
land, or
– Is taken by a lender that provides a loan that enables the
mortgagor to acquire the land and that is actually used to
acquire the land
• Analogous to Article 9 PMSI definition
Purchase Money Priority Hypo
• 2007: X gets judgment vs. Davis for $75,000 (judgment is
still unsatisfied in 2015)
• 2015: Davis buys Blackacre for $250,000, using the
proceeds of a $200,000 loan from Bank
– Bank takes/records mortgage on Blackacre
• Whose lien “attached” first: X’s judgment lien, or Bank’s
mortgage?
• Which lien has first priority if Davis defaults?
• X’s judgment lien attaches at the exact moment that
Davis acquires Blackacre (in most states)
• Bank’s mortgage attaches to Blackacre at the moment
that Davis executes a mortgage to the Bank
– Typically, Davis wouldn’t execute a mortgage to the Bank
until AFTER Davis received title to the land by deed
• Thus, based on timing (prior-in-time), it would seem
that X’s judgment lien would have arisen before
Bank’s mortgage
• Restatement § 7.2(b): “A purchase
money mortgage ... has priority over
any mortgage, lien or other claim that
attaches to the real estate but is
created by or arises against the
purchaser-mortgagor prior to the
purchaser-mortgagor’s acquisition of
title ....”
• Bank thus has priority over X
• Does this result make sense?
• Rationale for purchase money priority: giving priority to
PM mortgage lender (Bank) does not harm Davis’s prior
creditors (such as X)
• Now suppose that Bank failed to
record its mortgage
• Page 973: Bank’s unrecorded
mortgage would still have purchase
money priority over X’s judgment
lien (despite Bank’s failure to
record the mortgage)
• Can you explain why? Is this a
sensible result?
• Rationale: X (judgment lienholder) is not a reliance
creditor (e.g., like a buyer or mortgagee) who would
have relied on a record search; thus, recording act
doesn’t protect X
– In accounting terms, extension of PM credit had no negative
impact on Davis’s balance sheet (Davis did incur a new
liability to Bank, but it enabled Davis to acquire a new asset,
Blackacre)
– Giving Bank PM priority makes X no worse off than X was
before Davis acquired the land (and makes X better off, to
the extent Davis has equity in Blackacre)!
– Recording is necessary to protect Bank against subsequent
purchasers from Davis
• But note: if court orders a sheriff’s sale of land to satisfy
X’s lien, buyer at that sale without knowledge of Bank’s
unrecorded mortgage would be a protected BFP!
• Restatement § 7.2(b): PM
mortgage has priority over any
other mortgage or lien that
attaches to the land that is
created by or arises against
the purchaser-mortgagor by
virtue of acts that occurred
before purchaser-mortgagor
acquired title to the land
• Majority/Restatement rule: Bank has a PM mortgage
(and PM priority) for the full loan amount ($200K)
– Bank gets first $200K of sale proceeds, X gets next $40K
• Minority/MO rule: PM priority extends only to price of
land, not improvements [note 2, p. 972]
– First $40K to Bank; next $70K to X; remaining $130K to Bank
(leaving Bank with an unsatisfied deficiency of $30K)
• Which rule makes better sense?
• In MO, how would Bank need to structure the transaction to
account for the minority rule?
Construction Loan Scenario
• 2012: X has $70,000 unpaid judgment vs. Davis
• 2014: Davis borrows $200,000 from Bank, and uses
$40,000 of it to buy Blueacre (raw land), and grants Bank a
mortgage on Blueacre (which the Bank records)
– Davis then uses the other $160K to build a home on Blueacre
• 2015: Davis defaults to Bank, which forecloses
• If sale price is $240,000, how should proceeds be
distributed between Bank and X?
• Restatement rule is economically sensible
– Bank’s loan enabled Davis to acquire Blueacre and increase its
value by improvement, so giving Bank PM priority doesn’t harm a
judgment lien creditor like X
• How can Bank avoid Missouri rule?
– 1) It can refuse to make the loan to Davis unless X will agree to
subordinate its judgment lien to Bank’s mortgage (priority between
creditors is always subject to modification by agreement), or
– 2) Bank can have the builder buy the land and build the home;
then, have the builder sell the completed home to Davis (then,
Bank’s loan to Davis to finance that purchase would be a PM
mortgage to the full extent of $200K loan amount)
PM Seller v. PM Lender: Problem
• Seller sells land to Buyer for $800K
– Buyer pays $600K in cash, signs $200K PM note and mortgage
to Seller
– But, Buyer got the $600K cash from a mortgage loan from Bank
– When mortgages were recorded, Bank’s mortgage was recorded
first, then Seller’s mortgage was recorded second
• Both Seller and Bank have PM mortgages; which gets
first priority if Buyer defaults?
• Note 1, page 981: PM Seller has priority over PM
Lender [Restatement § 7.2(c)], unless PM Lender
obtains a subordination agreement from PM Seller
– Rationale: “The equities favor the vendor. Not only
does the vendor part with specific real estate rather
than money, but the vendor would never relinquish it
at all except on the understanding that the vendor will
be able to use it to satisfy the obligation to pay the
price.” [Restatement § 7.2 cmt. d]
Possible Rules
• (1) Common law “first in time, first in right” (i.e.,
whichever lien arose “first” gets priority, subject to the
application of the recording statute)
• (2) Shared priority (pro rata)
• (3) PM Seller gets priority over PM Lender [Restatement
of Mortgages § 7.2(c)], unless PM Seller expressly
agrees to subordinate its lien
• Insight LLC v. Gunter (page 974): Idaho Supreme
Court rejected Restatement § 7.2(c), and ruled that
Bank (PM Lender) had priority over PM Seller
– Reasoning: Bank’s mortgage was the first one executed (and
thus the first to attach); thus, Bank prevails under first-in-time,
unless state’s recording act says otherwise
– To prevail under Idaho race-notice statute, Seller would’ve
had to be the first to record, but Bank’s mortgage was
recorded first, so Bank still prevails as first-in-time
• Is this a sensible result?
• In this context, it is inappropriate to think of the mortgages
as arising at different times (even if they didn’t arise
simultaneously)
– Order of execution is subject to manipulation by lenders, who are
likely more sophisticated than sellers (and more likely to be
handling the closing)
– Seller and Lender PM mortgages in same transaction should be
“deemed” to have arisen simultaneously
• Also, closing/recording was handled by title company
(escrow), which recorded Lender’s mortgage first as per
Lender’s instructions
• Suppose that Smith is in default on a
15-year mortgage held by Bank1
– Principal balance = $1MM
– Accrued but unpaid interest = $100K
• Bank2 has a second mortgage (unpaid
balance = $500K)
• Bank1, Smith agree to modify the loan
to capitalize unpaid interest (increasing
the principal balance to $1.1MM) and
increase interest rate to 12%
Modification
Modification of Mortgage
• The mortgagor and the mortgagee are free to modify
mortgage loan terms, such as by:
– A change in principal amount, which could include:
• The extension of additional credit by mortgagee
• “Capitalizing” unpaid interest (adding it to principal balance)
• “Write-down” or reduction of principal
– Change in interest rate (either an increase or a decrease)
– Extension of mortgage term (e.g., going from 15-year term to 30year term)
• Modification of mortgage loan is effective between
mortgagor (Smith) and mortgagee (Bank1)
• But the full effectiveness of the modification may be
limited as against the junior lienholder (Bank2)
• Modification of mortgage loan is effective vs. junior
lienholder, but not to the extent that the modification is
“materially prejudicial” to the junior lienholder
[Restatement § 7.3(a)]
– Is this modification “materially prejudicial” to Bank2?
• At the time Bank2 made its loan, it knew (or should’ve
known) it was “behind” Bank1 to the extent of the original
loan terms
• As of date of modification, then, Bank2 was “behind” Bank1
to the extent of the then-unpaid balance of the debt ($1.1MM)
• But, capitalization of unpaid interest (which increases the
principal balance) and increase in interest rate means loan
will now accrue more interest (and, on an amortizing loan, the
principal balance would amortize more slowly)
– Modification materially prejudices Bank2 to that extent
• Bank2 reasonably expected that it would have priority
after Bank1’s original mortgage loan was repaid, based
on the loan’s original terms and amortization schedule
– Bank1’s lien priority remains subject to original terms of
Bank1 loan, but not to the modified terms, unless Bank1
obtains Bank2’s effective consent to the modification
– Obviously, Bank1 can obtain Bank2’s consent at the time
of the modification; can this consent actually come before
the modification, by drafting in Bank1’s mortgage?
Modification: Before and After
• Before: each month, the
loan would accrue
additional interest =
($1MM x 10%)/12 =
$8,333.33
• After: each month the
loan will accrue
additional interest =
($1.1MM x 12%)/12 =
$11,000
The difference between these amounts = “material prejudice” to Bank2
Reservation of Rights: Consent?
• Restatement § 7.3(c): if the senior mortgage provides that a
modification of the senior mortgage is enforceable against
third parties claiming through the mortgagor (e.g., junior
lienholders), that provision is enforceable against junior
lienholders [Note 3, p. 1007]
– Rationale: if Bank2 makes loan after having constructive notice of
Bank1’s mortgage, which has such a “reservation of rights” clause,
Bank2 has “consented” to future modifications
• Should this be enforceable?
Refinancing and Intervening Liens
• Uphoff owns land, subject to 2 mortgages
– First priority: Bank1 (debt = $100K, @ 7%)
– Second priority: Bank2 (debt = $50K)
• 2015: Uphoff goes to Bank1 to refinance
– Bank1 takes a new mortgage to secure repayment of a new
$100K promissory note (at 4% interest rate)
– Bank1 records the new mortgage and releases the old one
• Bank2 argues: our mortgage was recorded before
Bank1’s new mortgage, so we now have first priority
• Is Bank2 correct?
Third-Party Refinancing Hypo
• Uphoff owns land, subject to 2 mortgages
– First priority: Bank1 (debt = $100K, 7% interest rate)
– Second priority: Bank2 (debt = $50K)
• 2015: Uphoff goes to Bank3 to refinance at 4%, but
borrows $120K
– $100K is paid to Bank1 to pay off Bank1
– $20K paid to Uphoff (which he uses to buy wine/cigars)
– Bank3 records a new mortgage; Bank1 releases the old one
• Does Bank2 now have priority over Bank3?
• No, Bank 2’s argument is not correct
• Replacement mortgage gets the same priority of the
original mortgage, except to the extent of material
prejudice to the junior lienholder [Restatement of
Mortgages § 7.3(a); Sovereign Bank v. Gillis, p. 998]
– In this Problem, there’s no material prejudice to Bank2 — the
interest rate was lowered, not raised, and the principal balance
did not increase (no new money was loaned to Uphoff)
• Rationale: this equates treatment of (1) a replacement
mortgage and (2) modification of original mortgage
Subrogation: Restatement § 7.6
(a) One who fully performs an obligation of another, 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 would otherwise discharge the obligation and the mortgage,
they are preserved and the mortgage retains its priority in the hands of the
subrogee.
(b) By way of illustration, subrogation is appropriate to prevent unjust
enrichment if the person seeking subrogation performs the obligation . . .
upon a request from the obligor ... to do so, if the person performing was
promised repayment and reasonably expected to receive a security interest
in the real estate with the priority of the mortgage being discharged, and if
subrogation will not materially prejudice the holders of intervening interests in
the real estate.
• Under Restatement § 7.6, Bank3 would get priority (it
would be subrogated to the priority of the paid-off Bank1
loan) to the extent of the $100K balance being refinanced
• Bank3 would not have priority to the extent of the
additional $20K loaned to Uphoff (increase in the loan
amount would “materially prejudice” Bank2 as intervening
lienholder)
• Some courts reject the Restatement’s subrogation rule
(e.g., Countrywide, p. 1013)
• Houston v. BOA Federal (p. 1009) reflects this view
• Is this argument persuasive?
• Argument for Bank3?
• Arguments for Bank2?
– Thus, if Bank3 foreclosed, and sale brought price of $150K,
Bank3 would get the first $100K plus any accrued but unpaid
interest; Bank2 would get the rest of the proceeds
– Bank1 could’ve assigned its mortgage to Bank3 so that Bank3
would’ve taken the priority of that mortgage, at least to the
extent of then-existing balance ($100K)
– Bank3’s loan was refinancing Bank1 mortgage, and Bank2
knew or should’ve known it was subordinate to Bank1’s lien
position
– Giving Bank2 priority over Bank3 would give Bank2 an
unbargained-for windfall
– In equity, Bank3 should be subrogated to the priority of original
Bank1 mortgage (even though it is released of record)
– In these states, Bank3 would not be subrogated to the priority
of Bank1’s mortgage, because Bank3 had constructive notice
of Bank2’s mortgage
– Under that view, Bank2’s mortgage would then have priority
over Bank3’s mortgage
– Countrywide: the need for “clarity and certainty in matters of
land title” justifies rejecting equitable subrogation [p. 1017]
– Priority is usually governed by the recording act; Bank2’s
mortgage was recorded prior to Bank3’s; Bank3 thus had
constructive notice of Bank2’s prior mortgage
– Bank3 could’ve (1) taken an assignment of Bank1’s mortgage
(and thus gotten its priority by assignment), or (2) could have
required subordination by Bank2 as a condition of its
willingness to make the refinancing loan
– If Bank3 didn’t bother to do either (if it was “sloppy”), the court
shouldn’t step in and use its equitable power to protect a “lazy”
creditor like Bank3
• Countrywide and its “integrity of the recording act” argument
misunderstands the purpose of the recording act and who it
is meant to protect
– As between Countrywide (which refinanced the AWL first
mortgage) and FNB (the junior), FNB isn’t a “reliance” creditor; it
knew it was behind the AWL first mortgage (and thus behind
anyone who acquired the ability to enforce the AWL mortgage
debt)
– If a BFP had come along and purchased FNB’s loan, believing
(based on the land records) that it was first in priority, the BFP
would be protected (equitable subrogation would result in
“material prejudice” to the BFP based on its reliance)
This Deed of Trust shall secure repayment of the sum of all (1)
principal, interest and other amounts due under or secured by
the Loan Documents, (2) principal, interest, and other amounts
which may hereafter be loaned by Beneficiary, its successors or
assigns, to or for the benefit of the owner of the Mortgaged
Property, when evidenced by a promissory note or other
instrument which, by its terms, is secured hereby, and (3) all
other indebtedness, obligations and liabilities now or hereafter
existing of any kind of Grantor to Beneficiary under documents
which recite that they are intended to be secured by this Deed
of Trust. THIS DEED OF TRUST SECURES FUTURE
ADVANCES UNDER R.S.Mo. § 443.055 UP TO THE
MAXIMUM AGGREGATE AMOUNT OF $_________.
“Future Advances”
• In some situations, mortgage explicitly contemplates
that it will secure not only the original loan amount, but
future advances as well
• Common scenarios include:
– E.g., construction loans (typically funded in periodic
“draws,” as construction proceeds)
– E.g., home equity lines of credit, or business lines of
credit secured by real estate
• Objective of a “future advances” clause is to
enable lender to claim the same lien priority for
future advances as for the original loan
– E.g., Bank records its mortgage on Jan. 1, 2015
– Bank then advances $12MM construction loan
over next 12 months in $1MM monthly draws
– Intent: Once loan is fully funded, Bank’s lien
priority for the entire balance should relate back
to 1/1/2015
Future Advances and Priority
• What if another creditor gets a lien AFTER the original
loan, but BEFORE the later advance?
– 1/1: X gets $50K business loan from Bank; Bank records
future advance mortgage
– 3/1: Plaintiff gets $25K judgment vs. X
– 4/1: X borrows an additional $25K from Bank
• Traditional rule: Bank gets first priority for both
$50K original loan and $25K future advance only
if the future advance was “obligatory” [p. 1192]
• If advance was “optional,” Bank’s priority for the
future advance would date from time of advance
– Priority would look like an “Oreo” [p. 1192]: 1st priority
to Bank (original $50K loan); 2nd priority to Plaintiff
($25K judgment); 3d priority to Bank ($25K optional
advance)
• 6/1: Bank forecloses; sale price = $75K. How to
distribute sale proceeds?
Future Advance Priority Rules
• Rationale for optional/obligatory distinction: blanket future
advance priority could prevent landowner from obtaining
credit based on its equity in land
– Bank should get “relation-back” priority only if it was obligated to
make the advance (thus assuring mortgagor of access to credit)
• Restatement § 2.3(a): rejects optional vs. obligatory
advance distinction; mortgagee has same priority for all
advances
• Restatement § 2.3(b): mortgagor can give “cutoff notice” to
mortgagee, cutting off effectiveness of a future advance
clause going forward
– E.g., X owes Bank1 $200K, Bank1 holds mortgage on X’s home
(securing future advances)
– X gives Bank1 cutoff notice
– Bank2 then loans X $200K, takes 2d mortgage
– Later, Bank1 loans X $100K; then X defaults, Bank1 forecloses,
sells home for $400K
– Distribution: $200K to Bank1, $200K to Bank2
Missouri Future Advance Statute
Missouri Future Advance Statute
• § 443.055(2): “Security instruments may secure
future advances ... whether the advances ... are
optional or obligatory”
• § 443.055(5): “[T]he priority of the lien of a
security instrument securing future advances shall
date from the time the security instrument is
recorded ... whether or not such advances ... are
optional or obligatory ....”
• § 443.055(6): Mortgagor may issue a “stop notice”
cutting off effectiveness of future advance clause
• § 443.055(2): Fact that lien secures future
advances must be clearly stated; deed of trust must
recite it is governed by RSMo. § 443.055; and deed
of trust must recite maximum amount to be secured