Watch Out for the Exception to the Exception to the Rule: Contrasting Arizona, Colorado, New Mexico and Nevada Law on Equitable Subrogation
In America, we employ a system of recording title to real property whereby the entity that first records an interest in the property ordinarily has the first right of title or ownership in that property. There is an exception to this rule, however, known as equitable subrogation.
Put simply, this exception comes into play when one pays another’s debt, and can therefore claim the first debtor’s earlier recording date when determining ownership priority.
For those involved in construction, real estate, financing and underwriting of title, this concept of equitable subrogation can be especially important to understand. Further complicating matters is the fact that the approach to equitable subrogation can vary from state to state, and depending on other factors.
One factor that may change how equitable subrogation may be applied differently around the country is in the context of mechanics’ liens. One may think of a mechanics’ lien as an involuntary mortgage or trust deed that contractors record against real property for work done. Consider a refinancing situation where a subsequent lender (for instance, a mortgage) often repays earlier loans, (such as a construction loan), with the understanding that the later-recorded interest will “leap-frog” over any intervening lien holders, and automatically assume the earlier recording date of the paid-off debt. In this case, it is important to understand how the doctrine of equitable subrogation may – or may not -- apply in a specific jurisdiction when determining ownership priority in relation to mechanics’ liens.
In Nevada, the mechanics’ lien statute expressly provides that every mortgage, trust deed, or encumbrance imposed on real property after the commencement of construction of a new improvement or a remodeling is subordinate and subject to the mechanics' liens regardless of the recording dates of the notices of liens (Nev. Rev. Stat. 108.225). Arizona law is similar, though the starting point for subordination is ten days after construction begins (See A.R.S. § 33-981). Thus, it is possible that, at least in these two states mechanics’ liens can have priority over lenders’ deeds, depending upon when construction starts vs. when the deed was recorded.
So, there are rules, there are exceptions, and there, occasionally, exceptions to the exception. Given this, we recommend that if you have a question, you consult with counsel before making priority determinations related to either liens, lending or title.
In Nevada, the Supreme Court has ruled that the doctrine of equitable subrogation does not apply against mechanics’ liens. In re Fontainebleau Las Vegas Holdings, 289 P.3d at 1212. As the court explained, the state legislature created a specific statutory scheme whereby a mechanic's lien is afforded priority over a subsequent lien, mortgage, trust deed, or encumbrance in order to safeguard payment for work and materials provided for construction or improvements on land. Therefore, in Nevada, the mechanics’ lien claimants would win any priority dispute.
In Arizona, equitable subrogation generally does apply to override lien rights so long as the second lender is purchasing the entirety of the interest on a particular part or parcel of land. See Weitz L.L.C. v. Heth, 235 Ariz. 405, 410, 333 P.3d 23, 28 (2014).
In Colorado, equitable subrogation can permit another party to step into the shoes of an original lienholder as subrogee if five prerequisites are met Joondeph v. Hicks, 235 P.3d 303, 306 (Colo. 2010) (quoting Hicks v. Londre, 125 P.3d 452, 456–58 (Colo. 2005)):
(1) the subrogee [one who invokes equitable subrogation] made the payment to protect his or her own interest,
(2) the subrogee did not act as a volunteer,
(3) the subrogee was not primarily liable for the debt paid,
(4) the subrogee paid off the entire encumbrance, and
(5) subrogation would not work any injustice to the rights of the junior lienholder.”
However, a party seeking to invoke equitable subrogation with actual knowledge of the junior lienholders and their priority positions may not be permitted to invoke the doctrine. Joondeph, 235 P.3d at 307–08.
In New Mexico, the determination whether “one who advances money to discharge a prior lien” can invoke equitable subrogation is “guided by equitable considerations in determining the priority of liens.” Resolution Trust Corp. v. Barnhart, 116 N.M. 384, 390, 862 P.2d 1243, 1249 (Ct. App. 1993). The relevant “considerations include whether the senior lienholder had actual knowledge of the intervening lien and whether the intervening lienholder would be unjustly enriched by advancing its lien in priority.” Id.