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
2 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.
1 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.
3 ¶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.
4 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
5 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
6 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.
8 ¶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
10 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.
11 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
14 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