Jeffrey B. Steiner and Dino Fazlibegu

One of the most important features of a loan collateralized by real property is the priority of the lien of the mortgage. Attorneys representing mortgage lenders must remain conscientious when drafting loan documents and reviewing diligence or they might find themselves in the situation where their client's mortgage was primed by another mortgage. A recent decision from the Second Department of New York's Appellate Division, JPMorgan Chase Bank v. Zhan Hua Cao (2018 NY Slip Op 02603) serves as an example that there is no substitute for careful review of the details.

'Zhan Hua Cao'

In the Zhan Hua Cao case, JPMorgan Chase Bank, National Association (JPMorgan) had purchased loans purportedly secured by real property pursuant to a note and mortgage executed in 2005. The mortgage contained a standard metes and bounds description that included two lots, Block 5150, Lot 48 and Lot 49, in Flushing, Queens. However, the mortgage had, in fact, referred only to Lot 48 and was, therefore, recorded only against Lot 48. Subsequently, in 2008, E.R. Holdings, LLC (Holdings) had recorded a mortgage against both lots (properly referring to each lot), which mortgage was recorded as a second lien against Lot 48, and as a first lien against Lot 49. In 2009, JPMorgan attempted to foreclose on both Lots. Holdings asserted affirmative defenses and a counterclaim for judgment declaring itself to be holder of the superior, valid first lien on Lot 49.

JPMorgan proceeded with foreclosure, claiming that its mortgage used the correct legal description, thus illustrating the intent to encumber both parcels. Both the trial court and the appellate court disagreed. “Contrary to the plaintiff's contention,” the Second Department stated, “there is no rule that it is the metes and bounds description that determines what property is encumbered by any mortgage and not the street address or tax lot numbers. Rather, where, as here, there is a conflict between the metes and bounds description and the street address and/or tax lot numbers given in the mortgage, there is an ambiguity that requires consideration of parol evidence.”

The court found that the threshold issue is whether JPMorgan and the borrower intended for JPMorgan's mortgage to encumber both lots. If, at trial, the court finds that this indeed was the intent, the court would then proceed to determine whether Holdings's mortgage was a first mortgage on Lot 49.

Determining Priority

In order to determine which lender, JPMorgan or Holdings, has the superior mortgage, the court would analyze the facts of the case in relation to the New York “race-notice” recording statute and related case law. See Real Property Law §291. The general rule is that a transferee can take the transferred interest free of a prior lien so long as the transferee has “no knowledge of the outstanding lien and win[s] the race to the recording office.” Goldstein v. Gold (483 N.Y.S.2d 375 affd 66NY2d 624).

In practice, cases in which a later transferee wins the race to the recording office depend on whether (i) the later transferee had knowledge of facts that would lead an ordinarily prudent person to suspect a possible prior transfer, and (ii) if so, whether the transferee followed-up with a reasonable investigation. See Matter of Hill (943 N.Y.S.2d 558).

For example, in Gerow v. Sinay (905 N.Y.S.2d 827), Mortgage Lenders Network USA (Mortgage Lenders) provided a mortgage loan to the borrowers and received a mortgage on Oct. 31, 2003, which mortgage was recorded on November 13, 2003. The borrowers thereafter granted another mortgage on their property to the plaintiffs on Nov. 5, 2003, which mortgage was recorded on Nov.12, 2003. The plaintiffs claimed that because their mortgage, though granted after the Mortgage Lenders' mortgage, was recorded first, their mortgage should be deemed superior to the Mortgage Lenders' mortgage. The court ruled that the plaintiffs would receive the benefit of the recording statute only if they were good faith mortgagees.

To be a good faith mortgagee, one must prove that it did not have actual, constructive or inquiry notice of the prior lien. The court ruled that the plaintiffs had actual or constructive notice of the Mortgage Lender's mortgage because of a stock purchase agreement prepared by plaintiffs' attorney. The stock purchase agreement referred to a note to be executed by the borrowers to plaintiffs and which was to be “collateralized as and for a second mortgage on the buyers residence.” Additionally the stock purchase agreement stated that the mortgage tax and recording expenses “on the second collateral mortgage” would be paid by the borrowers. Based on the language in the stock purchase agreement, the court ruled that the plaintiffs were obligated to make some inquiry.

Furthermore, the plaintiffs' attorney was aware that the borrowers intended to refinance the property prior to the transaction with the plaintiffs. Even though the attorney did not have specific notice that the refinancing occurred, his knowledge was imputed to his principals, and the plaintiffs are bound to that knowledge, which was sufficient to place them on inquiry notice. Accordingly, the court ruled that the plaintiffs were not good faith mortgagees and the Mortgage Lenders' mortgage had priority over the plaintiffs' mortgage.

On the other hand, in Residential Funding Corporation v. Epps (901 N.Y.S. 2d 902), the defendant Peter Epps obtained a loan from, and granted a mortgage to, Accredited Home Lenders (Accredited) in 2003. The Accredited mortgage, however, was recorded with an incorrect lot designation. In 2004, Epps sold the property to Musa Ali, and Ali obtained a loan from, and granted a mortgage to, Wells Fargo, which mortgage was properly recorded. Plaintiffs commenced an action to foreclose the Accredited mortgage in 2008. Wells Fargo asserted as a defense that because the Accredited mortgage was improperly indexed, it should be removed from record as a cloud on title.

The court concluded that, because of the improper indexing and because Epps never informed Wells Fargo of the existence of the Accredited mortgaged, Wells Fargo had neither actual nor constructive notice of the Accredited mortgaged. Therefore, the court ordered that the Accredited mortgage be removed from title.

Conclusion

As the cases discussed in this article demonstrate, attorneys representing mortgage lenders must be vigilant when preparing mortgage loan documents and performing due diligence to ensure that the descriptions of the collateral, wherever referenced and in whatever form they take, are consistent throughout the documents. Attorneys must also follow up on any indication of which they become aware regarding any mortgage that might have been executed prior to their client's mortgage in order to avoid the situation in which their client would not be deemed to be a good faith mortgagee.

Jeffrey B. Steiner and Dino Fazlibegu are partners at McDermott Will & Emery. John Bauco and Shane Goodhue, associates at the firm, assisted in the preparation of this article.