New Jersey Courts Continue to Support Unsuspecting Mortgage Lenders

January 2013Articles In the Zone

Mortgage priority lawsuits continue to attract the attention of the New Jersey courts. In that context, the theory of equitable subrogation continues to play a pivotal role. Under that theory, a new mortgage, the proceeds of which are used to pay off an old mortgage, essentially jumps over an intervening mortgage to the extent of the payoff, and stands in the shoes of the old mortgage so long as the new mortgage lender has no actual knowledge of the intervening mortgage. This is true even in the presence of negligence on the part of the new mortgage holder in failing to discovery the existence of the intervening mortgage.

The Appellate Division of the Superior Court of New Jersey continues to hold as such. See, Palladino v. Melchionna, et al., Docket No. A-4877-10T2 (unpublished). The facts there were not in dispute. The Melchionnas purchased an investment property in Linden, New Jersey on March 14, 2006 and financed the purchase with a mortgage of approximately $373,000 from Accredited Home Lenders, Inc. (Accredited). This mortgage was not recorded for over four months, until July 20, 2006. In the interim, on April 10, 2006, the Melchionnas took out a second mortgage from Plaintiff-Palladino. The Palladino loan was secured by a $75,000 mortgage, recorded two days later on April 12, 2006, three months before Accredited recorded its mortgage. When Palladino made his loan, he knew that Accredited was the first mortgage holder on the property.

Thereafter, in September 2006, the Melchionnas refinanced the Accredited mortgage with loans from SouthStar Funding, LLC (SouthStar) totaling almost $400,000. SouthStar’s title search revealed the Accredited mortgage but failed to reveal the Palladino mortgage. SouthStar paid off the Accredited mortgage of approximately $373,000 as part of the refinancing; its mortgage was then promptly recorded after the closing.

By January 2011, both Palladino and SouthStar had begun foreclosure proceedings against the Melchionnas. The parties filed cross-motions asking the court to declare the mortgage held by each as superior to the other. Although New Jersey is a race-notice state1, the lower court applied the doctrine of equitable subrogation, granted SouthStar’s motion for priority and denied Palladino’s motion for priority. The lower court rejected Palladino’s argument that the negligence of SouthStar in not finding Palladino’s lien deprived SouthStar of its equitable position. The lower court held that, even though SouthStar’s security was defective, i.e. by virtue of its having been recorded after the Palladino mortgage, SouthStar, as the refinancing lender, was subrogated by equitable assignment to the position of the lender whose lien was discharged by the proceeds of the loan. This finding was affirmed on appeal. The Appellate Division’s statements on the viability of the doctrine of equitable subrogation are significant: a refinancing lender whose security turns out to be defective is subrogated by equitable assignment to the position of the lender whose lien is discharged by the proceeds of the later loan, there being no prejudice to or justified reliance by a party in adverse interest; equitable subrogation is a remedy highly favored in the law; it is an equitable doctrine applied only in the exercise of the court’s equitable discretion; and equitable subrogation may only be imposed if the cause is just and enforcement is consonant with right and justice.

Equitable subrogation may be afforded even though lack of knowledge on the part of the new mortgagee occurs as a result of negligence. On the other hand, the new lender is not entitled to subrogation, absent an agreement or formal assignment, if it possesses actual knowledge of the prior encumbrance. In this case, while negligence was present, the new lender had no actual knowledge of the Palladino encumbrance. Palladino shouldn’t be unjustly enriched on the basis of SouthStar’s mere negligence; Palladino’s initial intent, to be in second position, was not frustrated.2 Accordingly, SouthStar was granted to priority, not to the extent of its loan, but to the extent of the proceeds used to pay off the Accredited mortgage.


[1] Absent other circumstances, a party whose document is recorded first typically attains priority.

[2] An intervening mortgagee’s knowledge of the first mortgage is not a prerequisite for applicability of the doctrine, but it doesn’t hurt.