Press "Enter" to skip to content

5th Cir. Holds Refinance Mortgagee Not Entitled to Contractual Subrogation When DOT Invalid

The U.S. Court of Appeals for the Fifth Circuit held that a refinance lender is not entitled to contractual subrogation where it does not have a valid deed of trust.

Additionally, the Fifth Circuit certified the question of law to the Supreme Court of Texas regarding whether a lender is entitled to equitable subrogation where it failed to correct a curable constitutional defect in the loan documents under § 50 of the Texas Constitution.

A copy of the opinion in Zepeda v. Federal Home Loan Mortgage Corp. is available at:  Link to Opinion.

In 2007, a borrower took out a purchase-money loan (the “2007 loan”) from a lender to buy her homestead, which was used as collateral for her loan.

In 2011, the borrower took out a second loan (the “2011 loan”) from a different lender to refinance the debt.  The lender and the borrower executed an agreement for an extension of credit under § 50 of the Texas Constitution, secured by a lien on her homestead.

As you may recall, Section 50 of the Texas Constitution provides that no lien on a homestead shall be valid unless it complies with the requirements described in that section.  Among other things, it requires the owner of the homestead and the lender to sign a written acknowledgement of the fair market value of the homestead property on the date the extension of credit is made.

The borrower’s agreement with the lender required the lender to pay the balance of the 2007 loan and release the remainder of the funds to the borrower.  The agreement also contained an express subrogation provision, which provided that the lender would be subrogated to all rights of any other holder of liens or debts outstanding before the agreement was executed. 

Upon the lender’s payment of the balance of the 2007 loan, the prior lender released its claim on the homestead.

The borrower subsequently notified the lender that the loan documents for the 2011 loan contained a constitutional deficiency – namely, that the lender’s signature did not appear on the acknowledgement of fair market value. 

In response, the lender did not sign the document, but instead sent a new copy of the acknowledgement to the borrower, with no explanation for the lack of signature.

Thereafter, a new entity (“loan owner”) became the lender’s successor-in-interest for the 2011 loan.

The borrower sued the loan owner to quiet title, claiming that the loan owner’s failure to comply with the Texas Constitution meant that the loan owner did not possess a valid lien on her property.  In its defense, the loan owner asserted that it was both contractually and equitably subrogated to the original 2007 lien, because its predecessor-in-interest paid off the remainder of that loan.

Both parties filed cross motions for summary judgment, and the district court granted summary judgment on the borrower’s quiet title claim and denied the loan owner’s claim for contractual and equitable subrogation.  In reaching its decision, the trial court found that the loan owner could not avail itself of contractual subrogation because it did not have a valid contract.  The trial court also denied equitable subrogation because it found that the loan owner was negligent and therefore could not claim an equitable remedy.

The loan owner appealed the denial of its claim for both contractual and equitable subrogation.  Neither party disputed the validity of the 2007 loan or the invalidity of the 2011 loan.

On appeal, the Fifth Circuit first addressed the contractual subrogation claim, which it explained “arises from a valid deed of trust executed by both the borrower and lender.”

The Court noted that the loan owner failed to sign the acknowledgement of fair market value as required, and that it did not cure the deficiency after being properly notified by the borrower.  As a result, “it follows that the deed of trust is invalid, and that precludes any contractual subrogation.”

The Fifth Circuit therefore affirmed the trial court’s ruling on the contractual subrogation claim.

The Court next turned to the equitable subrogation claim, explaining that “equitable subrogation occurs when a subsequent lender pays off an existing debt, regardless of whether the subsequent loan was valid.”

The Fifth Circuit stated that “[s]ince at least 1890, the Texas Supreme Court has applied equitable subrogation in the face of a constitutionally-invalid home-equity loan.”  However, none of the cases “involve a constitutional defect that is exclusively the fault of the lender, as is the case here.”

The Court then asked “[i]f the party seeking equitable subrogation could have satisfied the requirements of § 50(a)(6)(Q)(ix) but failed to do so, does that failure preclude it from invoking equitable subrogation?” 

Because the Supreme Court of Texas has never before answered that question, the Fifth Circuit certified the following question for the Supreme Court of Texas: “Is a lender entitled to equitable subrogation, where it failed to correct a curable constitutional defect in the loan documents under § 50 of the Texas Constitution?”

Print Friendly, PDF & Email

Jeffrey Karek practices in Maurice Wutscher's Commercial Litigation, Consumer Credit Litigation, and Appellate groups. He has substantial experience in defending consumer finance lawsuits in both state and federal trial courts, and on appeal. Such litigation includes allegations brought under TILA, HOEPA, RESPA, FDCPA, TCPA, FCRA, and state consumer protection statutes, including in the defense of putative class actions. Jeff received his Juris Doctor from the University of Michigan Law School, and graduated magna cum laude with a Bachelor of Business Administration degree from Western Michigan University.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.