In a per curiam ruling, the Supreme Court of Texas recently held that the holder of a deed of trust was entitled to foreclose through equitable subrogation, even after it had failed to timely foreclose on its deed of trust.
Answering a certified question presented by the U.S. Court of Appeals for the Fifth Circuit, the Supreme Court of Texas held that 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 in Fed. Home Loan Mortg. Corp. v. Zepeda, 601 S.W.3d 763, 764 (Tex. 2020).
Applying Zepeda to the facts in this case, the Supreme Court of Texas held that the mortgagee maintained its equitable subrogation rights to assert a preexisting lien that was paid off with the proceeds from its loan, and its failure to timely foreclose under the deed of trust did not bar its subrogation rights.
A copy of the opinion in PNC Mortgage v. Howard is available at: Link to Opinion.
In 2003, husband and wife borrowers purchased a home with loans secured by two purchase-money liens on their property. Two years later, the borrowers refinanced the mortgages with a new loan through a different lender and paid off the purchase-money mortgages. The note and deed of trust securing the loan were subsequently assigned to and acquired by a new lending entity (“mortgagee”).
After the borrowers stopped making payments on the loan, in January 2009, the mortgagee notified the borrowers of their default and intent to accelerate the loan, and five months later, accelerated the note. Meanwhile, the original lender initiated foreclosure proceedings against the borrowers despite having assigned the loan to the mortgagee, which resulted in a foreclosure sale of the property to the original lender.
The borrowers filed suit against the original lender seeking to set aside the foreclosure sale on this basis, while adding the mortgagee as an interested party defendant. After the trial court declared the foreclosure void ab initio as to the original lender, in January 2015 the mortgagee asserted counterclaims against the borrowers seeking to foreclose the deed of trust lien, or alternatively, judgment declaring its right to foreclose through equitable subrogation should the trial court determine that the four years statute of limitations to foreclose after acceleration had lapsed. The mortgagee also filed a separate suit against the borrowers alleging breach of the loan, which was consolidated with the underlying action.
In ruling on the parties’ joint motion for judgment based on stipulated facts, the trial court entered judgment against the mortgagee, declaring the loan’s note and deed of trust lien unenforceable. The mortgagee appealed.
On appeal, the mortgagee argued that because the borrowers had used the loan’s proceeds to discharge the two pre-existing purchase-money mortgages, it held an equitable lien on the borrowers’ property.
Noting that the mortgagee failed to take corrective action after the borrowers’ suit provided notice to the mortgagee that the wrong entity had foreclosed the property, the court of appeals affirmed the trial court’s judgment, holding that the mortgagee’s negligent failure to timely foreclose the deed of trust lien barred its subrogation rights.
The appellate court’s ruling relied in part on the Supreme Court’s opinion in Zepeda v. Federal Home Loan Mortgage Association, which presented similar facts: the plaintiff borrower purchased a home with a loan secured by a mortgage lien, and later refinanced the debt, using its proceeds to pay off the balance of the first loan.
The borrower in Zepeda later notified the refinancing lender that its loan documents contained a constitutional defect, and requested that it cure the defect, but it failed to do so before selling the loan. After the new noteholder similarly failed to cure the defect, the borrower in Zepeda filed suit to quiet title in federal court, which held that the noteholder was not entitled to equitable subrogation because it negligently had failed to cure the constitutional defect in its loan documents.
Two months after the court of appeals’ ruling in this case, the lender in Zepeda appealed to the U.S. Court of Appeals for the Fifth Circuit, which certified the question of 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?” to the Supreme Court of Texas, which answered in the affirmative. Zepeda v. Fed. Home Loan Mortg. Corp., 935 F.3d 296, 301 (5th Cir. 2019); Fed. Home Loan Mortg. Corp. v. Zepeda, 601 S.W.3d 763, 764 (Tex. 2020).
In answering the Fifth Circuit’s certified question, the Supreme Court of Texas reasoned that equitable-subrogation rights become fixed at the time the proceeds from a later loan are used to discharge an earlier lien, and a lender’s negligence in preserving its rights under its own lien does not deprive the lender of its rights in equity to assert an earlier lien that was discharged using proceeds from the later loan. Zepeda, 601 S.W.3d at 766.
Based on this ruling, the mortgagee petitioned the Supreme Court of Texas for review, contending that the opinion in Zepeda required reversal of the court of appeals’ judgment.
Applying Zepeda to this case, the Supreme Court of Texas agreed that the mortgagee’s failure to timely foreclose under the deed of trust lien did not bar its subrogation rights, reasoning that subrogation operates as a hedge against the risk of refinancing the outstanding amount of an existing loan, permitting a lender to assert rights under a lien its loan has satisfied when the lender’s own lien is infirm. Zepeda, 601 S.W.3d at 768.
The Court rejected the borrowers’ attempts to distinguish Zepeda by arguing that this case involved purchase-money mortgages rather than a home-equity loan at issue in Zepeda, and their argument that a statutory default — the mortgagee’s failure to timely take action on the deed of trust lien — bars subrogation when a constitutional defect does not. Because the borrowers’ additional arguments — that the mortgagee’s subrogation rights were time-barred and not permitted under the deed of trust lien — were not addressed by the appellate court, these issues were remanded to the court of appeals for consideration.
Accordingly, the Court reversed the court of appeals’ judgment declaring the mortgagee’s equitable subrogation rights unenforceable and remanded for further proceedings consistent with its opinion.