Lenders not always protected by equitable subrogation

Very soon the Kentucky Supreme Court will publish its April 21, 2011 opinion limiting the applicability of equitable subrogation by lenders against taxing authorities. In the consolidated appeal of Wells Fargo Bank, Minnesota N.A. v. Commonwealth of Kentucky, 2008-SC-000419-DG, and Central Bank of Jefferson County, Inc. v. Commonwealth of Kentucky, 2008-SC-000427-DG, the Court determined that prior recorded general tax liens take priority over later filed mortgage liens, and that lenders having actual or constructive knowledge of an earlier recorded general tax lien may not rely on equitable subrogation to reorder lien priority. The facts in each case were simple. General tax liens under K.R.S. 134.420, now K.R.S. 131.515, had been recorded against the borrowers having an interest in the real properties. The lenders, which respectively held a refinanced mortgage and a purchase money mortgage, foreclosed on the respective real properties when the borrowers became delinquent on their obligations to the lenders. Both of the circuit courts below ruled that the lenders’ liens took priority over the prior recorded general tax liens. The appellate courts reversed the rulings, and the Court agreed.

Without tax revenue, the Court noted that government would grind to a screeching halt, thus it is imperative that citizens pay their fair share to provide essential government services. If the arguments of the lenders were accepted according to the Court, rarely would the Commonwealth realize tax revenue. Moreover, the Court noted that lenders have the means to protect themselves against any tax lien they consider unjust by requiring that the tax liens be paid prior to lending, or alternatively, choosing not to lend.

In situations where general tax liens exist of record prior to a refinance or a purchase money mortgage, the Court declined to apply the theory of equitable subrogation which would have allowed a creditor paying the debts of another to stand in the shoes of the original creditor, enjoying its rights and remedies. Instead, the Court determined that a lender having actual or constructive knowledge of an earlier general tax lien must resolve the lien prior to lending, or accept the lien on the real property, as there will be no equitable reordering of these general tax liens. The Court firmly asserted that equitable subrogation will not relieve a lender of a negligent title examination, and that if the lender chooses, by necessity or by mistake, to lend in spite of a cloudy title, the lender shall bear the risk the that borrower will default before the end of the loan term.

If you have any questions, please contact Chrissie Turner at [email protected].