SUBROGATION: ITS APPLICATION BY ILLINOIS COURTS.
In Illinois, the general rule is that lien priority is awarded to whoever records a lien against property first. This concept is often referred to as “first in time, first in right.” UnionBank v. Thrall, 374 Ill.App.3d 785, 788 (2nd Dist. 2007); Union Planters Bank, N.A. v. FT Mortgage Companies, 341 Ill.App.3d 921, 924-25 (5th Dist. 2003). If the property encumbered by the lien is eventually sold, the proceeds first go to the holder of the first lien recorded.
But there are exceptions to “first in time, first in right.” Indeed, “blind adherence to the first in time, first in right doctrine is sometimes insufficient to determine lien priority.” Id. at 925. One such exception is called subrogation. Subrogation may be a useful tool in resolving a lien priority case where another party is claiming its lien is superior to that of your client.
Illinois recognizes two forms of subrogation, equitable subrogation and conventional subrogation. The differences are clearly distinguished in Aames Capital Corp. v. Interstate Bank of Oak Forest, 315 Ill.App.3d 700 (2nd Dist. 2000).
Equitable subrogation is a creature of chancery used to prevent unjust enrichment. Id. at 706. To establish equitable subrogation, the equities must be in favor of subrogating the movant into the priority position of the lien holder who the movant paid off. Id. The court looks at all of the facts of the case to determine if the mortgagee is entitled to a first lien position by virtue of equitable subrogation. Id. Equitable subrogation’s application is considered to be rarer than that of conventional subrogation. LaSalle Bank, N.A. v. Cypress Creek 1, LP, 242 Ill.2d 231, 260 (2011) (dissenting opinion).
Conventional subrogation can occur when a mortgage pays off a prior lien. The mortgage may be entitled to the priority enjoyed by the prior lien in the amount of the payoff. Aames Capital, 315 Ill.App.3d at 706.
Another Illinois case that examines conventional subrogation is Union Planters Bank, N.A. v. FT Mortgage Companies, 341 Ill.App.3d 921 (5th Dist. 2003). Conventional subrogation first requires an express agreement between the parties that the party paying the prior creditor will be able to assert the rights of the prior creditor. Id. at 925. In Union Planters Bank, the court examined whether the defendant’s mortgage could be subrogated into a priority position through conventional subrogation. 341 Ill. App. 3d 921 (5th Dist. 2003). The plaintiff argued that the defendant had no express agreement allowing it to assert the rights of the original creditors. Id. at 926.
The Union Planters Bank court found that the form of the language in the contract was not as important as the intent of the parties to the contract. Id. The court further determined that it was clear the defendant intended to receive equal priority in its lien and be able to assert the rights of the mortgages it paid off in the refinance. Id. Ultimately, the court held that the defendant could be subrogated to the position of the prior liens. Id. at 927.
In addition, many modern mortgages include express language related to priority, namely the language “borrower shall promptly discharge any lien which has priority over this Security Instrument . . .”. This phrase is sometimes found in the “Charges; Liens” paragraph of the mortgage, or paragraph 5 in the “Uniform Covenants” section. It can be argued that this provision indicates an intent between the parties that the mortgagee receives a first position lien.
Conventional subrogation also requires that the loan proceeds were 1) used to refinance the mortgage for which the lender seeks to be subrogated, 2) that no harm will come to an innocent party if priority is granted to the lender, and 3) that there has been no gross negligence. Id. at 925.
A party with an intervening interest is not necessarily harmed by conventional subrogation. Id. The Union Planters Bank court ruled that the intervening lienor had constructive knowledge of the prior mortgage when the intervening lienor recorded its judgment. Id. at 927. As a result, subrogating the new mortgage into the position of the prior mortgage placed the intervening lienor in no worse of a position. Id.
For additional reading on equitable subrogation and conventional subrogation see:
Wilmington Savings Fund Society, FSB v. Zarkhin, 2019 IL App (2d) 180439;
Lobo IV, LLC v. V Land Chicago Canal, LLC, 2019 IL App (1st) 170955; and
PBEI Holdings, LLC v. First Nat. Bank of Dieterich, 2015 IL App (4th) 140850-U (unpublished opinion).