Lien Priority: First in Time, First in Right?  Not Always

Real Estate Lien Priority: First in Time, First in Right?  Not Always

An Illinois Appellate Court has provided a refresher on Illinois law concerning real estate lien priorities, in AS1, LLC v. Celtic Home Solutions, LLC, et al., 2022 IL.App (1st) 220485 (December 23, 2022).  

Although the facts of the case are more convoluted, the reader's digest version is as follows.  In 2015, a homebuyer purchased property and in doing so gave back a mortgage lien to the seller to finance the purchase.  In 2016, the homebuyer then refinanced the purchase-money mortgage, paying it off in full.  The 2016 refinance mortgage contained a subrogation clause stating that, if the refinance mortgage funds were being used to pay off a prior mortgage lien, then the refinance lender shall stand in the shoes of the prior lienholder as to all rights, titles, liens and equities, owned or claimed by the prior lienholder, regardless of whether the prior lienholder has released their lien upon payment.  

The refinancing closed on October 18, 2016, and the mortgage was recorded with the county recorder's office several weeks later on November 16, 2016.

At around the same time as the 2016 refinancing, a creditor had filed a lawsuit against the homeowner and successfully obtained a money judgment for $117,601.50.  The creditor then recorded its judgment lien with the county recorder's office on October 18, 2016, the same day as the refinancing closing but a few weeks before the refinancing mortgage was recorded, meaning the judgment creditor was prior in time to record.  Thereafter, the homeowner failed to pay the refinanced mortgage, and foreclosure proceedings were initiated.  

Which lienholder was entitled to be paid first from the foreclosure auction sale proceeds?  First in time, first in right?  Not so here.  

In this case, the court held that the 2016 refinance mortgage "conventionally subrogated" to the 2015 purchase money mortgage, meaning the 2016 refinance mortgage was deemed first in line with respect to the foreclosure sale proceeds, up to the amount owed on the 2015 mortgage loan at the time it was refinanced, ahead of the judgment creditor even though it recorded its lien first.

In reaching this legal conclusion, the Appellate Court gave the following refresher on Illinois law (internal citations omitted):

We begin with a few familiar legal principles regarding priority of liens against real property. A lien is “ ‘a charge upon property, either real or personal, for the payment or discharge of a particular debt ***; an encumbrance upon property as security for the payment of a debt; or a hold or claim on another’s property as security for the payment or performance of a debt, duty, or other obligation.’ ” 

A mortgage is a type of consensual lien on real property. Specifically, it is an interest in land created by a written instrument that secures real estate to ensure the payment of a debt. A mortgage lien is created upon recording of the mortgage with the county recorder of deeds. 

Quite often, the value of real property is insufficient to satisfy all the debts represented by the liens encumbering it. At common law, satisfaction of these liens and debts was governed by the “first-in-time, first-in-right” rule. Under that rule, a lien that is recorded first in time generally has priority and is entitled to prior satisfaction of the property it binds.

The Conveyances Act (Act) codifies the common law rule. Section 28 of the Act provides that deeds, mortgages, and other instruments relating to or affecting the title to real estate shall be recorded in the county in which such real estate is situated. ***

The Act thus allows third parties to readily ascertain the status of title to real property. A purchaser of real estate may rely on the public record of conveyances and instruments affecting title, unless he has notice or is chargeable with notice of a claim or interest that is inconsistent with the record.

As the dispute before us illustrates, the doctrine of first in time, first in right is not without its exceptions. A separate body of law governs lien priority in cases involving renewal or refinancing notes and mortgages. *** "...One who asserts a right of subrogation must step into the shoes of, or be substituted for, the one whose claim or debt he has paid and can only enforce those rights which the latter could enforce.”

Illinois law recognizes two types of subrogation: conventional and equitable. Conventional subrogation can occur when the parties expressly agree that the party paying the debts on behalf of the third party can assert the rights of the original creditor. Conventional subrogation is commonly seen in modern refinancing transactions. A new lender seeking to be subrogated in lien priority when refinancing must demonstrate (1) there is an express agreement providing that the new lender will be able to assert the rights of the original creditor, (2) the previous debt was in fact paid off by the new lender, (3) no harm will come to an innocent party if priority is granted to the lender, and (4) there was no gross negligence. Additionally, the lien priority is limited to the original amount perfected by the previous creditor.

Although the judgment lienholder lost out on its $117,601.50 lien priority, the Appellate Court concluded that no harm came to an "innocent party" by this result, because the judgment lienholder had constructive knowledge of the 2015 purchase-money mortgage that was already recorded and encumbering title to the property when the judgment lien was recorded.  

This case underscores that 'first in time' does not always mean 'first in right.'