Loan Modifications and Losing Lien Priority
Modifying a loan can sometimes cause a loss of lien priority. It all depends on the facts underlying the modification, and even the original loan.
A recent opinion by California’s Fourth Appellate District — SMN LO, Inc. v. M & A Enterprises, LLC — provides one interesting illustration of a lien losing its priority after a modification, although the problem had more to do with the original lien than with the modification. While the opinion is unpublished and therefore not precedential, it still provides a useful guidepost.
Facts: loan secured by second position lien is substantively modified
M & A Enterprises, Inc. (“M&A”) held a second position deed of trust on a 12-unit apartment building in Ontario securing a $160,000 loan. The note reflecting the loan did not state when the unpaid principal was due, did not contain a future advance clause, and did not allow M&A to make additional loans secured by the same deed of trust.
SMN LO, Inc. held a third position deed of trust securing a loan for $110,000, and Hanh Thi Tran held a fourth position deed of trust securing a loan of $200,000.
After Tran’s fourth position deed of trust was recorded, M&A recorded a modification of its second position deed of trust, increasing the secured debt from $160,000 to $410,000 and making the entire debt immediately due and payable, triggering a default. M&A then commenced nonjudicial foreclosure proceedings on its original deed of trust. M&A paid the first position deed of trust holder over $825,000 to pay off that first position lien.
Shortly after M&A initiated the foreclosure, SMN sued to determine the priority of the competing liens. The trial court ordered that all proceeds above $160,000 from M&A’s foreclosure sale would be held in escrow until the lien priorities were determined.
Trial court: entire lien lost its priority
After a bench trial, the trial court ruled that M&A’s second position deed of trust, both as originally recorded and as modified, lost its priority to SMN’s and Tran’s deeds of trust.
The court held: “Any modification to a senior mortgage that shortens the maturity date of the loan or increases the debt is considered a material modification, such that the senior mortgage will lose its priority to the junior mortgage.”
Court of Appeal: affirmed
The Court of Appeal disagreed with the trial court’s analysis, but nonetheless affirmed the judgment.
Contrary to the trial court’s reasoning, the Court of Appeal held that “in some circumstances, equity requires only that the modified portion of a senior lien, and not the unmodified portion, will lose priority to junior liens.” But here, the Court of Appeal agreed that M&A’s entire lien, including the unmodified portion securing the $160,000 sum, “must lose its priority[.]”
The Court of Appeal’s rationale focused less on the modification and more on M&A’s failure to show that it had a “valid lien” on the Ontario property for the original loan amount.
The evidence at trial confirmed that a debt from the borrower to M&A existed at the time the original deed of trust was recorded. However, M&A could not show how much of the debt had been repaid at the time of trial. M&A had been given other deeds of trust on other properties securing the debt from the borrower, some of which had been foreclosed on and later sold. M&A had also collected rents from the Ontario property that were required to be credited against the deed of trust. But M&A couldn’t account for any of those sums. The evidence suggested that M&A had received at least its $160,000 lien amount through its rent collections.
Thus, since M&A could not show that its second position deed of trust secured a “valid lien” on the property for $160,000, it had nothing to place senior to SMN’s and Tran’s deeds of trust.
Lesson
Modifying a loan can sometimes cause a loss of lien priority. But lien priority can also be lost if the lender cannot prove the existence of a valid debt and lien.