Equitable Subrogation Part Deux: Mechanic’s Lien vs. Later Bank Deed of Trust

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This post follows, almost two years to the day, Rick Erickson’s post of August 29, 2014. As noted by Rick Erickson in his August 29, 2014 post, the Arizona Supreme Court in the Weitz case (2014) had determined that equitable subrogation principles were applicable to enable an earlier-recorded mechanic’s lien to be trumped by a later-recorded bank deed of trust, if the loan secured by the later deed of trust paid off a lien that had been ahead of the mechanic’s lien.  In a decision filed August 9, 2016, the Arizona Court of Appeals further clarified the scope of such equitable subrogation.

In Markham Contracting Co., Inc. v. FDIC, No. 1 CA-CV 14-0752 (August 9, 2016), the Arizona Court of Appeals addressed a situation where a first-recorded deed of trust was followed by a second-recorded mechanic’s lien; and then, after the mechanic’s lien was recorded, a new lender made a secured construction loan that was used, in part, to pay off the loan that was secured by the first-position deed of trust.  The key being “in part.”  The subsequent lender loaned $4.8 million, but only $2.9 million went to pay off the balance owing on the first-position deed of trust.

At the trustee’s sale, the later lender made a credit bid of $3.175 million. The Court of Appeals held that a proper credit bid on the first-position portion of the later loan would have been limited to approximately $2.9 million, and therefore the credit bid was “unlawful.”  The credit bid was the successful bid at the trustee’s sale.  In effect, the Court of Appeals determined that the portion of the credit bid “purchase amount” above $2.9 million should have been paid to the mechanic’s lien holder for its second-positon lien.  Because the mechanic’s lien holder did not receive any of the trustee’s sale proceeds, even though the purchase price at the trustee’s sale exceeded the amount of the first-position lien (to which the later lender was equitably subrogated), the Court of Appeals held that the mechanic’s lien was not extinguished by the trustee’s sale.

The lesson from Markham:  although equitable subrogation principles will ordinarily apply when a post-mechanic’s lien lender pays off the first position lien that was ahead of the mechanic’s lien, whether the mechanic’s lien is extinguished by the trustee’s sale will depend on the specifics of the trustee’s sale.