By James L. Windsor, Real Estate Claims & Title Insurance Solutions

In February 2018, we issued a Title Insurance Client Alert on a very significant opinion of the Fairfax County, Virginia Circuit Court regarding subordination agreements, the rule of partial subordination, and related issues of lien priority. This was an issue of apparent first impression in Virginia. The circuit court decided that a lienholder could subordinate its first-priority lien to one of its subsequent liens, without waiving its priority with respect to any other liens or as to any third party claims. On November 27, 2019, the Supreme Court of Virginia (the “Court”) affirmed the decision of the circuit court in Futuri Real Estate v. Atl. Trustee Servs., LLC, Record No. 181501, 2019 Va. LEXIS 148 (opinion attached).  

The borrowers owned real property which was encumbered by three separate lines of credit: (1) a first-priority lien held by Wells Fargo in the amount of $415,000 (the “2005 Wells Fargo lien”); (2) a second-priority lien held by SunTrust in the amount of $220,000 (the “SunTrust lien”); and (3) a third-priority lien also held by Wells Fargo in the amount of $252,007.33 (the “2006 Wells Fargo lien”). In 2006, a Subordination Agreement (the Agreement) was recorded which provided, in pertinent part, that “Lender [Wells Fargo] has been requested to and has agreed to subordinate the lien of the Original Security Instrument [the 2005 Wells Fargo lien] to the lien of the Subsequent Security Instrument [the 2006 Wells Fargo lien].”

The borrowers defaulted on the loan secured by the SunTrust lien and the property went into foreclosure. In January 2017, the substitute trustee sold the property at public auction to Futuri Real Estate, Inc. (Futuri) for $468,000. The substitute trustee submitted its final accounting of the foreclosure sale to the commissioner of accounts. The accounting stated that from the $468,000 sale proceeds it disbursed $44,772.50 in applicable taxes, fees, and costs and $224,579.56 to SunTrust in full satisfaction of the loan secured by its lien with interest and late charges, leaving a surplus of $201,647.94 for other disbursements.

A dispute arose between Futuri and Wells Fargo concerning the disbursement of the surplus funds. The substitute trustee filed an interpleader seeking an order to pay the surplus funds to the Clerk of Court pending a judicial determination of the proper recipients. Futuri filed a cross‑claim against Wells Fargo seeking a declaratory judgment that the Agreement ousted the 2005 Wells Fargo lien from its first priority position and put it in line behind the 2006 Wells Fargo lien, and therefore, the SunTrust lien was moved into first priority over the 2005 and 2006 Wells Fargo liens. Following this reasoning, Futuri sought an order that the foreclosure on the SunTrust lien was of a first-priority lien and that the foreclosure extinguished both Wells Fargo liens.

The circuit court ruled in favor of Wells Fargo. It determined that Virginia law was in harmony with the partial subordination rule because it does not interfere with the rights or position of intervening lienors not parties to the subordination agreement, does not create a windfall to the intervening lienors by elevating their priority positions as the complete subordination rule does, and that, where the intent of the parties to a subordination agreement is clear, less than perfect drafting of the subordination agreement should not defeat that intent. Concluding that the plain language of the Agreement demonstrated that Wells Fargo intended to impact only the 2005 Wells Fargo lien and the 2006 Wells Fargo lien, the circuit court held that the Agreement was a partial subordination agreement, dismissed Futuri’s cross-claim and request for declaratory judgment, and denied Futuri’s subsequent motion for reconsideration.

Futuri appealed, noting two assignments of error: (1) the circuit court erred by following the rule of partial subordination, especially where the intent of the parties at the time of the Agreement was ambiguous; and (2) the circuit court erred by finding the Agreement unambiguous on its face. On appeal, Futuri argued that the trial court should have adopted the complete subordination rule.

With respect to the first assignment of error, the Court noted that the partial subordination rule begins with the basic rule of contract construction that a contract is to be interpreted to enforce the intent of the parties. A partial subordination exists if the terms of the subordination agreement clearly intend to affect only the priority of the liens held by the parties to the agreement and if it does not affect the priority status of any intervening or other lienholders. The Court agreed with the circuit court that the partial subordination rule is the better rule. This was true even though the complete subordination rule might be simpler and more straightforward. The fundamental problem with the complete subordination rule is that it deviates from Virginia law. The complete subordination rule results in raising the priority of intervening lienholders, thereby making them third-party beneficiaries to an agreement in which they are not even mentioned, and giving them the windfall of being elevated to a higher priority position.

With respect to the second assignment of error, the Court agreed with the holding of the circuit court that the Agreement on its face clearly addressed, and was intended to address, only the priority status between the two Wells Fargo liens. The Court rejected Futuri’s argument that the failure to address the priority status of the SunTrust lien relative to the Wells Fargo liens made the Agreement ambiguous and that the circuit court should have resorted to parol evidence to determine the intent of the Agreement.  

The Court affirmed the judgment of the circuit court adopting the partial subordination rule to construe the Agreement, determining that the Agreement was not ambiguous, and dismissing Futuri’s cross-claim with prejudice. The Court entered final judgment in favor of Wells Fargo.

If you have any questions regarding this significant opinion on an issue of first impression in Virginia, or title and real property issues in general, please contact Jim Windsor at (757) 873.6308 or jlwindsor@kaufcan.com or Dan Basnight at (757) 873.6309 or dfbasnight@kaufcan.com.  

The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.