Another day, another post about mortgage priority. Last week, I posted about how refinancing a first mortgage impacts its priority — click here if you don't remember — and now comes an even more interesting, and more unique, case about mortgage priorities.
In Rosenthal & Rosenthal, Inc. v. Benun, plaintiff was a factoring company (factoring is the sale of accounts receivable at a discount price). It entered into two factoring agreements with several entities owned by Jack Benun and his family (the "Benun Companies"). Each of the factoring agreements was personally guaranteed by defendant, Vanessa Benun, Jack Benun's daughter, and each of her personal guarantees was secured by a mortgage on property she owned in Ocean Township. These mortgages were recorded in 2000 and 2005 respectively. Each mortgage contained both a "dragnet clause" — a provision stating that if the borrower ever becomes liable to the lender on any other loan, the mortgage will also secure that loan — and an anti-subordination clause.
In 2007, after both of the above mortgages were recorded, Ms. Benun gave the law firm Riker Danzig a mortgage on the same property in Ocean Township that secured her personal guarantees on the two factoring agreements. The purpose of this mortgage was to secure payment of almost $1.7 million owed to Riker Danzig by Mr. Benun at that time. After the mortgage was recorded, plaintiff's counsel sent an email to Riker Danzig acknowledging the Riker Danzig mortgage. More importantly for the purpose of the Appellate Division;s decision, plaintiff also continued to make disbursements to the Benun Companies under the factoring agreements after the Riker Danzig mortgage was recorded and acknowledged by plaintiff.
When the factoring agreements (and the personal guarantees) went into default, plaintiff filed a foreclosure complaint against Ms. Benun, her husband, and Riker Danzig. Ms. Benun and her husband did not file an answer, but Riker Danzig did, raising a number of affirmative defenses, including that its mortgage had priority over plaintiff's mortgages. Both sides subsequently filed for summary judgment. The Chancery Division granted plaintiff's motion and Riker Danzig appealed.
The Appellate Division reversed. It noted that the mortgages made in favor of plaintiff were future advance mortgages," which, as the name suggests, provide that the property encumbered by the mortgage acts as security not only for the funds advanced at the time of the mortgage, but also for obligations incurred after this initial advance. Under New Jersey law, determining whether a future advance mortgage has priority over a later-recorded mortgage depends on (1) the nature of the future obligations secured by the future advance mortgage and (2) whether the lender under the future advance mortgage has actual notice of the later-filed mortgage. If a lender's future obligations under a future advance mortgage are optional and the lender has actual knowledge of an intervening mortgage, then any advances made after the intervening mortgage is recorded will be subordinate to the intervening mortgage. Under this scenario, advances made prior to the lender's actual knowledge of the intervening mortgage still have priority, but not advances made after.
In Rosenthal, all of the advances plaintiff sought to recover were optional. And, all of the advances came after plaintiff had actual knowledge of the Riker Danzig mortgage. Accordingly, the Riker Danzig mortgage had priority over plaintiff's earlier-recorded mortgages.
The Appellate Division held that the anti-subordination clauses in plaintiff's mortgages were irrelevant to determining the priorities of the various mortgages. Plaintiff's remedy for the alleged violation of these clauses lied with Ms. Benun, not with Riker Danzig, which was not a party to the mortgages that contained the anti-subordination clauses. Moreover, the Appellate Division noted that, in the two years between the recording of the Riker Danzig mortgage and the default by one of the Benun Companies, plaintiff "took no action to protect its interests" (ie., by declaring the Benun Companies to be in default or seeking to discharge or subordinate the Riker Danzig motion).
The Appellate Division ultimately held that plaintiff had actual knowledge of the Riker Danzig mortgage and was in a position to "avoid subordination of its future advances simply by declining to make additional advances until the Riker [Danzig] mortgage might expressly be made subordinate to [plaintiff's] mortgages." By failing to do so, plaintiff "subjected itself to the application of the common law rules on priorities." This appears to be the lesson from Rosenthal — lenders should think twice (or make a later-filed mortgage expressly subordinate to your mortgage) before making optional advances in the face of a later-filed mortgage.
Finally, the Appellate Division made clear that constructive notice of the Riker Danzig mortgage would not have been enough to give it priority over plaintiff's mortgages. It held that it would be "impractical to expect a commercial lender such as [plaintiff] to conduct a search of intervening recorded encumbrances every time another advance is made in a transaction such as the factoring agreements of this case." But, Riker Danzig was not relying on constructive notice. It relied on plaintiff's actual knowledge, confirmed by plaintiff's email to Riker Danzig acknowledging the Riker Danzig mortgage, in support of its arguments.