If you are like me, nothing piques your interest more than a case about the priority of liens and mortgages. I am joking of course. I am not (quite) that boring. But, there are occasionally cases that come along on seemingly dry issues that are nonetheless interesting. The New Jersey Supreme Court's decision in Rosenthal & Rosenthal, Inc. v. Benun is one of those cases. I wrote about the Appellate Division's decision in Rosenthal here, and now the Supreme Court has issued its own opinion, affirming the Appellate Division's judgment.
In Rosenthal, 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, 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. Therefore, the Appellate Division held that the Riker Danzig mortgage had priority over plaintiff's earlier-recorded mortgages. Plaintiff appealed.
The Supreme Court affirmed for substantially the same reasons as the Appellate Division. In a unanimous decision, the Supreme Court held that the law governing the case was well settled: "When a lender holds a mortgage that secures optional future advances, [its] prior lien loses priority for advances made after actual knowledge of an intervening mortgage." The Supreme Court explained the rationale behind this well-settled law as follows:
The policy guiding that rule is straightforward — to protect the borrower “so that she can borrow from other lenders and can sell the property.” If optional advances were to retain priority over subsequent mortgages, the borrower would be doubly mistreated. The borrower “could not demand the contemplated additional loan funds[,]” because, again, they are made at the lender’s discretion. Nor could she “obtain financing from another lender, because no one will lend on security that will be reduced or eliminated if the first mortgagee decides to make subsequent advances.” Vesting the first mortgagee with priority, even over optional advances, thus creates the risk that the borrower will have substantial, but unavailable, equity.
Because there was no question that the future advances made by plaintiff were optional and that plaintiff had actual knowledge of the intervening mortgage, its prior mortgage was not entitled to priority. (Like the Appellate Division, the Supreme Court observed that this might not have been the case if plaintiff only had constructive, as opposed to actual, knowledge of the intervening mortgage. Currently, constructive knowledge will only result in a lender like plaintiff losing priority if the case involves a construction loan, not a commercial loan like the one in this case.)
In its decision, the Supreme Court traced the law on this issue from its common law origins through to its codification in New Jersey's mortgage-priority statutory scheme. It also acknowledged that, "there [were] policy reasons identified by [plaintiff] and amici that question the continuing value of the common law rule," that the common law rule has "been the subject of scholarly criticism," and that "[a] number of states have modified or discarded the common law rule." Nonetheless, the Supreme Court held that, because "the common law rule governing priority of optional future advances has been codified by statute, any plea to fundamentally alter the rule [was] best addressed to the Legislature."