Equitable Subrogation is a legal concept that allows one party to replace another party when it comes to a legal right. As a legal doctrine, equitable subrogation permits courts to declare that the owner of a mortgage has the same rights as an earlier-in-time owner of another mortgage on the same property, if certain conditions are met. It allows a subsequent holder of a mortgage to step into the shoes of a previous holder affording priority over other subsequent liens and creditors, so long as equity is served by allowing the subsequent holder to do so.
The intent of the doctrine, which is based upon principles of equity and objective fairness, is to protect the expectations of parties, avoid injustice, and prevent windfalls. The application of the doctrine should therefore promote common justice to all, prevent injury to the new lender, give the lender the benefit of his payment, carry out the intention of the parties, and leave the prior junior lienholder in his original position.
The doctrine has been applied in various ways in different jurisdictions but derives primarily from the idea that one who assumes the debt of another is entitled to stand substitute for that debtor with regard to the debtor’s interest or, in the alternative, to pursue the debtor for repayment. This concept was handed down from British common law where a surety, guaranteeing a debt, could be forced to pay upon default, and after.
The Courts in Maryland have interpreted it thusly: “[w]here a lender has advanced money for the purpose of discharging a prior encumbrance in reliance upon obtaining security equivalent to the discharged lien, and his money is so used, the majority and preferable rule is that if he did so in ignorance of junior liens or other interests he will be subrogated to the prior lien. Although stressed in some cases as an objection to relief, neither negligence nor constructive notice should be material.” Levenson, 338 Md. at 231-32, 657 A.2d at 1172
Under D.C. law, a five-part test is used to determine whether a lender is entitled to equitable subrogation. The Court will consider (1) whether the lender paid off the previous mortgage to protect its own interest; (2) whether the lender acted as a volunteer; (3) whether the lender was primarily liable for the previous mortgage; (4) whether the lender paid off the previous mortgage in its entirety; and (5) whether utilizing the doctrine of equitable subrogation would work any injustice to the rights of others. In Smith v. First American Title Insurance Company, the U.S. Court of Appeals for D.C. held that a lender was entitled to equitable subrogation against a co-owner’s interest in a property jointly owned when the new loan paid off the entire amount previously owed on the property even though the co-owner was not a party to the subsequent mortgage; the borrower was the only party to execute the mortgage; and the lender had actual knowledge that the co-owner refused to sign. This case is of critical importance to the development of the doctrine in D.C. in that the Court concluded, as a matter of law, that actual knowledge does not bar equitable subrogation. This approach is more in keeping with the Restatement (Third) of Property: Mortgages, and is generally considered a more liberal approach to equitable subrogation.