Hu Hyun Kim v. Lee

Ireland, J. This is a discretionary review of a Court of Appeals’ decision which extended to Yakima Title & Escrow Company the first lienholder position of its insured, through the doctrine of equitable subrogation, over a prior perfected judgment creditor. We hold under the facts of this case that the title insurer should not avoid liability through the doctrine of equitable subrogation because the title insurer had actual knowledge of a prior judgment lien and failed to disclose such a lien to its insured before issuance of the title policy. The Court of Appeals’ decision is reversed, and the trial court’s judgment is reinstated. FACTS Background The pertinent facts in this case are not in dispute. On December 5, 1995, Kenneth and Yun Ok Chang bought a home in Yakima for their daughter and son-in-law, Sharon and Stanley Lee. Of the $165,000 purchase price, $130,000 was financed by a promissory note from Sterling Trust Company (Sterling) in the Changs’ name at an interest rate of 10.5 percent per annum, maturing in six years. The promissory note was secured by a deed of trust dated December 5, 1995, and was recorded on December 11, 1995 in Yakima County Auditor’s file number 3118149. Yakima Title & Escrow (Yakima Title) recorded the statutory warranty deed in favor of the Changs and the deed of trust was executed at the direction of Sterling Escrow Company. The Lees moved into the home and made payments owed by the Changs on the Sterling loan as each became due. Meanwhile, on April 28, 1997, Hu Hyun Kim obtained a — 83 — default judgment against the Lees in King County Superior Court for failure to comply with discovery orders. Judgment was entered for a total of $83,565.37. The judgment was recorded in Yakima County on May 16, 1997, under auditor’s file number 7010775. On December 22, 1997, two years after purchasing the home, the Changs quitclaimed an undivided one-half interest in the property to the Lees. The Changs and the Lees filed an excise tax affidavit claiming the one-half interest as a gift to claim the gift exemption. The home was still subject to the loan from Sterling’s deed of trust. Subsequently, the Lees sought their own financing in order to take advantage of lower interest rates. In March 1998, the Lees procured financing through Pioneer National Bank (Pioneer Bank) to pay off the underlying deed of trust granted by the Changs to Sterling. As part of the deal, the Changs agreed to quitclaim their remaining undivided one-half interest to the Lees in consideration of love and affection. The quitclaim deed was signed on April 10, 1998 and recorded on April 28, 1998. Yakima Title’s employee, Rae Dawn Hawley, signed a real estate tax affidavit in which the Changs and Lees were not subject to pay excise tax by claiming that “grantor gifts property which has no underlying debt.” Clerk’s Papers (CP) at 156. On April 20, 1998, the Lees executed their own promissory note and deed of trust to Pioneer Bank with an interest rate of 6.75 percent per annum, maturing in 30 years. All of the Lees’ loan proceeds were used to pay off Sterling’s deed of trust, plus settlement charges. On April 28,1998, a year after Kim had recorded the King County judgment in Yakima County, Pioneer Bank recorded its deed of trust and the second quitclaim deed. Yakima Title issued a commitment for title insurance insuring Pioneer Bank’s first lien position effective March 16,1998, and updated it on April 22,1998. In conducting its title search, Yakima Title failed to discover Kim’s judgment — 84 — lien. Thus, the commitment for title insurance did not mention Kim’s judgment against the Lees. On June 17, 1998, an assignment of Pioneer Bank’s deed of trust to Countrywide Home Loans, Inc. was recorded by Yakima Title. Once Kim learned of the new loan by Pioneer Bank, Kim’s counsel informed Yakima Title of Kim’s judgment, its date and recording number, and that Kim’s judgment was now the first lien on the Yakima property, on July 13, 1998. Yakima Title’s agent responded that he had not found an abstract with the Yakima Superior Court Clerk’s Office and believed that Kim could not have held a perfected judgment lien. Later the same day, Kim’s counsel confirmed the telephone conversation with Yakima Title and sent copies to Pioneer Bank and Kim. On July 16, 1998, an assignment of deed of trust was amended to show PHH Mortgage Services Corporation (PHH) as an assignee; it was re-recorded by Yakima Title. On July 17, 1998, Yakima Title issued an ATLA (American Land Title Association) title policy with PHH as the insured, showing the Lees as owners of the property and Pioneer’s deed of trust in first position, with no mention of Kim’s judgment. On December 10, 1998, Kim’s counsel notified PHH’s counsel of Kim’s judgment lien, of which they had been unaware. On June 21, 1999, Kim’s counsel notified Yakima Title that Kim would begin execution on the judgment.1 PHH had previously notified Yakima Title, on May 10,1999, that Kim would execute on his judgment lien as soon as possible. Yakima Title, as the agent for the policy issuer, accepted — 85 — this notice as a tender of defense of PHH’s lien position.2 On September 9, 1999, a writ of execution was issued by King County Superior Court. Procedural History King County Superior Court At Kim’s request, King County Superior Court issued a writ of execution on the Lees’ real property in Yakima. Yakima Title moved to intervene and to quash the execution sale. Kim opposed these motions and filed a motion for CR 11 sanctions against Yakima Title. On October 21,1999, the trial court granted Yakima Title’s motion to intervene, denied Kim’s motion for CR 11 sanctions, and denied Yakima Title’s motion to quash. Yakima Title appealed the denial of the motion to quash. Court of Appeals, Division One The Court of Appeals’ decision reversed the King County Superior Court’s order denying Yakima Title’s motion to establish as a first lien on defendant Lee’s real property, prior to the previously filed judgment against Lee and in favor of Kim, a deed of trust given by Lee to Yakima Title’s assignee PHH. Kim now seeks this Court’s review. ANALYSIS Standard of Review Determination of a proper standard of review of whether equitable subrogation should be applied to give a mortgage lender first lien position over a prior perfected judgment creditor rests upon whether the question presented for review is one of fact, one of law, or a mixed question of law and fact. Rasmussen v. Employment Sec. Dep’t, 98 Wn.2d 846, 850, 658 P.2d 1240 (1983). Since the — 86 — pertinent facts of this case are not in dispute, the lien priority of PHH over a prior perfected lien creditor is a question of law, which is subject to de novo review. Millay v. Cam, 135 Wn.2d 193, 198, 955 P.2d 791 (1998) (citing Medcalf v. Dep’t of Licensing, 133 Wn.2d 290, 297, 944 P.2d 1014 (1997)). Recording Statute Under Washington’s recording act, RCW 65.08.070, a subsequent mortgagee takes subject to any prior encumbrances of which the mortgagee has either actual or constructive knowledge: The purpose of the recording statute is to make the deed first recorded superior to any outstanding unrecorded conveyance of the same property unless the mortgagee or purchaser had actual knowledge of the transfer not filed of record. Tacoma Hotel, Inc. v. Morrison & Co., 193 Wash. 134, 140, 74 P.2d 1003 (1938). Judgment attaches automatically as a lien upon the real estate of the judgment debtor. RCW 4.56.190. A superior court judgment becomes a perfected lien against the judgment debtor’s real property from the time the judgment creditor records the judgment with the recording officer of the county where the property is located. RCW 6.13.090. See In re Deal, 85 Wn. App. 580, 583, 933 P.2d 1084 (1997). Moreover, under the amendments to the law enacted by the 1999 Legislature, a judgment creditor is entitled to execute on the judgment debtor’s equity in real estate, net of the homestead amount, less all liens and encumbrances senior to the creditor’s judgment. RCW 6.13.010(3); Laws of 1999, ch. 403, § 1. In the instant case, when Kim’s judgment was filed in Yakima County on May 16, 1997, it became a lien on the Lees’ one-half interest in the Yakima property on December 22, 1997, the date the Lees acquired their one-half interest from the Changs. The Kim judgment lien attached to the entire Yakima property when the Changs conveyed their remaining one-half interest to the Lees by quitclaim deed — 87 — on April 10, 1998. Kim’s judgment was perfected for almost a year before the Lees placed the Pioneer Bank deed of trust on the Yakima property. Once the Sterling deed of trust was paid, there were no liens on the Yakima property senior to Kim’s judgment when the King County Superior Court issued its writ of execution in September 1999. Refinance Generally, when the doctrine of equitable subrogation applies, its effect is to restore the first lien position of the mortgage refinance lender. Grant S. Nelson & Dale A. Whitman, Real Estate Finance Law § 10.6 (3d ed. 1993). In order for the doctrine of equitable subrogation to apply, the loan must be considered a refinance. Black’s Law Dictionary defines “refinance” as follows: To finance again or anew; to pay off existing debts with funds secured from new debt; to extend the maturity date and/or increase the amount of an existing debt; to arrange for a new payment schedule. The discharge of an obligation with funds acquired through the creation of a new debt, often at a different interest rate. Black’s Law Dictionary 1281 (6th ed. 1990). Webster’s Third New International Dictionary defines “refinance” as “to renew or reorganize the financing of : provide capital for afresh : provide for (an outstanding indebtedness) by making another loan or a larger loan on fresh terms.” Webster’s Third New International Dictionary 1908 (3d ed. 1986). In the present case, the Lees paid off the Changs’ existing debt with funds secured from new debt incurred by the Lees. Although the borrowers are different parties, since they are family and the transfer of title from the Changs to the Lees was a gift, that fact should not preclude treatment of the new deed of trust as a refinance. The terms of the loan significantly changed, even though it was for the same collateral and the amount of the indebtedness did not change significantly. For instance, the interest rate was reduced from 10.5 percent to 6.75 percent and the maturity — 88 — date was extended from 6 years to 30 years. These loan terms from Pioneer Bank were substantively different from the Changs’ loan. The lower interest rate is of no prejudice to the judgment lienholder. However, the increase in term from 6 to 30 years is prejudicial should the judgment lien be subrogated to the new deed of trust.3 Doctrine of Equitable Subrogation “Subrogation is a consequence which equity attaches to certain conditions. It is not an absolute right, but one which depends upon the equities and attending facts and circumstances of each case.” Coy v. Raabe, 69 Wn.2d 346, 351, 418 P.2d 728 (1966). As the Court of Appeals noted, Washington has not yet adopted the doctrine of equitable subrogation; this is a matter of first impression in Washington. Kim v. Lee, 102 Wn. App. 586, 592, 9 P.3d 245 (2000). Subrogation is fundamentally an equitable concept designed “to impose ultimate responsibility for a wrong or loss on the party who, in equity and good conscience, ought to bear it.” Mahler v. Szucs, 135 Wn.2d 398, 411, 957 P.2d 632 (1998) (subrogation in auto insurance context allows insurer to recover payments made to insured from third party tortfeasor). The doctrine of subrogation is not a fixed and inflexible rule of law or of equity. Han v. United States, 944 F.2d 526, 529 (9th Cir. 1991). Generally, in federal courts, equity has acted only when legal remedies were inadequate. Beacon Theatres, Inc. v. Westover, 359 U.S. 500, 508, 79 S. Ct. 948, 3 L. Ed. 2d 988 (1959). “Subrogation is always liberally allowed in the interests of justice and equity.” J.D. O’Malley & Co. v. Lewis, 176 Wash. 194, 201, 28 P.2d 283 (1934) (agent paying on behalf of bonding company entitled to subrogation from third — 89 — party obligated to reimburse the principal). However, in the real estate context, equitable subrogation has been traditionally invoked only to prevent unjust enrichment; equitable remedies are not granted where it would produce injustice. Restatement (Third) of Prop.: Mortgages § 7.6 cmt. fat 522 (1997). We adopt the principle of subrogation in the mortgage loan context as set forth in the Restatement (Third) of Property: Mortgages § 7.3, as follows: (a) If a senior mortgage is released of record and, as part of the same transaction, is replaced with a new mortgage, the latter mortgage retains the same priority as its predecessor, except (1) to the extent that any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest in the real estate, or (2) to the extent that one who is protected by the recording act acquires an interest in the real estate at a time that the senior mortgage is not of record. (b) If a senior mortgage or the obligation it secures is modified by the parties, the mortgage as modified retains priority as against junior interests in the real estate, except to the extent that the modification is materially prejudicial to the holders of such interests and is not within the scope of a reservation of right to modify as provided in subsection (c). Under the principles of replacement and modifications of mortgages in section 7.3, “[t]he result is analogous to subrogation, and under this Restatement the requirements are essentially similar to those for subrogation.” Restatement (Third) of Prop.: Mortgages § 7.6 cmt. e at 519. Under the Restatement, a modification of a mortgage will ordinarily cause it to lose priority to junior interests to the extent that the modification is materially prejudicial to those interests. Id. § 7.3. Not all modifications will materially prejudice junior interests. For example, mortgagees commonly consent to an extension of the mortgage maturity date or to a rescheduling or “stretching out” of installment payments. Id. § 7.3 cmt. c. Absent an increase in the — 90 — principal amount or the interest rate of the mortgage, such modifications normally do not jeopardize the mortgagee’s priority as against intervening interests. Id. In the present case, the modifications made to the loan from the Changs to the Lees were not merely an extension of the maturity date or stretching out installment payments of the existing mortgage; rather, it was a new mortgage and the change was from a 6-year maturity date to a 30-year maturity date. These modifications were materially prejudicial to Kim. Existing mortgages replaced by new mortgages do not always fall within the rules of replacement and modification of senior mortgages. However, in this case, because the intent of the Kims and the Lees was for the Lees to obtain the home, the rules of replacement and modification should apply. Actual notice of an intervening judgment lien often bars subrogation. See generally Dodge City of Spartanburg, Inc. v. Jones, 317 S.C. 491, 454 S.E.2d 918, 920-21 (1995). When Kim’s counsel contacted Yakima Title on July 17, 1998, it received actual notice of Kim’s judgment lien before the title policy was issued. In spite of this knowledge, Yakima Title chose not to disclose Kim’s judgment lien to the insured. Yakima Title concedes it missed the recorded judgment. Yakima Title recorded an assignment of the Pioneer Bank deed of trust to PHH and issued its title insurance policy to PHH. The Restatement (Third) of Property: Mortgages has adopted the view that, “subrogation can be granted even if the payor had actual knowledge of the intervening interest; the payor’s notice, actual or constructive, is not necessarily relevant.” Restatement (Third) of Prop.: Mortgages § 7.6 cmt. e at 520 (1997) (emphasis added). However, allowing subrogation in the face of actual knowledge would discount the purpose of the recording statute, RCW 65.08.070. The purpose of the recording statute is to make the deed first recorded superior to any outstanding unrecorded conveyance of the same property unless the mort — 91 — gagee or purchaser had actual knowledge of the transfer not filed of record. Tacoma Hotel, 193 Wash, at 140. Further, allowing subrogation in this case would ignore the interests of equity and justice established by Washington jurisprudence. Mahler, 135 Wn.2d at 412. Equitable remedies should not be granted where it would result in injustice. Id. In the Coy case, the title company failed to ascertain the existence of a lease and option to purchase regarding property purchased at a tax sale. This Court held that the purchasers, their lender, and their insuring title company were all placed on constructive notice of the plaintiff’s interest in the property. Coy, 69 Wn.2d at 349.4 The purchaser and title insurer nonetheless claimed to be subrogated to the federal government’s tax claims, which they had paid. This Court determined that the purchasers could claim a subrogation interest, but the title company could not, since the purchasers were “bona fide purchasers to the extent that they were entitled to rely upon others who were paid to give an expert opinion and insure title,” while the title company was “engaged in giving those expert opinions for a consideration.” Id. at 350. This Court ultimately held that it was “not the province of the court to relieve a title insurance company of its contractual obligation” to insure title. Id. at 351. The role of the title insurer is to insure title; “[e]ither they insure or they don’t.” Coy, 69 Wn.2d at 351. Generally, the role of the title insurer is relied upon by the lender, judgment creditor, and other lienors. Just as a lender relies on the title insurer to commit that title is vested in its borrower, subject only to known exclusions, judgment creditors and other lienors rely on title insurers to prevent a debtor from conveying real property without first satisfying a perfected lien. In the instant case, legal remedies and equity suggest that the loss should fall on the title company rather than the innocent judgment creditor. As in Coy, this case was — 92 — precipitated by the title company’s negligence and failure to acknowledge the lien. Yakima Title not only failed to discover Kim’s judgment lien when it conducted its title search for the Lees’ loan from Pioneer, as in the Coy case, but also failed to acknowledge the lien when it had actual knowledge of it from Kim’s counsel. With the information at hand, Yakima Title still issued the title policy insuring PHH’s first lien position. Applying equitable subrogation to extend in favor of Yakima Title would result in alleviating Yakima Title of its own negligence and complete disregard of the actual notice at the expense of an innocent judgment creditor. CONCLUSION Under Washington’s recording act, from the time the judgment creditor records the judgment with the recording officer of the county where the property is located, the judgment attaches automatically. RCW 4.56.190 and 6.13.090. Since Kim’s judgment was perfected and attached almost a year before the Lees placed the Pioneer Bank deed of trust, the senior judgment lien under the statute was Kim’s judgment lien. This financing arrangement falls under the definition of a refinance. Although the doctrine of equitable subrogation may be applied, this case is controlled by Coy, 69 Wn.2d 346, which allows equitable subrogation to a bona fide purchaser (or refinance lender) to the extent they were entitled to rely on others to guarantee title. However, equitable subrogation should not apply in favor of a title company which guaranteed title while on constructive or actual notice of a prior judgment. Under a contractual obligation, Yakima Title was negligent in giving its expert opinion and insuring title. The doctrine of subrogation does not apply to relieve a title insurance company of its contractual obligation because a title insurance company not only receives consideration for rendering an expert opinion, but also for acting as an — 93 — insurer of its accuracy. Coy, 69 Wn.2d at 351. Yakima Title failed to discover a recorded and perfected judgment lien and upon receiving actual notice, failed to disclose or remedy the situation. The title insurer should not be able to invoke the doctrine of equitable subrogation to be relieved from a contractual obligation when the title insurer had constructive and actual notice of a prior judgment and when the new obligation prejudices lienholders who would be junior by subrogation. The case is reversed, and the trial court’s judgment is reinstated.5 Smith, Johnson, Bridge, and Owens, JJ., concur. Footnotes [1] When Em’s judgment lien was recorded in Yakima County on May 16, 1997, Washington case law held that any deed of trust encumbering property after entry of default judgment, but before executing, was to be counted as part of the “liens and encumbrances” under RCW 6.13.010(3) before arriving at a net property value upon which a judgment creditor could execute. Robin L. Miller Constr. Co. v. Coltran, 87 Wn. App. 112, 119, 940 P.2d 661 (1997). [2] Effective July 25, 1999 the Washington State Legislature amended ROW 6.13.010(3) from “As used in this chapter, the term ‘net value’means market value less all liens and encumbrances,” to adding after encumbrances “senior to the judgment being executed upon and not including the judgment being executed upon.” [3] The dissenting opinion states Kim would not be prejudiced because in a sheriffs sale he would “simply step into the shoes of the judgment debtor and take title subject to all prior liens, including the one with high interest and a balloon payment in six years.” Dissent at 102. The dissent fails to consider the clauses in the promissory notes of Chang and Lee, which provide for acceleration of the notes upon transfer of any part of the property or any interest therein. Clerk’s Papers at 176-79. [4] The parties failed to argue the Coy case in their briefs to the Court of Appeals. Consequently, it was not mentioned in the Court of Appeals’ decision. [5] Kim requested attorney fees in the Court of Appeals, but failed to do so under RAP 18.1 in this Court. Even if Kim had requested fees in this Court, Kim has established no basis to warrant an award of fees.