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July 2015

Recent Appellate Division Holding Underscores Need for Mortgage Subordination Agreement

A recent holding by the New Jersey Appellate Division underscores the need for a senior lender to obtain a written subordination agreement from a junior lender who is allowed to take a subordinate mortgage on real estate serving as collateral for the senior credit facilities. In Rosenthal & Rosenthal v. Benun and Riker, Danzig, Scherer, Hyland & Perretti, L.L.P., 2015 WL 3752524, decided June 17, 2015, the court held that certain advances secured by Rosenthal's mortgages, which were recorded in 2000 and 2005, respectively, were subordinate to the third mortgage held by Riker, even though the Riker mortgage was not recorded until 2007.  According to the court, the two reasons that Rosenthal was not entitled to the benefit of the "first in time, first in right" rule were (1) Rosenthal had actual rather than constructive notice of the junior mortgage lien and (2) future advances under the Rosenthal factoring arrangements were optional rather than mandatory.  All amounts that had been outstanding under the Rosenthal factoring agreements at the time the Riker mortgage was recorded was revolving debt and was ultimately repaid.  Therefore, in the priority dispute between the two creditors, the entirety of Rosenthal’s indebtedness was comprised of future advances made by Rosenthal after it had actual knowledge of the Riker mortgage.  The court ruled that those future advances were subordinate in lien right to the mortgage indebtedness owed to Riker.  

In the wake of this holding, what precautions should be taken by a senior lender whose collateral pool includes a mortgage? The simple answer is to require a subsequent lender, as a condition to obtaining a mortgage lien, to enter into a subordination agreement that provides, among other things, that irrespective of the order of recording or the lien priority accorded by law, debt secured by the senior lender's mortgage takes precedence.  If the junior lender or the borrower refuses to cooperate, then the senior lender may elect to cease advancing new funds—and thereby ensure its priority is not eroded—and may also seek to declare a default and foreclose its mortgage, if the granting of the subordinate mortgage or other circumstances give rise to default rights and remedies in favor of the senior lender.

It is noteworthy that Riker, as well as Rosenthal, made future advances subsequent to the time that Riker's mortgage was recorded.  At the time the mortgage was issued to Riker on March 25, 2007, it was owed $1,679,701.33, while at the time Riker and Rosenthal cross moved for summary judgment in their priority dispute, Riker was owed in excess of $3,000,000.  Thus, both the holder of the first and second mortgages, on the one hand, and the holder of the third mortgage, on the other hand, made future advances, yet the court ruled that all future advances made by Riker, as the third mortgagee, were prior in lien right to all future advances made by Rosenthal.  In reaching its conclusion, the court distinguished a revolving line of credit, under which future advances, by statute (N.J.S.A. 46:9-8.1), relate back to the original recording of the mortgage for priority purposes, from Rosenthal’s factoring arrangements and futures advances thereunder, which were of a discretionary nature.  Among the issues raised but not answered by this decision is the degree to which a court will parse the language in a credit agreement in making a determination whether future advances are mandatory—in which case the arrangement will likely be deemed a revolving line of credit entitled to priority under N.J.S.A. 46:9-8.1—or discretionary, in which case a senior secured lender may lose a priority battle with a subsequent lender that is granted a mortgage on the same real property.

For more information, please contact your Chiesa Shahinian & Giantomasi PC attorney or the authors listed below.

Laurence M. Smith
Co-Chair, Corporate & Securities Group | lsmith@csglaw.com | (973) 530-2021

Joseph Zawila
Counsel | jzawila@csglaw.com | (973) 530-2042