The Statewide Title Newsletter and Legal Memorandum

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Issue  15  Article  29
Published:  10/1/1996

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Subordination Agreements
Ed Urban, Vice President and Corporate Counsel

M-1 records his deed of trust. It states that M-1 agrees that M-1’s deed of trust shall be subordinate to any future deed of trust provided that the proceeds secured by that future deed of trust are used to construct improvements upon the land encumbered. M-1’s deed of trust might or might not go on to state that M-1 will execute any additional documents required. The title insurer is asked to insure M-2’s deed of trust priority over M-1’s deed of trust by virtue of the subordination.

When the title examiner finds such a subordination, the examiner should exercise extreme caution. The title examiner should list M-1’s deed of trust in his opinion and should attach a copy of the subordination language for the title insurer to review prior to closing.

Most title insurers will be concerned about the above subordination for several reasons. First, the subordination is "automatic" or "self executing." This means that the subordination does not expressly reference an existent deed of trust to which M-1 is subordinating. Second, the subordination is "conditional." This means that the subordination is effective, if at all, only if the proceeds are used as specified in the subordination. An "automatic" or "self executing" subordination might be valid, depending upon its terms under the rule of MCB Limited v. McGowan, 86 N.C. App 607, 359 S.E. 2d 50 (1987). But a conditional subordination, if otherwise valid, will entitle the title insurer to take an exception to the conditions in M-1’s subordination agreement. Another important case involving the difficulties of subordinations is National Mortgage Corp. v. American Title Insurance Company, 299 N.C. 369, 261 S.E. 2d 844 (1980). This case involves an automatic and conditional subordination.

Subordination (1) of one deed of trust or lien to another deed of trust or lien; (2) of condominium declaration liens or "PUD" declaration liens to a deed of trust; or (3) of a fee to a tenant’s mortgage to a lender should be reported to and be reviewed by the title insurer prior to closing. This should eliminate the title examiner assuming unwanted liability for the pitfalls involved in subordinations.

12 U.S.C. Sec. 1823(e) applies when the FDIC or RTC is involved. It provides that no agreement, which can include a subordination agreement, is valid against the FDIC or RTC unless it is in writing, was approved by the failed depository institution’s board of directors or its loan committee as reflected in the minutes and is an official record of the depository institution. 12 U.S.C. Sec. 1823(e)(1)(B) says the agreement must be executed by the depository institution and any party "claiming an adverse interest thereunder." The quoted language has been interpreted not to include the lender to whom the depository institution is subordinating.

You can expect to see a commitment requirement similar to the following in regard to a subordination of one lien to another: "Proper execution and recordation of valid unconditional subordination of [ insert reference to lien being subordinated ] to the lien of the deed of trust to be insured. The Company must be given a copy of the subordination agreement."

Our position is that, in a deed of trust, the beneficiary lender subordinating its lien, but not the trustee, needs to sign the subordination agreement.

The commitment for a loan policy should list the lien to be subordinated to the deed of trust to be insured and the subordination agreement under "subordinate matters," with blanks left for recording data. The policy should list the completed reference under subordinate matters. An exception should be taken to the subordinated deed of trust and the subordination in the owner’s policy and commitment for the owner’s policy. This will be of some value when the prior policy is used as a "starter" for "tacking."

For additional reading material, see E. Urban North Carolina Real Property Mechanics’ Liens and Future Advances, Including Title Insurance, Sec. 51-2 (Harrison Co. 1989); E. Urban and G. Whitney, North Carolina Real Estate, Sec. 21-80 (Harrison Co. 1996).

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