A recent decision of the North Carolina Court of Appeals, American General Financial Services, Inc. v. Barnes, COA05-478, filed on January 3, 2006 will likely provide some helpful guidance on the issue Equitable Subrogation. North Carolina has long recognized the application of the doctrine but the few modern cases that provided any meaningful direction as to how and when the doctrine is to be applied, leave a few issues undecided.

Peek v. Wachovia Bank & Trust Co, 242 N.C. 1, (1955) is the leading case on the doctrine of equitable subrogation. It is often cited for the proposition that “estoppel is not available to protect one against his own negligence” see; Wachovia Bank & Trust Co. v. Wayne Finance Co., 262 N.C. 711, (1964). The North Carolina Supreme Court in Peek stated; “Subrogation is a mode of equitable relief which operates on principles of natural justice without regard to form and independent of any contractual relation between the parties to be affected by it. Story's Equity Jurisprudence, Fourteenth Edition, Volume 2, section 706.” The Court noted that it has been defined “‘as that change by which another person is put into the place of a creditor, so that the rights and securities of the creditor pass to the person who, by being subrogated to him, enters into his right. It is a legal fiction, by force of which an obligation extinguished by a payment made by a third person is treated as still subsisting for the benefit of this third person, who is thus substituted to the rights, remedies, and securities of another. The party who is subrogated is regarded as entitled to the same rights, and indeed as constituting one and the same person with the creditor whom he succeeds.’ Sheldon, The Law of Subrogation, Second Edition, section 2. See also Pomeroy's Equity Jurisprudence, Fifth Edition, Volume 4, section 1211.”

After defining the doctrine, the Court sets out its application where “as a general rule one who furnishes money for the purpose of paying off an encumbrance on real or personal property, at the instance either of the owner of the property or of the holder of the encumbrance, either upon the express understanding or under circumstances from which an understanding will be implied, that the advance made is to be secured by a first lien on the property, will be subrogated to the rights of the prior lienholder as against the holder of an intervening lien, of which the lender was excusably ignorant. Wilkins v. Gibson, 113 Ga. 31, 38 S.E. 374, 84 Am. St. Rep. 204; Bankers' Loan & Investment Co. v. Hornish, 94 Va. 608, 27 S.E. 459; Huggins v. Fitzpatrick, 102 W. Va. 224, 135 S.E. 19; Pomeroy's Equity Jurisprudence, Fifth Edition, Volume 4, section 1212; Annotation, 70 A.L.R. 1396. See also Boney v. Insurance Co., 213 N.C. 563, 567, 197 S.E. 122; 50 Am. Jur., Subrogation, sections 107, 108, and 109.”

The Court then limits the application in that “one who loans money which is used in paying off a mortgage or encumbrance is not entitled, from that circumstance alone, to be subrogated to the rights of the holder of the encumbrance. Price v. Courtney, 87 Mo. 387, 56 Am. Rep. 453; Carolina Interstate Bldg. & Loan Ass'n v. Black, 119 N.C. 323, 25 S.E. 975; Kline v. Ragland, 47 Ark. 111, 14 S.W. 474. See also Seeley v. Bacon (N. J. Eq.), 34 Atl. 139. Consequently, the mere fact that the proceeds of a later mortgage are applied to the discharge of a prior one does not, as a rule, entitle the mortgagee therein to be subrogated to the rights of the prior mortgagee. Ayers v. Staley (N. J. Eq.), 18 Atl. 1046; Bradshaw v. Van Valkenburg, 97 Tenn. 316, 37 S.W. 88; Annotation: 99 Am. St. Rep. 474, p. 513. In Peek the doctrine was unavailable because the payment was a new loan and had not been made for the purpose of liquidating the first lien.

In this case, plaintiff American General Financial Services, Inc. (“American General”) and Substitute Trustee, Robert A. Forquer (“Forquer”), (collectively “plaintiffs”) appealed from a summary judgment order in favor of the defendant Pennsylvania National Mutual Insurance Company (“Penn National”). Timothy H. Barnes and Lori A. Barnes acquired property in Onslow County by a deed recorded in 1994. They executed a promissory note secured by a deed of trust in the property to Branch Banking and Trust recorded in 1999. In 2000, they executed a promissory note, secured by a deed of trust in the property to American General, which was recorded in 2000. In 2001, they executed a confession of judgment to Penn National admitting to breach of fiduciary duty, having previously agreed to indemnify Penn National, upon issuing a probate and fiduciary bond. In January of 2002, the confession of judgment was properly entered, filed, and docketed in the office of the Clerk of Superior Court of Onslow County in the amount of $430,230.00, together with attorney's fees and interest.

Mr. and Mrs. Barnes then sought to refinance the BB&T and American General deeds of trust. They executed a new promissory note, secured by a deed of trust, to American General in the amount of $116,819.00, which satisfied the original deeds of trust and provided additional funds in the amount of approximately $1,573.00. Immediately prior to recordation, American General updated the title and the title search did not reveal the 17 January 2002 judgment entered for Penn National. The loan proceeds were disbursed to fully satisfy both the BB&T deed of trust and the initial American General deed of trust. American General also disbursed additional funds of approximately $1573.00 directly to the Barnes family. American General's new deed of trust was properly recorded on January 18, 2002. Both the BB&T deed of trust and the initial American General deed of trust were cancelled of record, leaving Penn National's docketed judgment as a first-priority lien on the Onslow County property.

Plaintiffs commenced the underlying action seeking to quiet title to the property by a determination that American General held the senior lien on the property. The plaintiffs filed a motion for summary judgment against Penn National that the trial court denied and then granted summary judgment, sua sponte, in favor of Penn National.

In the appeal, the plaintiffs argued that the trial court erred in granting summary judgment in favor of Penn National because Penn National's judgment should be subrogated to American General's lien under the doctrine of equitable subrogation.

The court in its analysis of the law noted that the remedy of equitable subrogation might be available “when one person has been compelled to pay a debt which ought to have been paid by another and for which the other was primarily liable. Trustees of Garden of Prayer Baptist Church v. Geraldco Builders, Inc., 78 N.C. App. 108, 114, 336 S.E.2d 694, 697-98 (1985) (citations omitted)”. Key to the outcome in this appeal, the Court of Appeals observes that the doctrine “will not be invoked in favor of mere volunteers; rather, a plaintiff must show that he paid another's obligation for the purpose of ‘protecting some real or supposed right or interest of his own.’ Jamestown Mut. Ins. Co. v Nationwide Mut. Ins. Co., 277N.C. 216, 221, 176 S.E.2d 751, 755 (1970) (citations omitted).”

The Court then cites Peek, for the general statement of the doctrine. The decision notes the doctrine is limited to prevent its application where the party seeking relief is a “mere volunteer”. When a party is entitled to equitable subrogation, the Court quotes that “‘the party in whose favor [the right to subrogation] exists is entitled to all of the remedies and security which the creditor had against the person whose debt was paid.’ Trustees of Garden of Prayer Baptist Church, 78 N.C. App. at 114, 336 S.E.2d at 698.”

The doctrine of equitable subrogation was not available to the plaintiffs in this case because Penn National had no responsibility for the plaintiff's inferior lien position. Penn National did nothing by act or omission to cause the plaintiff to satisfy the senior liens. When Penn National docketed its judgment in 2002, it was subordinate to the two prior deeds of trust. The plaintiff’s failure to accurately search the public records is what resulted in Penn National's judgment moving from last priority to first priority after the two prior deeds of trust were cancelled of record.

It is reasonably certain that the plaintiffs would have refused to disburse the refinance loan had the judgment been reported. The Court states that “Penn National is an innocent third party, and even assuming, arguendo, that American General was “excusably ignorant,” the equities do not favor subordinating Penn National's judgment to American General's lien. If we were to subrogate Penn National's judgment to American General's second deed of trust, we would place Penn National in a worse position because it would be subordinate to the additional sum of $1,573.00 that American General provided to the Barnes family. It would be inequitable to place an innocent third party in an inferior position. See 73 Am. Jur. 2d Subrogation § 11 (2005) (saying, “relief by way of subrogation will not be granted where it would work injustice”).”

The opinion contains some elements that may give rise to concern. First, we must acknowledge that we don’t have the record on appeal before us. The Court of Appeals states; “On 17 January 2002, the confession of judgment was properly entered, filed, and docketed”. If correct on the record and on the facts, the Court was correct in its determination that the plaintiff was not “excusably ignorant”. The public records impart constructive notice. Without justification, the payment is equivalent to that of a volunteer and there is no merit in providing relief for mere error.

However, this brief statement of the facts clearly seems to imply that there was an error on the part of the title examiner. The Court of Appeals’ recitation of the facts does not address an implied question that would be obvious to any competent title examiner. From the close proximity in time in the recording of the deed of trust and the filing of the judgment, it seems as if there may be an implicit question of whether the judgment was properly indexed at the time of the search. If not, a question exists as to whether the lien actually attached prior to the judgement. If it did attach, the next question is whether a reasonably careful examiner would have turned up the lien. This, in turn, goes to the heart of the question of whether American General was, in fact, excusably ignorant of the existence of the lien. Again, the docket might not accurately reflect the exact time a searcher would have been able to see the judgment on a computer screen. It might be that a summary judgment order was premature if there was any arguable issue as to what a prudent search would have revealed at that particular time on January 18, 2002. This supposition is purely speculation, but it would have been comforting if the Court’s opinion had better put the question to rest.

Here we take issue with the legal analysis in the opinion. The second issue is the assumption on the part of the Court of Appeals that the cash-out portion of the refinance loan, standing on its own, somehow prevented the application of the equitable doctrine. The Court says that even if the plaintiff was excusably ignorant they “would place Penn National in a worse position because it would be subordinate to the additional sum of $1,573.00 that American General provided”. This question has clearly been disposed of to the contrary in North Carolina. In the case of Carolina Builders Corp. v. Howard-Veasey Homes, Inc., 72 N.C. App. 224, 324 S.E.2d 626, cert. den. 313 N.C. 597, 330 S.E.2d 606, (1985), the equitable doctrine of instantaneous seisin is clearly set forth. Dalton Moran Shook Inc. v. Pitt Development Co., 113 N.C. App. 707, 440 S.E.2d 585, (1994) modifies this doctrine to the extent that a deed of trust securing the purchase price of property as well as a construction loan is superior to an existing materialmen’s lien only to the extent that the deed of trust secures the purchase price of the property. Applied in this case, the cash-out portion of the loan would be junior to the judgment if the equities were in the plaintiff’s favor. Dalton also was a summary judgment case and the order was overturned for further findings. It is possible that had the Court decided this issue correctly, the issue of excusable neglect might have attracted closer scrutiny by the Court.

Other than this second issue of the application of equitable doctrine, we do not take issue with the legal analysis in this opinion, though we do wonder about the facts of the case. Some practitioners question whether due diligence requires ascertaining whether the Clerk’s office is holding any ‘filed’, but non-indexed judgments. Opinions vary widely, but we believe that this case tends to marshal support for the position that doing so may be prudent.