Subrogation Page2

---

 

Plaintiffs' other cited caselaw does not change this conclusion. For example, Plaintiffs cite to Mort v. United States [ 96-1 USTC ¶50,315], 86 F.3d 890, 894 (9th Cir. 1996), to establish that they are not volunteers, but Mort relied on a more restrictive definition of volunteer supplied by California law. Specifically, the Mort court read California law as allowing subrogation for a "person who lends money to pay off an encumbrance on property and secures the loan with a deed of trust on that property," id.; this is clearly contradictory to Michigan law as pronounced in Lentz and Lewis. Plaintiffs also argue that the government would unjustly receive a windfall if the Court denied subrogation here, because the USA 's lien would have its priority elevated with the 1999 mortgage's priority disappearing. See Dietrich Indus., Inc. v. United States , 988 F.2d 568, 573 (5th Cir. 1993). Plaintiffs' windfall argument is not persuasive, however, because allowing subrogation would give Plaintiffs the windfall; further, the logic of Plaintiffs' argument would have applied just as well in Lentz or Lewis, and both of those courts denied subrogation. Finally, Plaintiffs cite to United States v. Baran, 996 F.2d 25, 29 (2nd Cir. 1993), but Baran never discussed the volunteer issue. In conclusion, the Court denies Plaintiffs equitable subrogation argument.

B. Citizens Bank's Mortgage gets priority over the tax lien as a purchase money mortgage under federal law

Both parties agree that Citizens Bank has a purchase money mortgage on the property, but disagree over whether such a mortgage gets priority over the tax lien. Plaintiffs argue that the current state of Michigan law favors their position. Specifically, Plaintiffs contend that a Michigan Appeals Court decision, Graves v. American Acceptance Mortgage Corp., 246 Mich. App. 1 (2001), held that purchase money mortgages always have highest priority. Plaintiffs acknowledge that the Michigan Supreme Court later overruled Graves , but observe that the Michigan Supreme Court has since vacated its overruling opinion to reconsider the case. Plaintiffs conclude that with the Supreme Court opinion vacated, the Appeals Court opinion is once again good law. The government responds that state law is unsettled as to the priority of a purchase money mortgage versus other liens and securities. The USA continues to say that the state of Michigan law is irrelevant, because priority in this case is governed by federal law, and federal law allows for no special priority for purchase money mortgages.

As both parties agree, state law dictates the existence of property interests, but the priority of those interests with respect to tax liens or other portions of the tax law is an issue of federal law. United States v. National Bank of Commerce [ 85-2 USTC ¶9482], 472 U.S. 713, 722 (1985); Blachy v. Butcher [ 2000-2 USTC ¶50,629], 221 F.3d 896, 905 (6th Cir. 2000). Defendant is correct that the dispute over Graves is moot, as the question of priority is not governed by state law. Federal law, however, does generally give priority to purchase money mortgages. The Supreme Court has held that a federal tax lien is subordinate to "a purchase-money mortgage regardless of whether the agreement was entered into before or after the filing of a tax lien." Slodov v. United States [ 78-1 USTC ¶9447], 436 U.S. 238, 257-58 (1978). "Decisional law has long established that a purchase-money mortgagee's interest in the mortgaged property is superior to antecedent liens prior in time ... and, therefore, a federal tax lien is subordinate to a purchase-money mortgagee's interest notwithstanding that the agreement is made and the security interest arises after notice of the tax lien." Id. at n. 23; accord First Interstate Bank of Utah , N.A. v. Internal Revenue Serv. [ 91-2 USTC ¶50,303], 930 F.2d 1521, 1523 (10th Cir. 1991). This fact has recently been recognized by another court in this District. Wilson v. Wilson [ 2003-1 USTC ¶50,153], No. 02-CV-70833, 2002 WL 31545995, at *8 (E.D. Mich. Oct. 21, 2002 ) (citing First Interstate Bank [ 91-2 USTC ¶50,303], 930 F.2d at 1523). Thus, the government's tax lien seems at first glance subordinate to Citizens Bank's mortgage.

The Court, however, agrees with Defendant that Slodov is distinguishable from the instant case because the mortgagor in Slodov was the taxpayer himself, whereas here, the mortgagor is Bednarowski, a separate purchaser. Defendant insists that this is a crucial distinction between Slodov and the instant case because of the rationale underlying the priority given to purchase money mortgagees. In a typical purchase money mortgage situation, the property-buyer receives a loan from the lender to buy property, and secures that loan by granting the lender a mortgage on the purchased property. In such a scenario, the purchase of the land and the mortgage are seen as simultaneous events, so that the mortgagor obtains the land already encumbered by the mortgage. United States v. New Orleans R.R., 79 U.S. 362, 365 (1870); cited in Slodov [ 78-1 USTC ¶9447], 436 U.S. at n. 23. In other words, it is not the case that the mortgagor acquires the land and then gives a mortgage interest to the lender.

This chronology is critical in explaining why purchase money mortgages get priority over preexisting liens. A preexisting lien, i.e., a tax lien, encumbers whatever property the lienee thereafter acquires. Thus, when a lienee buys property, the lien automatically attaches to it. This is in contrast to a non-purchase money situation, in which the lien is the first encumbrance on the property. If the lienee subsequently gives out a mortgage on that property, the lien takes priority over the mortgage because the lien attached first. In a purchase money situation, on the other hand, the property enters the lienee's hands with the mortgage already attached, and so the lien attaches after the purchase money mortgage, even though the lien existed in time before the purchase money mortgage. Thus, the purchase money mortgage has priority over the lien, because it attached to the property before the lien. Put another way, the lien can only extend to the property actually owned by the lienee; the priority given to purchase money mortgages reflects the fact that the property comes to the mortgagor already "owned" to a certain extent (the extent of the mortgage amount) by the mortgagee. Slodov [ 78-1 USTC ¶9447], 436 U.S. at n. 23 (citing New Orleans R.R., 79 U.S. at 365; Rev. Rul. 68-57, 1968-1 C.B. 553). Therefore, the lienor's interest in the property is subordinate to the mortgagee's, because the lien does not encumber the portion of the property "owned" by the mortgagee.

The Court finds that the rationale for granting priority to purchase money mortgages does not apply in the case at bar. In the instant case, the tax lien had already attached to the Property before Plaintiffs got involved. In this way, Bednarowski acquired the Property with the lien attached. Even though the mortgage to Citizens Bank occurred simultaneously with Bednarowski's acquisition of the property, it still occurred after the tax lien had attached. Put another way, when the tax lien attached, Citizens Bank did not yet have an interest in the Property, unlike the classic purchase money mortgage situation described above. While Citizens Bank's mortgage would take priority over any tax liens imposed on Bednarowski, it does not take priority over a preexisting tax lien on Wallace that was inherited by Bednarowski in its purchase of Wallace's property. Therefore, the Court concludes that the purchase money mortgage in this case does not take priority over the tax lien.



V. CONCLUSION

For the reasons set forth above, the Court GRANTS Defendant's Motion for Summary Judgment and DENIES Plaintiff's Motion for Summary Judgment. Specifically, the Court holds that the Property is encumbered by the tax lien, and that the tax lien has priority over Citizens Bank's mortgage.

IT IS SO ORDERED.

 

In re Karl Rob ert Simms, Debtor. Equicredit Corporation, Plaintiff v. Karl R. Simms, Jane Doe, unknown spouse of Karl Simms, United States of America, General Motors Acceptance Corp., Ohio Bureau of Employment Services, Ohio Department of Job & Family Services, Pamela Simms Leasure, Carlile Patchen & Murphy, and the Washington County Treasurer, Defendants.

U.S. Bankruptcy Court, So. Dist. W.V.; 02-40183, 300 BR 877, May 30, 2003.

[ Code Secs. 6323 and 6871]

Bankruptcy: Validity and priority against third parties: Equitable subrogation. --

A mortgage company was not entitled to the proceeds on the sale of a debtor's home because it did not have priority over federal tax liens recorded before the mortgage. The mortgage company claimed that it satisfied the debtor's previous home mortgage and, as a result, was subrogated to the rights of the previous mortgage, which was incurred before the tax liens at issue. However, the doctrine of equitable subrogation was not applicable because the mortgage company was negligent in failing to do a title search before extending credit to the debtor, which would have revealed the tax liens. As such, the mortgage company had no reasonable expectation of priority.

ORDER GRANTING DEFENDANT'S MOTION FOR SUMMARY JUDGMENT

PEARSON, Bankruptcy Judge: Pending are motions for summary judgment filed by the defendants, United States of America and Karl R. Simms ¹ . At issue is entitlement to the proceeds of the sale of real estate owned by the debtor upon which various liens had attached. The legal issues underlying the motions have been fully briefed, and the Court finds them ripe for review.

FACTUAL BACKGROUND

With this Court's permission, the Debtor, Karl Rob ert Simms, sold his real property located a 207 VanBergan Street , Marietta Ohio , free and clear of liens. The proceeds from the sale, which amounted to $75,857.31, were placed in the registry of the Court. The plaintiff, Equicredit Corporation filed this proceeding alleging that it had a valid first priority mortgage on the property which entitled its lien to have priority over all others and demanded that it receive a portion of the sale proceeds before all other creditors.

On October 15, 1992 , the Debtor granted a mortgage to First Bank of Marietta on the subject property. Subsequently, this mortgage was released ² . On July 26, 1995 , defendant United States of America , through the Internal Revenue Service, recorded in the proper county a lien against the Debtor in the amounts of $688.75 and $38,162.56. On September 28, 1995 , the IRS recorded another tax lien in the amount of $34,769.79. Thereafter, but before February 14, 2000 , additional liens were filed against the Debtor in the county where the subject property was situated. On February 14, 2000 , the Debtor granted a mortgage on the subject property to Equicredit Corporation which was recorded on March 6, 2000 . Out of the funds secured by the Equicredit Mortgage, $36,340.41 was paid to satisfy the mortgage of First Bank of Marietta .

DISCUSSION

Bankruptcy Rule 7056 incorporates the standards set forth in Federal Rule of Civil Procedure 56, which governs when summary judgment is appropriate. That rule provides that summary judgment shall be rendered if the pleadings, discovery, or affidavits submitted show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c).

The moving party has the initial burden of proving that no genuine issue of fact exists. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). The burden then shifts to the nonmoving party to demonstrate that a triable issue of fact exists which precludes summary judgment against the nonmovant. Holland v. Double G. Coal Co., 898 F.Supp. 351 (S.D. W.Va. 1995). For a genuine issue of fact to exist, there must be sufficient evidence that a reasonable jury could find, by a preponderance of the evidence, for the nonmoving party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986).

Where competing liens involve a federal tax, federal law controls. Aquilino v. United States [ 60-2 USTC ¶9538], 363 U.S. 509 (1960); In re Darnell [ 88-1 USTC ¶9123], 834 F.2d 1263, 1269 (6th Cir. 1987). Under federal law, the priority of competing liens is determined by the principle of "first in time is first in right." United States v. McDermott [ 93-1 USTC ¶50,164], 507 U.S. 447, 449 (1993); United States v. Vermont [ 64-2 USTC ¶9520], 377 U.S. 351, 355 (1964); United States v. New Britain [ 54-1 USTC ¶9191], 347 U.S. 81 (1954); In re Priest [ 83-2 USTC ¶9530], 712 F.2d 1326, 1327-28 (9th Cir. 1983); In re Alliance Transp. Inc., 47 B.R. 473, 475 (Bankr. N.D. Ga. 1985). In the present case, it is undisputed that the United States ' tax liens were filed in July and September 1995, while the plaintiff's mortgage lien was executed on February 14, 2000 and recorded on March 6, 2000 . Thus, the tax liens are "first in time" and have priority over the plaintiff's mortgage lien.

However, the plaintiff has argued that it has priority over the other liens on the subject property on the basis that it is subrogated to the rights of First Bank of Marietta as a result of satisfying the purchase money mortgage on the subject property.

Under Ohio law, "[i]n order to entitle one to subrogation, his equity claim must be strong and his case clear." Ohio Dept. of Taxation v. Jones, 61 Ohio St.2d 99, 399 N.E. 2d 1215 ( Ohio 1980); see also Associates Financial Servs. Corp v. Miller, 2002 WL 519667 (Ohio App. 2002) "Equitable subrogation will not be used to benefit parties who were negligent in their business transactions, and who were obviously in the best position to protect their own interests." Associates, 2002 WL 519667.

In Jones, the Ohio Supreme Court refused to apply equitable subrogation, finding that Jones' "own actions led to its dilemma of not obtaining the best priority lien." Jones, 61 Ohio St.2d at 102, 399 N.E.2d at 1218. The Court pointed out that Jones was "in complete control of the refinancing application, and yet by [his] own actions and inactions the state, without acting fraudulently, was able to secure priority" of its state tax lien Id. , 61 Ohio St.2d at 102-103, 399 N.E.2d at 1218.

Similarly, the plaintiff in the present case negligently extended financing under circumstances that prevented Equicredit from obtaining adequate security. A simple title search prior to the extension of financing would have disclosed the existence of liens that far exceeded the value of the property. Any creditor who expects to acquire a valid mortgage is required to do at least this much. Moreover, if Equicredit was aware of the liens and chose to extend the financing anyway, then it would have had no reasonable expectation of having priority. Thus, the fact that Equicredit does not have priority in this case is due entirely to its own carelessness. Therefore, the doctrine of equitable subrogation does not apply in this case.

It is accordingly,

ORDERED that the Motion for Summary Judgment filed by the defendant, United States of America is GRANTED and the proceeds from the sale of the subject property shall be distributed to the United States of America to the full extent of its liens and any remaining funds shall be distributed to creditors based on their lien priority without subrogating the lien of the plaintiff.

IT IS SO ORDERED.

¹ The plaintiff, Equicredit Corporation, has not filed a motion for summary judgment but has asserted in its response to the defendants' motions that it is entitled to judgment as a matter of law.

² Equicredit asserts that this mortgage was released following payment with monies obtained by the Debtor which were secured by a mortgage granted to Equicredit on February 14, 2000 .

 

[2001-1 USTC ¶50,367] United States of America , Plaintiff v. Harold Morrell and Michael F. Morrell, Defendants

U.S. District Court, East. Dist. N.Y., 97 CV 5344 (NG), 3/23/2001

[Code Sec. 6323 ]

Liens and levies: Enforcement: Validity: Foreclosure: Transfer of property subject to lien.--Federal tax liens on a residence conveyed by married taxpayers to their son and an annuity traceable to securities also transferred to their son, in exchange for a promise of future support were valid and could be foreclosed. The parents conceded that they divested themselves of their assets through the conveyance, rendering them unable to satisfy their tax obligations and the son admitted that the purported agreement arose after the transfer had taken place. Further, there was no supporting documentation for the claim that the son purchased the securities with his own money. Thus, there was no basis for concluding that the shares had not been transferred to the son in the same manner as other securities were transferred or that the transfer occurred before the tax assessments were made.

[Code Sec. 6323 ]

Liens and levies: Enforcement: Validity: Foreclosure: Transfer of property subject to lien: Purchaser: Oral agreement.--An individual who promised to provide future support for his parents in exchange for their transfer to him of their home was not a purchaser whose interests in the transferred property were superior to federal tax liens on the property. The purported oral agreement under which the property was transferred was unenforceable under the statute of frauds and the son admitted that the agreement arose after the property was transferred. Moreover, courts have repeatedly rejected the argument that promises of future support constitute fair consideration.

[Code Sec. 6323 ]

Liens and levies: Enforcement: Validity: Foreclosure: Transfer of property subject to lien: Purchaser: Equitable subrogation.--An individual who promised to provide future support for his parents in exchange for their transfer to him of their home was not entitled equitable subrogation. He did not have an equitable lien superior to the government's lien because he did not satisfy a senior encumbrance on any of the properties, nor did his payments to his parents confer any benefit upon the government. Moreover, equitable principles did not point to the type of relief requested by the taxpayer.
ORDER

GERSHON, District Judge:

The United States moves pursuant to Rule 56, Fed. R. Civ. P., for summary judgment to declare the validity of certain tax liens and to order foreclosure on the liens and sale of property, consisting of a residence conveyed by taxpayers to their son and an annuity traceable to securities that had been transferred by taxpayers to their son, that is subject to the liens. Defendants oppose the motion, arguing that there are factual issues for trial: (1) that the son"s interests in the real and personal property that had been transferred to him are superior to the tax liens; (2) that some of the funds used to purchase the annuity came from the son's independently accumulated assets, or alternatively, from property transferred by the taxpayers before the liens attached; and (3) that the government is not entitled to the appreciation in the value of assets after the transfers by the parents to the son.

The Facts

The facts, which in part are set forth in a Joint Agreed Statement of Material Facts ("Joint Statement") entered into by the parties, are undisputed except as indicated. Defendant Harold Morrell invested in tax shelters and claimed deductions on his joint income tax returns filed with his wife, Dolores Morrell, for the years 1977--1980. ¹ The IRS disallowed the deductions for these four years and assessed deficiencies. Harold and Dolores Morrell contested the deficiencies in Tax Court. On August 13, 1990 , the Tax Court entered an agreed decision finding deficiencies for those years, exclusive of interest, of $182, 645, which with interest had grown to over $750,000 as of the date of the decision and approximately $1.4 million when the parties entered into the Joint Statement.

The IRS separately assessed the deficiencies and demanded payment for each of the years 1977--1980 between November 15 and December 10, 1990, thereby creating liens against all property of Harold and Dolores Morrell pursuant to 26 U.S.C. §§6321 and 6322. These statutes provide that a lien attaches at the time of assessment to "all property and rights to property" of the taxpayer for the amount of the assessment, including interest that may accrue, and continues until the liability is satisfied or becomes unenforceable by lapse of time. Tax liens were filed against Harold and Dolores Morrell in Suffolk County on September 11, 1991 . Harold Morrell does not contest the deficiencies, and agrees that judgment should be entered against him for the full amount of the liability.

Harold and Dolores Morrell transferred real estate, stocks and other securities to their son, defendant Michael F. Morrell. The real estate, a home in Suffolk County having a fair market value of approximately $400,000 at the time, was transferred by deed dated May 24, 1991 , after the assessment and attachment of the government's lien. ² Harold and Dolores Morrell continued to reside there after the transfer as they had before. There was no mortgage on the property. Harold and Dolores Morrell also transferred to Michael Morrell in May 1991 their holdings in municipal trusts worth over $217,000. The transfer was effectuated by transferring the holdings from the parents' account at Dean Witter to Michael's account at Dean Witter. Michael subsequently transferred the municipal trusts to a joint Dean Witter account of Michael and his spouse. In April 1992, Harold and Dolores Morrell transferred stock holdings worth approximately $200,000 from their Dean Witter account to the Dean Witter account of Michael and his spouse.

Harold Morrell claimed in his deposition that all of these transfers, which admittedly followed the assessment, were not undertaken to avoid payment of tax deficiencies. Instead, he asserted, the assets were transferred in light of the declining health of Dolores Morrell, so that the parents would qualify for government medical assistance. Michael Morrell testified in his deposition that he shared the same understanding of the reason for the transfers of assets, and was not aware at that time of his parents' tax difficulties. For purposes of the summary judgment motion, the government does not contest motivation, but asserts that it is entitled to foreclose on its liens regardless of motivation.

Michael Morrell's assertion of an interest superior to the government liens is based upon the defendants' claim that in exchange for the transfer of assets, Michael orally agreed to support his parents and in fact did so. Defendants argue that Michael Morrell therefore is a "purchaser" protected under 26 U.S.C. §6323(a) or, alternatively, that he is entitled to an equitable lien for the hundreds of thousands of dollars he spent to support his parents over the years following the transfers of assets.

Harold Morrell testified at his deposition that he and his wife transferred their residence, stocks and securities pursuant to a unitary plan to divest themselves of all assets, and that no other assets were left after the transfers. ³ Harold Morrell testified as follows as to the timing of the alleged support agreement in relationship to the transfer of property:

Q. In connection with the transfer of the assets, did your son later make some promises to you as to what he would do for you?

A. Well, we had set up for a planned estate, and he agreed after we transferred everything over to his name he would support us. We were concerned about our health, my wife's health, which subsequently has died, but concerned about Medicare, so we didn't want to have anything around. So we made a deal. We decided that we'll have Michael take everything now and then support us so that we wouldn't be exposing the assets to Medicaid.

*****

Q. At the time of the transfers that you made to your son, had your son agreed to give you support?

A. Yes.

*****

Q. And your recollection is that his promise for the support was before the transfers were made, not after?

A. I don't remember whether it was before or after. I don't remember that part, before or after.

Q. It could have been one or the other?

A. Yeah, it could have been.

*****

Q. Everything was oral?

A. Oral.

Q. Did your son ever tell you what he would do for you in the way of providing you support?

A. He would support us the way we were--the way we lived, you know.

Michael Morrell admitted at his deposition that he first found out about the transfer of property to him during a telephone call from his father saying, "here is what I've done, and I'm really doing this because of these Medicare issues." As far as Michael knew, the documentation for effecting the transfer of securities consisted simply of a name change in ownership of the Dean Witter account. Michael Morrell testified that the circumstances surrounding the support arrangement "was simply, We're going to give you this money, and, you know, I agreed to support them. I mean it was no--there was no formal arrangement." Michael reiterated that he thought "the transfer took place and then we had the discussion," which could have taken place one or two months after the transfer. The discussion was: "I would just pay all their expenses." In the deposition, Michael Morrell recollected that the transfer of securities occurred after the real estate had been transferred; he believed the transfer of securities took place in late 1991.

Michael Morrell's affidavit submitted in opposition to the summary judgment motion simply states, in reference to the purported agreement: "In exchange for the transfer of the assets, I agreed to support my parents for their lifetime," and that he "kept that promise" by the substantial deposits to his parents' bank accounts and his purchase of a townhouse in 1996 where his father lives rent free. The affidavit identifies the transferred assets as his parents' entire portfolio of stock and municipal bonds, and their home. The affidavit states that the home was transferred in May 1991, and the securities in May 1991 and April 1992.

In October 1995, Michael Morrell liquidated his joint Dean Witter account and used all of the proceeds to purchase a variable annuity for approximately $833,000. The government claims that its lien attaches to the entire amount of the annuity, which had increased in value to over $1 million as of March 31, 1998 . In opposition to the summary judgment motion, Michael Morrell claims that at least $380,000 in the Dean Witter account that was used to purchase the annuity represented separate savings accumulated by Michael and his wife and did not come from his parents. Michael also argues that the government should not be entitled to payment of the portion of the proceeds from his Dean Witter account used to purchase the annuity that represents appreciation in the Dean Witter account; Michael attributes that appreciation in asset value to his prudent and skillful management of the account.

The government agrees in principle that, to the extent that Michael could show that a portion of the annuity was purchased with funds that were not traceable to transfers from his parents after the lien attached, Michael would be entitled to retain a pro rata share of the proceeds of the annuity. However, the government contends that there is no genuine factual dispute that all of the funds in the Dean Witter account that were used to purchase the annuity are traceable to transfers made by Harold and Dolores Morrell after the tax liens had attached. The government also contends that, since the lien follows the property, it is entitled to foreclose on the entire value of the annuity, including any appreciation in value of the annuity or the Dean Witter fund used to purchase the annuity, until the deficiency, including accrued interest, is fully satisfied.

The property that Michael Morrell asserts had been purchased with his own funds is a tax free fund of Dean Witter. Neither Harold Morrell nor Michael Morrell produced most of their securities account records in discovery for the critical period of 1990 through the first few months of 1992, which would have shown all holdings and activity in the accounts in the periods preceding and following the assessments. Michael Morrell's affidavit in opposition to summary judgment attached his Dean Witter account statement for June 1991, which reflected a holding of 33,769 shares of Dean Witter New York Tax Free Inc. Fund, then worth approximately $378,000, as well as approximately $2,000 in a U.S. government money market fund. Michael claimed that these investments were acquired with his own funds and were not derived from property his parents transferred to him. Michael explained his failure to produce that statement and others or to discuss those holdings at his deposition by stating that he had only recently located some of these records, and that his memory had been impaired because of a heart condition. Michael Morrell did not produce any records that showed that he in fact purchased shares of this tax free fund from his own savings. The government responded to this new information by obtaining other records from Dean Witter, including the account statement for Harold and Dolores Morrell as of April 30, 1990 , showing that the exact same quantity, 33,769 shares of Dean Witter New York Tax Free Inc. Fund, then worth approximately $364,000, was held in the parents' account.

Because the account statements produced by the defendants and those obtained by the government from Dean Witter are incomplete, there is a gap between the April 1990 statement of the taxpayers and the June 1991 statement of Michael Morrell. Therefore, no document shows when, after April 1990, the 33,769 shares of Dean Witter New York Tax Free Inc. Fund were withdrawn from the taxpayers' account or where it went, or when, before June 1991, 33,769 shares of Dean Witter New York Tax Free Inc. Fund first were carried in Michael's account or where it came from. Defendants argue that there are factual issues, precluding the granting of summary judgment to the government, as to whether this fund was transferred from the parents to Michael Morrell, and if it was, when the transfer took place, i.e., before or after the tax liens attached in November and December, 1990.

Examination of the Dean Witter monthly statements for the account of Michael Morrell and his spouse from the end of 1991 until its liquidation in October and November 1995, when Michael used the entire proceeds to purchase the annuity, confirms the government's assertion that no new money or other assets were put into the account except for securities transferred by Harold and Dolores Morrell in April 1992. Defendants were afforded an opportunity after oral argument to identify any such assets that Michael put into the account, but their counsel notified the court that they had no further information to offer. The account statements show that there were few purchases and sales of securities, except for liquidations to withdraw funds from the account, and that all purchases of securities in the account during this time period were made with the proceeds from redemption of other securities held in the account and accumulated dividends and interest from those securities. Although Michael Morrell placed no new money in the account, he frequently made withdrawals from it between December 1992 and September 1995, for a total of approximately $119,000. The record contains no explanation of these withdrawals. As a result of these withdrawals, there was in fact negligible increase in the value of the account: it had a value of approximately $778,000 on March 31, 1992 , $807,000 on November 30, 1992 , $781,000 on February 28, 1995 , and $814,000 on May 31, 1995 , before being liquidated for approximately $833,000 in October and November, 1995.

Discussion

Summary Judgment Standards

Motions for Summary judgment are granted if there is no genuine issue as to any material fact, and the moving party is entitled to judgment as a matter of law. See Lipton v. Nature Co., 71 F.3d 464, 469 (2d Cir. 1995). The moving party must demonstrate the absence of any material factual issue genuinely in dispute. See id. A material fact is one whose resolution would "affect the outcome of the suit under governing law," and a dispute is genuine "if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). The court must view the inferences to be drawn from the facts in the light most favorable to the party opposing the motion. See Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). However, the non-moving party may not "rely on mere speculation or conjecture as to the true nature of the facts to overcome a motion for summary judgment." Knight v. U.S. Fire Ins. Co., 804 F.2d 9, 12 (2d Cir. 1986). Nor may the non-moving party "simply show that there is some metaphysical doubt as to the material facts." Matsushita Elec., 475 U.S. at 586. The party must produce specific facts sufficient to establish that there is a genuine factual issue for trial. See Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986).

"Purchaser" Under 26 U.S.C. §6323(a)

Section 6323(a) of Title 26, United States Code, provides that "[t]he lien imposed by section 6321 shall not be valid as against any purchaser" until notice of the lien has been filed. A "purchaser" is defined in Section 6323(h)(6) as "a person who, for adequate and full consideration in money or money's worth, acquires an interest . . . in property which is valid under local law against subsequent purchasers without actual notice." The Treasury Regulations define "adequate and full consideration" to require "consideration in money or money's worth having a reasonable relationship to the true value of the interest in the property acquired." 26 C.F.R. §301.6323(h)-1 (f)(3). "Money or money's worth" is defined in the regulation as including "tangible or intangible property, services and other consideration reducible to a money value," but excluding such things as "love and affection . . . or any other consideration not reducible to a money value." Id. §301.6323(h)-1(a)(3).

No reasonable juror could find that Michael Morrell was a "purchaser" within the meaning of this provision. First, defendants conceded during oral argument of the summary judgment motion that the purported oral agreement by Michael Morrell to support the taxpayers for their lives is unenforceable under the statute of frauds. Obviously, an unenforceable promise of future support is not "adequate and full consideration in money or money's worth" under any rational construction of the statute.

Second, there is no genuine issue of fact as to the existence of an agreement, even an oral one, in which Michael Morrell furnished consideration in exchange for which Harold and Dolores Morrell transferred these properties to him. Michael Morrell testified at his deposition that his best recollection was that any discussion he had with his father concerning support occurred after the property had already been placed in his name by the unilateral action of his parents. Viewed most favorably to him, Harold Morrell admitted that he could not recall whether any such discussion preceded or followed the transfers. Accordingly, there is no basis for a reasonable jury to find that consideration was furnished in exchange for the transfers of property, even if any such promise would have been enforceable.

Third, even if there had been an agreement that was enforceable before the transfers took place, Michael Morrell's promise to support his parents is not "adequate and full consideration in money or money's worth" for the immediate conveyance of unencumbered assets worth over $800,000 (or almost $1.2 million when the Dean Witter New York Tax Free Inc. Fund is included, see pp. 13-14 infra). The issue of adequate consideration is a matter of federal and not state law, and as the Second Circuit has stated, "a finding that [taxpayer] conveyed the Property to her daughters for adequate consideration under New York law, while helpful, does not provide a rule of decision that [the daughters] are federally protected 'purchasers' under Section 6323(a)." United States v. McCombs [94-2 USTC ¶50,363], 30 F.3d 310, 330 (2d Cir. 1994). Nevertheless, in the absence of reported federal cases construing Section 6323's requirement of "adequate and full consideration" when the consideration furnished by the reputed purchaser is a promise of parental support, and notwithstanding the variations in statutory language, the New York decisions that have construed the requirement of "fair consideration" under Section 273 of New York Debtor and Creditor Law in similar circumstances are persuasive. ⁴ Courts have rejected repeatedly the argument that promises of future support constitute fair consideration within the meaning of Section 273. Schmitt, 98 A.D.2d at 936 (purchaser's promises to take over payments on mortgage, furnace and taxes, to permit debtors to remain in house rent-free, and to convey ten acres to debtors' sons did not constitute "fair consideration" under §273; "[s]uch promises . . . are akin to promises of future support, which are insufficient as a matter of law to be considered a fair equivalent of the property transferred"); Petition of National City Bank of New York, 269 App. Div. 1040 (2d Dep't 1945) (promise of future support is not fair consideration); see United States v. Bushlow [93-2 USTC ¶50,556 ], 832 F.Supp. 574, 582 (E.D.N.Y. 1993) (promises of future services are not "fair consideration" under §273).

Defendants concede that Harold and Dolores Morrell divested themselves of virtually all their assets when they conveyed their real and personal property to their son, which rendered them unable to satisfy their tax obligations, and received nothing in return except at most an oral promise of support. It is not reasonable to find this promise to be "adequate and full consideration in money or money's worth."

Equitable Lien

Defendants argue that, even if Michael Morrell is not a purchaser within the meaning of Section 6323(a), he is entitled to an "equitable lien," that is superior to the government's lien, for the hundreds of thousands of dollars he spent to support his parents. Pursuant to 26 U.S.C. §6323(i)(2), equitable subrogation applies in certain circumstances where a transferee of property or a junior lienor has satisfied a lien that is superior to the tax lien. The statute provides: "Where, under local law, one person is subrogated to the rights of another with respect to a lien or interest, such person shall be subrogated to such rights for purposes of any lien imposed by section 6321." Equitable subrogation is designed to avoid the unjust enrichment that would occur if the government could reap the benefit of having the senior lien satisfied but deprive the party who satisfied that senior lien of any benefit in a foreclosure proceeding. To avoid such unfairness, the party that satisfied the senior encumbrance is allowed to assume the position that had been occupied by the original holder of the senior lien, if equitable subrogation is authorized by state law. See United States v. Avila [96-2 USTC ¶50,357], 88 F.3d 229, 237-39 (3d Cir. 1996); Mort v. United States [96-1 USTC ¶50,315], 86 F.3d 890, 893-95 (9th Cir. 1996); Progressive Consumers Federal Credit Union v. United States [96-1 USTC ¶50,160], 79 F.3d 1228, 1234-37 (1st Cir. 1996).

Even assuming arguendo that the Second Circuit would recognize a non-statutory equitable doctrine applicable to tax liens, equitable principles do not point to the relief requested. ⁵ Michael Morrell did not satisfy a senior encumbrance on any of these properties; indeed, there was no mortgage on the real property. Nor did Michael's payments to his parents confer any benefit upon the government. Michael Morrell received property from his parents that they should have used to satisfy their indebtedness to the government and then gave money back to his parents so that they could continue to live in the same style as that to which they were accustomed, as if they had never incurred liability pursuant to an agreed judgment. Equity is not served by giving Michael Morrell credit for these payments to his parents.

Source of Funds for Annuity

It is undisputed that the residence and over $400,000 worth of securities were transferred from Harold and Dolores Morrell to Michael Morrell after the assessments were made. On review of the entire record, the undisputed facts also establish that additional securities worth approximately $380,000, consisting of 33,769 shares of Dean Witter New York Tax Free Inc. Fund also were transferred to Michael by his parents. With no supporting documentation of any kind, Michael Morrell claims that he purchased the 33,769 shares of the Dean Witter New York Tax Free Inc. Fund with his own money. There is no explanation for the astounding coincidence that a year before, the taxpayers had the exact same number of shares of the same fund in their account. Moreover, Harold Morrell testified that he transferred all of his assets to his son, ostensibly so that Harold and Dolores could qualify for government medical assistance, and defendants offer no other explanation for the fact that the 33,769 shares of the fund the parents held in 1990 were no longer owned by them later. Since all other securities were conveyed from parents to son by directing transfer of the securities from the parents' Dean Witter account to the son's Dean Witter account, there is no rational basis for concluding that the 33,769 shares in Michael Morrell's account had not also been transferred in the same manner.

Furthermore, no rational juror could find that the transfer of this fund was made by the parents to their son before the liens had attached. As set forth in the Facts section above, Harold Morrell testified that the transfer of all assets held by him and his wife to Michael took place pursuant to one plan to divest themselves of all assets. Michael Morrell testified that all securities he received from his parents were transferred after the residence had been conveyed to him; it is undisputed that the real property was transferred approximately six months after the assessments. The parties agree that the assessments were made in November and December 1990, the real property was conveyed in May 1991, and that other securities were transferred in May 1991 and April 1992. Accordingly, there is no basis in the undisputed evidence for finding that the Dean Witter New York Tax Free Inc. Fund was transferred before the assessments.

Appreciation

Michael Morrell's argument that the government is not entitled to foreclose on the annuity to the extent that it represents appreciation in the value of the security holdings after the transfers of assets from the taxpayers is erroneous. He does not question the well-settled principle that the lien follows the property. "The transfer of property subsequent to the attachment of the lien does not affect the lien, for 'it is of the very nature and essence of a lien, that no matter into whose hands the property goes, it passes cum onere. . . .' " United States v. Bess [58-2 USTC ¶9595], 357 U.S. 51, 57 (1958) (citations omitted). This principle has been held to mean that the lien attaches to any appreciation in the value of the property until the taxpayer's liability has been discharge. Avila [96-2 USTC ¶50,357], 88 F.3d at 231, 233-34 (government lien is not limited to taxpayer's equity when he conveyed the property subject to the lien; it also attaches to the appreciation in the value of the property after the conveyance); Han v. United States [91-2 USTC ¶50,486], 944 F.2d 526, 528-29 (9th Cir. 1991) (same); see United States v. Librizzi [97-1 USTC ¶50,263], 108 F.3d 136 (7th Cir. 1997) (government's lien extended to appreciated fair market value of deceased taxpayer's interest in the property at the time of foreclosure and is not limited to value at death).

Furthermore, the premises of defendant's argument, that the annuity was purchased with appreciated assets and that the appreciation is attributable to Michael Morrell's skillful and prudent management of his Dean Witter account, are unfounded under the undisputed facts recited earlier. Almost all of the appreciated value in the Dean Witter account was taken out of it by Michael between 1992 and the account's liquidation in late 1995; and, with the inclusion of approximately 380,000 from the New York Tax Free Inc. Fund that defendant omitted in advancing his contention, the remaining minimal appreciation is attributable to passive reinvestment of interest and dividends which there is no persuasive reason to exempt from the government lien.

Conclusion

The motion of plaintiff United States of America for summary judgment is granted. The government should submit a proposed judgment on fourteen days' notice to the defendants.

SO ORDERED.

¹ Dolores Morrell died after this action was commenced and is no longer a party.

² The parties agree that the fact that certain transfers were made after the attachment of the liens but preceded their filing, is not determinative in this case.

³ Harold and Dolores Morrell in fact continued to retain ownership of a condominium, but the government is not seeking to foreclose on that property in this proceeding.

⁴ N.Y. Debtor & Creditor Law §273 declares that any conveyance made by a person who is thereby rendered insolvent is constructively fraudulent as to creditors regardless of the transferor's "actual intent if the conveyance is made or the obligation is incurred without a fair consideration." Section 272 provides that "fair consideration" is given for property when, as a fair equivalent for it and in good faith, property is conveyed or an antecedent debt is satisfied, or when the property is received in good faith to secure a present advance or antecedent debt in an amount not disproportionately small as compared with the value of the property. Schmitt v. Morgan, 98 A.D.2d 934, 935 (3d Dep't 1983 ), appeal dismissed, 62 N.Y.2d 914 (1984).

⁵ In McCombs [94-2 USTC ¶50,363], 30 F.3d at 333, the court in dictum apparently applied the equitable subrogation doctrine of §6323(i)(2) without citing the statute.

 

 

[2000-2 USTC ¶50,696] The Sum of $66,839.59 Filed in the Registry of this Court, Plaintiff v. United States of America , Internal Revenue Service, and the Sunshine House, Inc., Defendants

U.S. District Court, No. Dist. Ga., Atlanta Div., Civ. 1:99-cv-0776-CC, 5/17/2000

[Code Sec. 6323 ]

Priority of liens: Tax lien: Recorded: Equitable subrogation: State law: Negligence: Failure to discover.--A day care corporation became equitably subrogated to a bank's position as senior lienholder when it paid off the bank's loan to a corporation as part of an asset purchase agreement without knowledge of the IRS's recorded tax lien. The IRS conceded that the bank's interest in the assets was superior to its tax lien, but argued that the corporation was not entitled to equitable subrogation under state ( Georgia ) law because it was negligent in failing to discover the tax lien. However, the IRS did not identify any duty or standard of care that was breached by the corporation's agent.

ORDER

COOPER, District Judge:

Pending before the Court are cross-motions for summary judgment filed by The Sunshine House, Inc. ("Sunshine House") [15-1] and the United States Internal Revenue Service (the "IRS") [24-1], and the IRS' Motion to Strike Paragraphs 5 and 7 of the Affidavit of George C. Calloway ("Calloway") [23-1]. ¹

I. BACKGROUND

This action arises from an interpleader action originally filed the Georgia Building Authority ("GBA") in the Superior Court of DeKalb County on February 24, 1999 . On April 1, 1999, the Superior Court of DeKalb County ordered the sum of $66,839.59, representing the amount due by GBA under a Rental Agreement it had with Americare Development, Inc., ² to be paid into the registry of that Court. On April 9, 1999 , GBA paid said amount into the registry of the DeKalb County Superior Court. After a Notice of Removal pursuant to 28 U.S.C. §1444 was filed by the IRS, the action was removed to this Court. This Court then ordered that the interpleaded funds held in the DeKalb County Superior Court registry be transferred to the Clerk of this Court. Both the Sunshine House and the IRS have now moved for summary judgment with respect to their purported entitlement to the funds being held in this Court. ³

Defendant Sunshine House operates several child care centers in Georgia , South Carolina , and North Carolina . On September 30, 1998 , Carolina Child Care and Sunshine House (collectively referred to herein as the "Purchasers") purchased the assets of Americare Child Enrichment Centers, Inc. and the Americare Trust (collectively referred to herein as "Americare") for the total sum of $2,365,166.00. As part of this asset purchase, Purchasers purchased and received an assignment of the $66,839.59 at issue in this case.

Also as part of the asset purchase price, Purchasers paid off a loan from The First National Bank of Griffin ("First National") to Americare in the amount of $1,421,307.00. The loan that had been given by First National to Americare was secured by, among other things, two UCC-1 Financing Statements that encompassed the assets and equipment from which the funds in this case arose.

Purchasers also purchased certain real property located on Montreal Circle in DeKalb County as part of the asset purchase. In connection with the purchase of the Montreal Circle property, Specialized Title Services, Inc. ("Specialized Title") performed an examination of the DeKalb County title records on August 12, 1998 . In a letter to Specialized Title requesting the title search, Brooks Baker ("Baker"), the closing attorney involved in the asset purchase, wrote that there was a possibility of numerous liens outstanding on the Montreal Circle property (as well as on certain property located in Henry County that was part of the purchase), including IRS liens. While other encumbrances upon the property were discovered, however, no federal tax lien encumbering the Montreal Circle property or against Americare was discovered by Specialized Title. On September 30, 1998 , the day of the closing of the transaction between Purchasers and Americare, Specialized Title again examined the DeKalb County records to determine whether any encumbrances existed upon the property or against Americare, but no lien was discovered.

Although no federal tax lien had been discovered either on or prior to the date of the closing, on August 24, 1998 , the IRS had filed a Notice of Tax lien against Americare with the Superior Court of DeKalb County . The tax lien against Americare involved Form 941 taxes for the period ending March 31, 1997 , in the amount of $202,839.20. According to Jeannette Rozier ("Rozier"), the DeKalb County Clerk of Superior Courts, ⁴ at the time the IRS' tax lien was filed and entered into the court computer system on August 24, 1998, a sticker and bar code were placed on the lien specifically indicating the date and time it was entered into the computer system as well as the book and page number it would later appear on in the deed books. Even though the lien had been entered into the court's computers, however, it was not immediately available in the public indices. ⁵ As an alternative to only searching the public indices, Rozier testifies that once a lien has been entered into the computer system the public can search for the lien with the assistance of clerk personnel at workstation computers at the information desk. The workstation computer provides up-to-the-minute alphabetized indices of deeds entered into the computer system even before they are made publicly available. Rozier also testifies that if an individual seeks a recently recorded or filed lien that does not appear in the public indices or on the workstation computer index, upon request the clerk of court personnel will search incoming mail and the records awaiting entry into the computers to assist the individual.

As discussed above, while the IRS' tax lien was filed on August 24, 1998 , it had not yet been indexed in the DeKalb County public indices by the date of the closing, and it was not discovered by Specialized Title when it performed the title examination on the day of the closing. It was not until after the September 30^th closing date that the Purchasers received notice of the IRS' tax lien.

II. DISCUSSION

The outcome of this action rests upon whether the Sunshine House or the IRS has priority to the $66,839.59 being held in the registry of this Court. It is well-settled that the question of the priority of a federal tax lien is a question of federal, rather than state, law. Aquilino v. United States [60-2 USTC ¶9538], 363 U.S. 509, 513-14, 80 S.Ct. 1277, 4 L.Ed.2d 1365 (1960). The rule providing for the priority of federal tax liens is codified in §6321 of the Internal Revenue Code, which states: "[i]f any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . shall be a lien in favor the United States upon all property and rights to property, whether real or personal, belonging to such person." 26 U.S.C. §6321. The lien imposed by §6321 arises at the time of the assessment and continues until the liability is satisfied or becomes unenforceable. 26 U.S.C. §6322. However, "the lien imposed by section 6321, is not valid as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until notice of the federal tax lien is recorded as provided for in §6323(f). 26 U.S.C. §6323(a). In addition, Section 6323 also provides that "[w]here, under local law, one person is subrogated to the rights of another with respect to a lien or interest, such person shall be subrogated to such rights for purposes of any lien imposed by section 6321 or 6324." 26 U.S.C. §6323(i)(2).

Under Georgia law, equitable subrogation arises when one having a liability, right or fiduciary relationship pays a debt due by another under such circumstances that he is, in equity, entitled to the securities held by the creditor who has been paid. " 'Subrogation . . . is of equitable origin and benevolence. It is founded upon the dictates of refined justice. Its basis is the doing of complete, essential, and perfect justice between all the parties, without regard to form, and its object is the prevention of injustice. . . The courts incline rather to extend than restrict the principle.' " Davis v. Johnson, 241 Ga.436, 439, 246 S.E.2d 297(1978) (quoting Cornelia Bank v. First Nat. Bank of Quitman, 170 Ga. 747, 750, 154 S.E. 234, 236 (1930)).

In the present case, Sunshine House contends that it is entitled to summary judgment because it became equitably subrogated to the rights of First National when it paid off the existing loan between First National and Americare, and because said loan was prior in time to the IRS' federal tax lien, its security interest has priority over the tax lien. The IRS asserts, on the other hand, that Sunshine House is not entitled to equitable subrogation because it was negligent in failing to discover the IRS' properly recorded tax lien. The IRS argues that Sunshine House, through Specialized Title, could have used the workstation computers at the information desk of the clerk's office and asked clerk personnel to search incoming mails and records to discover the lien prior to the asset purchase closing at issue here. The government also argues that Sunshine House had at least constructive, if not actual, notice of the lien against Americare due to Baker's mention of the possibility of a lien in his letter to Specialized Title. The IRS contends that because Sunshine House's predicament was caused by its own negligence in conducting the title examination, it is not entitled to invoke the doctrine of equitable subrogation. This Court disagrees.

Simply because Sunshine House's agent could have asked for help from court personnel does not mean that it was negligent in not doing so. The IRS's bare allegation that Specialized Title should have done more in performing the search is insufficient for this Court to find that it was so negligent in not discovering the lien such that Sunshine House would not be entitled to equitable subrogation. The IRS has not pointed this Court to the duty or standard of care that was purportedly breached by Specialized Title. ⁶ In addition, Baker's mention of the possibility of IRS liens in his letter to Specialized Title is insufficient to put Sunshine House on actual notice of a lien when no such lien was found in the public indices. Accordingly, the Court concludes that Sunshine House became equitably subrogated to First National's position as senior lienholder when it paid off the First National loan to Americare as part of the asset purchase agreement without knowledge of the IRS' filed but not yet publicly available tax lien. ⁷ Where the IRS does not dispute that First National's interest was prior in time and therefore superior to the federal tax lien, the Court finds that Sunshine House's security interest has priority over the IRS' lien, and summary judgment is GRANTED in favor of Sunshine House. See, e.g., Dietrich Industries, Inc. v. U.S., 988 F.2d 568 (5th Cir. 1993) (applying Texas law of equitable subrogation and finding purchaser's interest superior to federal tax lien).

III. CONCLUSION

Sunshine House's Motion for Summary Judgment [15-1] is GRANTED. The IRS' cross Motion for Summary Judgment [24-1] is DENIED. The IRS' Motion to Strike Paragraphs 5 and 7 of the Affidavit of George C. Calloway [23-1] is DENIED. Sunshine House' Motion for Additional Time to Respond to the IRS' Motion for Summary Judgment [29-1] is DENIED as moot.

The Clerk of Court is DIRECTED to release the total sum of $66,839.59 being held in the registry of this Court to the Sunshine House.

¹ With respect to the IRS' motion to strike, because a motion, to strike is only appropriate with regard to a pleading and an affidavit is not a pleading (see Fed. R. Civ. P. 7), the motion to strike Calloway's affidavit is procedurally improper. Rather than filing a motion to strike as under Rule 12, the proper method for challenging the admissibility of evidence in an affidavit is to file a notice of objection to the challenged testimony. On a motion for summary judgment, the Court will evaluate the evidence presented in the affidavit and consider any objections raised to the testimony. Further, having reviewed Calloway's deposition and affidavit testimony, the Court finds that the arguments raised by the IRS go to the weight to be given to his testimony rather than its admissibility. Accordingly, the IRS' motion to strike paragraphs 5 and 7 of Calloway's affidavit [23-1] is DENIED.

² Pursuant to the Rental Agreement between GBA and Americare Development, Inc., upon termination of the Agreement, monies were to be paid by GBA to Americare Development, Inc. for the purchase of certain assets and equipment that had been placed in a child care center owned by GBA. The Rental Agreement was terminated on July 20, 1998 .

Thereafter, on September 30, 1998 , Americare Child Enrichment Centers, Inc., which was formerly known as Americare Development, Inc., entered into a Limited Warranty Assignment & Bill of Sale with Sunshine House, pursuant to which Americare Child Enrichment Centers, Inc. conveyed all of its rights, title and interest under the Rental Agreement to Sunshine House.

³ Pursuant to GBA's unopposed motion to be discharged from these proceedings, GBA was dismissed as a party to this action by this Court on February 11, 2000 . GBA has filed responses indicating that it takes no position with respect to either of the motions for summary judgment filed by the Sunshine House or the IRS.

⁴ The IRS did not identify Rozier at any time during discovery in this matter, and her testimony was not offered until after the IRS had filed its response to Sunshine House's motion for summary judgment.

⁵ Public indices include a computer index and the general execution index for notices of federal tax liens and deeds. The time between the filing of a lien or document and the effective date of the record is identified as the "gap period." Documents filed and recorded in the gap period are not immediately available on the public indices.

⁶ Matthew Deberadinis, a title examiner with Specialized Title who has 15 years of experience in performing title searches, testified that his customary method of conducting the most updated search for a lien in the DeKalb County records is to look in a blue book in the general execution index, which is a computer printout that is updated daily. If there is no lien showing in the index, he will indicate that no lien on the property has been found. There is nothing to indicate that an examiner is then required to ask the clerk personnel to assist him if no lien is shown in the index.

⁷ The Court also notes here that "knowledge of the existence of an intervening encumbrance will not alone prevent the person advancing the money to pay off the senior encumbrance from claiming the right of subrogation where the exercise of such right will not in any substantial way prejudice the rights of the intervening encumbrancer. . . ." Davis, 241 Ga. at 438. The party seeking equitable subrogation is estopped from the same only when the intervening lienholder, in this case the IRS, has taken or purchased the lien in reliance upon his status as senior lienor. Id. at 440. At the time that the IRS filed its tax lien in this case, the security interests held by First National were superior to the tax lien, and thus the IRS could not have relied upon its status as a senior lienor. As such, Sunshine House is not estopped from claiming equitable subrogation.

 

 

[99-2 USTC ¶50,843] Home Haven, Inc., et al., Plaintiffs v. United States of America , Defendant

U.S. District Court, Dist. Nev., CV-N-97-508-ECR (RAM), 9/2/99

[Code Secs. 6323 and 7426 ]

Equitable subrogation: Notice: Tax lien: Transferred assets: Third-party claims.--A corporation, its two incorporators, and the incorporators' limited partnership each had actual knowledge of a tax lien against property acquired by the corporation and were, therefore, not entitled to defeat the tax lien by the doctrine of equitable subrogation. The incorporators learned of the lien directly from the previous owner of the property, and their knowledge was imputed to their partnership and their corporation.
MINUTES OF THE COURT

MINUTE ORDER IN CHAMBERS

REED, JR., Senior District Judge:

On July 21, 1999, (#37) the Magistrate Judge filed a report and recommendation recommending that summary judgment be granted in favor of defendant and recommending that plaintiffs' motion for summary judgment be denied.

Objections were filed by plaintiffs (#39) on August 16, 1999 , and defendant has responded (#40) on August 27, 1999 .

IT IS, THEREFORE, HEREBY ORDERED that the report and recommendation of the Magistrate Judge is approved and adopted.

IT IS FURTHER ORDERED that motion for summary judgment filed by defendant on September 11, 1998 , (#20) is GRANTED. Plaintiffs' motion for summary judgment filed on September 18, 1998 (#21) is DENIED.

The Clerk shall enter judgment accordingly.

Plaintiffs may not make use of the doctrine of equitable subrogation because they had actual knowledge of the tax lien filed by the Internal Revenue Service at the time they acquired the property.

JUDGMENT IN A CIVIL CASE

Decision by Court. This action came to be considered before the Court. The issues have been considered and a decision has been rendered.

IT IS ORDERED AND ADJUDGED that motion for summary judgment filed by defendant on September 11, 1998 , (#20) is granted. Plaintiffs' motion for summary judgment filed on September 18, 1998 , (#21) is denied.

 

 

[98-1 USTC ¶50,343] Harley J. Rob inson Trust, a Michigan Trust, Plaintiff v. Ardmore Acres, Inc., a Michigan corporation, United States of America, State of Michigan, and Michigan Employment Security Commission, Defendants

U.S. District Court, East. Dist. Mich. , So. Div., 96-74182, 3/31/98, 6 FSupp 2 d 640, 6FSupp 2d 640

[Code Secs. 6321 and 6323 ]

Foreclosure: Priority of liens: Liens for taxes: Property subject to: Real property: Subrogation.--A trust acting as guarantor of a loan secured by a mortgage on real property was equitably subrogated to the rights of the mortgagee and, therefore, had priority in its foreclosure action over federal tax liens. Although the tax liens attached before the mortgage was assigned to the trust, the trust by satisfying its obligation as guarantor paid a debt for which the mortgagor was primarily answerable and was entitled to equitable subrogation. The trust was not primarily answerable for the debt where there was no evidence it was the alter ego of the mortgagor or that the loan was made primarily on the strength of the trust's guarantee. A question of fact remained as to the outstanding amount secured by the mortgage.

OPINION AND ORDER

I.

COHN, District Judge:

This is an action to foreclose on real property. Plaintiff Harley J. Rob inson Trust (the Trust) sued Ardmore Acres, Inc. (Ardmore), the United States of America, the State of Michigan, ¹ and the Michigan Employment Security Commission, all of which claim an interest in the real property. The Trust guaranteed a loan from Comerica Bank (Comerica) to Ardmore , which was secured by a mortgage on the real property. The Trust says that because it satisfied its obligation as guarantor, it is entitled to foreclose on the real property.

The Trust has moved for summary judgment against the United States (the government), asserting that its interest in the real property is superior to that of the government, which claims an interest through tax liens. Specifically, the Trust argues that by satisfying its obligation as guarantor of the mortgage, it should be equitably subrogated to the rights of Comerica. The government also moves for summary judgment, asserting that its tax liens are entitled to a priority interest in the real property because the tax liens arose prior to the Trust's interest. The Trust also has filed a motion for leave to amend its complaint and add party defendants. ²

For the reasons that follow, the Trust's motion for summary judgment will be granted in part and denied in part. The government's motion will be denied.

II.

The material facts as gleaned from the papers follow. ³

A.

In June 1988, Ardmore executed a promissory note secured by a mortgage on the real property in favor of Comerica in exchange for a loan of $2,400,000. The loan was also secured by a guaranty agreement executed by the Trust. The guaranty agreement states in part:

The [Harley J. Rob inson Trust], for value received, unconditionally guarantee(s) to Comerica Bank-Detroit . . . payment when due, whether by acceleration or otherwise, of all existing and future indebtedness to the Bank . . . of Ardmore Acres, Inc. . . .

Comerica properly recorded the mortgage.

B.

In September 1993, January 1994, and August 1994, the Internal Revenue Service (IRS) recorded Notices of Federal Tax Lien against Ardmore for assessed but unpaid employment tax liabilities arising out of Ardmore 's operation of a nursing home. In June 1994, the IRS levied upon and seized the real property in an effort to collect Ardmore 's unpaid taxes which totaled over $1,125,000.

C.

Ardmore defaulted on the Comerica loan. In February 1993, Comerica sued the Trust ⁴ as guarantor to collect the unpaid balance of the loan. ⁵ Eventually, in July 1994, after two of the tax liens were recorded, Comerica and the Trust executed a settlement agreement.

According to the terms of the settlement agreement, the Trust agreed to pay Comerica $2,350,000 to satisfy its obligations under the guaranty agreement. Specifically, the Trust agreed to pay $1,000,000 when the settlement agreement was executed, and $1,350,000 in January 1995. In the settlement agreement, the parties stated that the Trust's payment to Comerica did not satisfy Ardmore 's obligation. The settlement agreement further stated that in consideration for the Trust's agreement to satisfy its guaranty obligation, Comerica agreed to sell and assign its rights under the note and mortgage to the Trust. Comerica initially delivered the note and mortgage to an escrow agent, and after the Trust made all of the required payments to Comerica, the agreement provided that Trust would receive the note and mortgage from the escrow agent.

Comerica and the Trust modified the settlement agreement in January 1995 to provide that the Trust would pay $100,000 in January 1995, and $1,270,000 by March 3, 1995 . The payment of $1,270,000 was made on March 15, 1995 , twelve days late, from proceeds of the sale of assets of Harley's Golf Course, Inc. (Harley's Golf Course). The Trust says that at the time Harley's Golf Course owed the Estate of Harley Rob inson approximately $1,400,000, and the Trust was the residuary beneficiary of the Estate of Harley Rob inson. ⁶ Therefore, the Trust says that payment was made by Harley's Golf Course directly to Comerica on behalf of the Trust for the sake of convenience. Because the guaranty obligation was satisfied, the mortgage and note were delivered by the escrow agent to the Trust, which properly recorded it.

D.

The IRS sent an inquiry to Comerica to determine the outstanding balance owed by Ardmore in March 1995. The government says Comerica answered that the balance was about $300,000. ⁷ Shortly thereafter, the IRS levied upon Harley's Golf Course for the Estate of Harley Rob inson's unpaid estate tax liability of over $1,300,000. The IRS says that it levied on the same day that the $1,270,000 was wired to Comerica from the sale of Harley's Golf Course to satisfy the Trust's obligation under the settlement agreement.

III.

The Trust sued Ardmore to recover the amount it paid to satisfy the guaranty obligation. The Trust named, among others, the government as a defendant, requesting that the Court find that the Trust's interest has priority over the competing interests.

The Trust moves for summary judgment, arguing, among other things, that because it satisfied the guaranty obligation, it should be equitably subrogated to the rights of Comerica. The government also moves for summary judgment, asserting that because its tax liens arose prior to the delivery of the mortgage to the Trust, the tax liens have priority over the Trust's interest in the real property.

A.

Summary judgment will be granted when the moving party demonstrates that there is "no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). There is no genuine issue of material fact when "the record taken as a whole could not lead a rational trier of fact to find for the non-moving party." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).

The Court must decide "whether the evidence presents a sufficient disagreement to require submission to a jury or whether it is so one-sided that one party must prevail as a matter of law." In re Dollar Corp., 25 F.3d 1320, 1323 (6th Cir. 1994) (quoting Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 251-52 (1986)). In so doing, the Court "must view the evidence in the light most favorable to the non-moving party." Employers Ins. of Wausau v. Petroleum Specialties, Inc., 69 F.3d 98, 101 (6th Cir. 1995).

B.

The Trust argues that it should be equitably subrogated to the rights of Comerica pursuant to 26 U.S.C. §6323(i)(2) because it satisfied the guaranty obligation. Although state law defines the nature of a taxpayer's interest in real property, federal law governs the priority of a federal tax lien over competing interests in real property. See United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 722 (1985). The government filed its tax lien pursuant to 26 U.S.C. §6321:

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.

Id. According to 26 U.S.C. §6323(a), Comerica's interest in the real property had priority over the tax liens:

The lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary.

Id. ; see also First of America Bank- West Michigan v. Alt [94-1 USTC ¶50,169], 848 F. Supp. 1343, 1347 (W.D. Mich. 1993) (stating that a "tax lien has priority if it was recorded first"). The government argues that because the Trust's interest in the real property arose after the tax liens were recorded, the tax liens are entitled to priority over the Trust's interest.

If the Trust was subrogated to Comerica's rights, however, the Trust would have an interest superior to the tax liens:

Where, under local law, one person is subrogated to the rights of another with respect to a lien or interest, such person shall be subrogated to such rights for purposes of any lien imposed by section 6321 or 6324.

26 U.S.C. §6323(i)(2).

The doctrine of equitable subrogation has been used by courts to allow an interest arising after a federal tax lien to be subrogated to the rights of a prior, senior lienholder. In Dietrich Industries, Inc., v. United States, 988 F.2d 568 (5th Cir. 1993), the original owner of real property executed a deed of trust on real property in favor of Broadlands Limited (Broadlands) to secure a $2,000,000 debt. Subsequently, the IRS filed two federal tax liens on the property. Shortly thereafter, Dietrich Industries (Dietrich) purchased the property from the original owner for $385,000. Proceeds from the sale of about $320,000 were paid to Broadlands in consideration for Broadlands's release of its lien. ⁸ See id. at 570.

A dispute thus arose as to who had a priority interest in the real property because Dietrich claimed that it should be subrogated to Broadlands's status as senior lienholder. The Court of Appeals for the Fifth Circuit examined Texas subrogation law, where the general rule is that "any person who pays the debt of another to protect her own interest in property is entitled to subrogate to the rights of the creditor whose claim was paid. This rule extends to purchasers who pay an existing mortgage debt as a part of the purchase transaction." Id. at 571 (citations omitted). Accordingly, the Fifth Circuit held that Dietrich was entitled to subrogate to Broadlands's status as senior lienholder and thus obtain priority over the federal tax liens. See id. at 572.

Other courts also have found equitable subrogation applicable in this context. See Mort v. United States [96-1 USTC ¶50,315], 86 F.3d 890, 893 (9th Cir. 1996) (holding that party was entitled to priority over tax lien because "the doctrine of equitable subrogation allows a person who pays off an encumbrance to assume the same priority position as the holder of the previous encumbrance"); United States v. Baran, 996 F.2d 25, 29 (2d Cir. 1993) (vacating a district court's judgment because it failed to recognize that it had discretion under New York law to apply equitable subrogation in determining priority of tax lien).

C.

No court has published an opinion applying Michigan equitable subrogation law to determine the priority of a tax lien. Further, Michigan courts have not been recently confronted with a situation to apply equitable subrogation where a guarantor satisfied its obligation under a guaranty agreement. Nevertheless, the policy underlying Michigan 's equitable subrogation doctrine indicates that equitable subrogation should be applied in this case.

In In re Air Crash Disaster, 86 F.3d 498 (6th Cir. 1996), the Court of Appeals for the Sixth Circuit, in its thorough examination of Michigan equitable subrogation law, noted that:

The doctrine of equitable subrogation benefits from the flexibility of application that is characteristic of all equitable remedies. The doctrine is "broad enough to include every instance in which one party pays the debt for which another is primarily answerable." Notions of "equity and good conscience" should guide a court's application of the doctrine. Subrogation is an important device for "placing the economic responsibility for injuries on the party whose fault caused the loss." The doctrine "prevent[s] unjust enrichment by assuring that the person who in equity and good conscience is responsible for the debt is ultimately answerable for its discharge."

Id. at 549 (citations omitted). ⁹

Older Michigan case law also indicates that the Trust should be subrogated to Comerica's status. In Myres v. Yaple, 60 Mich. 339 (1886), the plaintiff signed a ninety-dollar note in favor of a creditor as a surety at the behest of the purchaser of a carriage. Subsequently, the carriage was sold by the creditor, with the consent of the purchaser, to the defendant by way of another note for fifty dollars. The creditor then called upon the plaintiff for payment of the balance because the original purchaser had left the state. The plaintiff paid the balance, and the note was delivered to him.

The plaintiff then sought possession of the carriage from the defendant, or alternatively, reimbursement for his payment of the balance on the original note. The plaintiff claimed that, because he paid the balance on the original note and received possession of the note, he was entitled to the same right to recover as the original creditor. The Michigan Supreme Court stated that

when the plaintiff, as such surety, was obliged to pay, and did pay, the debt of the [original purchaser], an equity arose in his favor, by which he was entitled to have all the securities which [the original creditor] held against the person or property of [the original purchaser] transferred to him, and to enforce such securities as fully as [the original creditor] could have done; and, for the purpose of obtaining indemnity from the [original purchaser], he must be considered as at once subrogated to all the rights, remedies, and securities of the original creditor.

Id. at 344. The court thus held that the defendant, who received the carriage with the original purchaser's consent and knew of the plaintiff's surety agreement, was required to give possession of the carriage to the plaintiff. See id. at 345.

Although equitable subrogation has not been applied to the specific context of this case--namely, when an obligation under a note was satisfied by a guarantor trust whose settlor was also the sole shareholder of the obligor corporation--the doctrine indicates that the Trust is entitled to be subrogated to Comerica's status. Indeed, equitable subrogation is a doctrine that "is broad enough to include every instance in which one party pays the debt for which another is primarily answerable." Allstate Ins. Co. v. Snarski, 174 Mich. App. 148, 154 (1988).

Moreover, allowing the Trust to be subrogated to Comerica's status does no injustice to the government. When the tax liens were filed, they were junior to Comerica's interest. Allowing the Trust to subrogate to Comerica's position thus leaves the government in the same position as it was when it filed the tax lien. "If equitable subrogation is denied, however, the government will receive a windfall, moving up to a better position than it originally had." Mort [96-1 USTC ¶50,315], 86 F.3d at 895; see also Dietrich Industries, 988 F.2d at 573 ("Denying subrogation in this case would give the government an unearned windfall in that it would elevate the government's liens for no good reason.").

D.

The remaining question is whether the Trust, whose settlor was the sole shareholder of the primary obligor, was "primarily liable" on the note so as to preclude the application of equitable subrogation. See Michigan Hosp. Serv. v. Sharpe, 339 Mich. 357, 373-74 (1954) (finding that a party who is primarily obligated cannot use equitable subrogation to recover from other parties).

The government argues that the Trust, as guarantor of the loan to Ardmore , was "primarily obligated" to Comerica, citing Rassette v. Frankel, 39 Mich. App. 172 (1972). In Rassette, Motor City Vendors, Inc. ( Motor City ) purchased all of the outstanding shares of capital stock of another company. A promissory note and a security agreement as part of the payment for the shares were guaranteed by all officers and directors of Motor City , including the defendant. Subsequently, Motor City defaulted on the note, and the plaintiff sued the guarantors, demanding payment in full. The defendant argued that because the plaintiff failed to take possession of the collateral before suing the guarantors, the plaintiff had discharged the defendant as guarantor. See id. at 173-74. The Michigan Court of Appeals rejected the defendant's argument, stating that because the defendant was a guarantor pursuant to Mich. Stat. Ann. §19.3416, ¹⁰ "[h]is liability was the same as a co-maker," ¹¹ and thus the plaintiff did not have a duty to take the collateral before seeking payment from the guarantors. ¹² Rassette, 39 Mich. App. at 175.

The government's reliance on Rassette to support the proposition that the Trust was primarily liable misconstrues the guarantor's obligation in this case. The question here is essentially whether the Trust was a "guarantor" or a "surety" under Michigan law. Although the terms are often used interchangeably, "in Michigan sureties and guarantors are legally distinguishable." In re Campbell , 207 B.R. 861, 865 (Bankr. W.D. Mich. 1997); see also In re Kelley's Estate, 173 Mich. 492, 498 (1914) (cited in First Nat'l Bank & Trust Co. of Ann Arbor v. Dolph, 287 Mich. 219, 225 (1938)). Michigan law defines a "guarantor" as a party that "enters into an 'independent, collateral agreement' of guaranty, becoming only secondarily liable upon the principal obligor's default." In re Campbell, 207 B.R. at 865 (quoting Dolph, 287 Mich. at 225). As opposed to a guarantor, a "surety" is a party that is "obligated with the principal under the primary agreement." Id. Although both a guarantor and a surety "agree to satisfy a debt in the event of the principal obligor's default," it is only the surety that is "immediately and primarily liable upon the default of the principal." Id.

Specifically, in Dolph, the defendants were found to be sureties. See Dolph, 287 Mich. at 225. Although the agreement stated that the defendant "guaranteed" payment, it also stated that "the obligation hereunder shall be absolute and primary and performable on demand." Id. at 221-22. Also, in Campbell, the debtor was held to be a surety, see Campbell, 207 B.R. at 865, where the surety provision was printed on the back of the original lease document, the lease and surety agreement were signed on the same day, and the agreement stated that "I do hereby become surety for the punctual payment of the rent and performance . . . and if any default shall at any time be made therein [I] do hereby promise and agree to pay unto [the lessor] the said rent and arrears thereof that may be due." Id. at 863.

Here, however, the Trust appears to be a "guarantor" rather than a "surety." Indeed, the agreement signed by the Trust was titled "Guaranty" and stated that "[t]he undersigned . . . unconditionally guarantee(s) to Comerica Bank-Detroit . . . payment when due." ¹³ No language in the guaranty agreement indicates that the Trust was "primarily liable." Also, the fact that the guaranty agreement appears to be a distinct agreement contained in a document separate from the note further indicates that it was an "independent, collateral agreement." ¹⁴ Although the guaranty was "unconditional," and the mortgage and guaranty agreement were entered into on the same day, these facts alone do not contradict the language of the guaranty agreement. As such, the circumstances indicate that the Trust was a guarantor and thus secondarily liable.

Further, the government has not established that a genuine issue of material fact exists as to whether the Trust and Ardmore should be considered effectively the same legal entity. The government also has not demonstrated that there is a genuine issue of material fact regarding whether the real property was inadequate security for the loan. In other words, there is no evidence that the loan from Comerica was given to Ardmore primarily on the strength of the Trust's guaranty. Therefore, on the record as it stands, there is no dispute that the loan was the primary obligation of Ardmore , and the Trust was secondarily liable. Accordingly, because the Trust satisfied the guaranty obligation, the Trust is subrogated to the rights of Comerica. The Trust's interest in the real property thus has priority over the government's tax liens. See 26 U.S.C. §6323(i)(2).

IV.

A.

The government asserts that there is a question of fact regarding the amount secured by the mortgage. The government contends that the Trust should have priority over the tax liens "in a maximum amount equal to the lesser of the outstanding debt which was assigned or the amount of the consideration provided by the Trust." The government argues that the IRS's inquiry and the subsequent response in March 1995 establish that the note had an outstanding balance of about $300,000. In contrast, the Trust argues that the note had an outstanding balance of over $2,500,000 in July 1994, offering the Trust's agreement to pay Comerica this amount as evidence. As such, a genuine issue of material fact exists as to the balance secured by the mortgage.

B.

The government also asserts that there is a question of fact as to whether the payment of $1,270,000 was actually made by the Trust because the money was wired directly to Comerica from the proceeds of the sale of Harley's Golf Course. The government offers no specific facts to support this assertion. The Trust, however, has come forward with evidence showing that the Trust was the primary beneficiary of the Estate of Harley Rob inson, and that Harley's Golf Course owed the Estate of Harley Rob inson approximately $1,400,000. The Trust says that because it was already twelve days late in making its payment to Comerica, it was more convenient to wire the money from the sale of Harley's Golf Course directly to Comerica. The government's conclusory assertion therefore fails to rise to a level sufficient to withstand summary judgment.

V.

The Trust's motion to amend its complaint and add party defendants is GRANTED. For the reasons stated above, the Trust's motion for summary judgment is GRANTED IN PART and DENIED IN PART. The Trust is subrogated to Comerica's rights under the mortgage and note. The only question of material fact remaining is the amount of the outstanding balance of the loan that was secured by the mortgage at the time the Trust satisfied the guaranty obligation. The government's motion is DENIED.

SO ORDERED.

¹ Under the Order of May 20, 1997 , the Trust's interest is prior and superior to the State of Michigan 's interests in the property. The State of Michigan has been dismissed.

² The Trust's purpose in amending the complaint is to comply with the particularity requirements of 28 U.S.C. §2410 because it has not identified Ardmore's complete address and has not identified the Internal Revenue Offices that filed the notices of federal tax lien. Also, after a title search, the Trust found that Henry Woodworth, Mamound Darbragh, and Rob ert Niccolini have filed claims of interest against the real property. The government concurs in the motion.

³ The Trust did not follow the Court's guidelines for a summary judgment motion.

⁴ Comerica sued the Trust in state court. Comerica also sued other related parties in an effort to obtain payment on other loans. Comerica made no effort to foreclose on the mortgage.

⁵ In response to Comerica's motion for summary disposition in state court, the Trust argued that Comerica should marshal its security under the loan apparently in a belief that marshaling would relieve or ameliorate its obligation to Comerica.

⁶ Apparently, Rob inson died before this dispute arose.

⁷ In July 1995, in response to a second inquiry by the IRS, Comerica said that it did not know the outstanding balance because Comerica sold the note and assigned the mortgage and related documents to the Trust.

⁸ Dietrich had no knowledge of the tax liens when it purchased the property.

⁹ Although In re Air Crash Disaster is a tort case, equitable subrogation is not limited to tort cases. Indeed, Michigan courts have applied the doctrine in a variety of situations, including several insurance contract cases, and as discussed below, in the setting of a surety agreement. Further, as set forth in Dietrich Industries, Mort, and Baran, application of equitable subrogation is proper in the context of this case.

¹⁰ Mich. Stat. Ann. §19.3416 is part of Article 3 of the Uniform Commercial Code (UCC), which governs negotiable instruments, and has been revised since Rassette. In the papers, each of the parties discuss why the revision of Article 3 may or may not render the holding in Rassette obsolete. The Rassette Opinion, however, does not mention equitable subrogation. Further, neither party affirmatively states whether Article 3 of the Uniform Commercial Code is applicable to this dispute.

¹¹ Under the Michigan 's current version of Article 3, a "maker" is defined as "a person who signs or is identified in a note as a person undertaking to pay." Mich. Stat. Ann. §19.3103(1)(e).

¹² In further support of its argument, the government maintains that under Mich. Stat. Ann. §19.3419, the Trust is an "accommodation party" and hence primarily liable. Under §19.3419(2), however, an accommodation party "is obliged to pay the instrument in the capacity in which the accommodation party signs." Id. The Trust signed a guaranty agreement and therefore has the capacity of a guarantor.

¹³ Although the copy of the guaranty furnished to the Court does not have the title "Guaranty" at the top, it appears to have been cut off by the copier. The other guaranty agreements for the other loans appear to contain identical language to the Trust's guaranty, and they have the word "Guaranty" at the top of the document.

¹⁴ The note was not furnished to the Court by the government as an exhibit, although the mortgage was.

 

 

[97-2 USTC ¶50,535] First Federal Savings Bank of Wabash, Plaintiff-Appellant v. United States of America , Defendant-Appellee

(CA-7), U.S. Court of Appeals, 7th Circuit, 96-3364, 6/30/97, Affirming a District Court decision, 96-2 USTC ¶50,479

[Code Sec. 6323 ]

Tax liens: Equitable subrogation: Bank: Notice: Title insurer's negligence.--A bank that paid off a couple's first mortgage, which was secured by real property that was subject to an IRS tax lien, by granting a second mortgage, which was secured by the same property, was not entitled to be equitably subrogated to the rights of the first mortgagee in order to establish the priority of its lien over that of the IRS. Equitable subrogation was not an appropriate remedy under state ( Indiana ) law because, although the bank had no actual notice of the IRS lien, it knew of the prior mortgage and should have been put on notice by the couple's request for a mortgage twice as large as the first. Further, the bank's title insurer, which was negligent in failing to discover the tax lien, not the bank, would bear any loss. Thus, it would have been improper to apply the doctrine of equitable subrogation to the benefit of a negligent title insurer.

Patricia McCrory, A. Donald Wiles II, Harrison & Moberly, 135 N. Pennsylvania St., Indianapolis, Ind. 46204, for plaintiff-appellant. Kenneth L. Greene, Curtis C. Pett, Gerald H. Parshall Jr., Department of Justice, Washington, D.C. 20530, for defendant-appellee.

Before: CUMMINGS, FLAUM, and EVANS, Circuit Judges.

FLAUM, Circuit Judge:

When a bank loans money to extinguish a first mortgage in certain property and secures the loan with a new mortgage in the property but fails, due to the negligence of its title insurer, to discover an intervening tax lien, may the bank rely on the doctrine of equitable subrogation to establish the priority of its lien over that of the government? Applying Indiana law to the circumstances of this case, we agree with the district court that the plaintiff, First Federal Savings Bank of Wabash , is not entitled to step into the shoes of the first mortgagee. Accordingly, we affirm.

I.

The relevant facts are not complicated. In February 1987, Danny and Janet Lantz borrowed $50,000 from First National Bank of Elkhart , Indiana . As security for the loan, the Lantzes gave First National a mortgage in a piece of property located in Kosciusko County , Indiana . First National, in turn, assigned the mortgage to the Federal Home Loan Mortgage Corporation ("FHLMC"), which duly recorded the assignment on February 8, 1988. Shortly thereafter, on February 19, the IRS recorded in Kosciusko County a notice of tax lien against the Lantzes in the amount of $51,226.95. As of February 19, then, FHLMC's interest in the Kosciusko property had priority over that of the government.

More than four years later, the Lantzes borrowed $100,000 from First Federal, which secured this loan with a mortgage in the Kosciusko property. Of the loan amount, First Federal paid $47,917.37 to extinguish the initial mortgage originally held by First National. First Federal recorded its mortgage on September 25, 1992 , and the first mortgage was released three days later. Although First Federal obtained title insurance, the insurer failed to discover the tax lien, and it is undisputed that the bank had no actual notice of the government's interest in the property.

In 1995, after the IRS sought to foreclose on its lien, First Federal brought this wrongful levy action pursuant to 26 U.S.C. sec. 7426(a)(1). ¹ The bank argued that it was entitled under Indiana law to be equitably subrogated to the rights of the first mortgagee. In other words, to the extent that its loan had been used to pay off the prior mortgage, First Federal sought to step into the shoes of the first mortgagee and thereby to leap ahead of the government in priority. The district court, however, determined that the equities did not weigh in First Federal's favor. Observing that First Federal had notice of the prior, $50,000 mortgage, the court reasoned that the bank "should have been on guard when the Lantzes borrowed a second mortgage twice as large as the first." In addition, the title insurance company had been negligent in failing to discover the tax lien while the IRS "ha[d] done nothing but properly file a tax lien and wait patiently to collect." The district court therefore denied First Federal's motion for summary judgment and granted the government's motion to dismiss. On First Federal's motion for reconsideration, the court distinguished Mort v. United States [96-1 USTC ¶50,315], 86 F.3d 890 (9th Cir. 1996), a case upholding a second mortgagee's right to equitable subrogation despite the presence of an intervening federal tax lien, on the ground that Mort involved unsophisticated, non-commercial lenders. ² Accordingly, the district court denied the motion for reconsideration. First Federal now appeals.

II.

The parties do not agree on the appropriate standard of review. Not surprisingly, the government would have us review the court's equitable determination for abuse of discretion, while First Federal, treating the court's ruling as any other grant of summary judgment, urges us to exercise our plenary review. Although there is authority to support the government's position, see Mort [96-1 USTC ¶50,315], 86 F.3d at 892; United States v. Baran, 996 F.2d 25, 29 (2d Cir. 1993), the choice of a standard has no impact on our decision. Under either the government's or First Federal's proposed standard, we would affirm the district court's judgment.

Because section 6323(i) of the Internal Revenue Code directs that where local law subrogates a person to the rights of another, that person "shall be subrogated" for purposes of a federal tax lien, 26 U.S.C. sec. 6323(i), the question presented by this appeal demands a foray into Indiana law. Unfortunately, Indiana law provides no ready answer to our query. In Indiana, equitable subrogation "[is founded] upon principles of equity and is applicable in every instance in which one party, not a mere volunteer, pays the debt of another which, in good conscience, should have been paid by the one primarily liable." Loving v. Ponderosa Systems, Inc., 479 N.E.2d 531, 536 ( Ind. 1985); see also Home Owners' Loan Corp. v. Henson, 29 N.E.2d 873, 875 ( Ind. 1940). Although the doctrine is to be applied liberally, Loving, 479 N.E.2d at 536-37 (quoting 73 Am. Jur. 2d sec. 7 (1974)), and a party's mistake does not necessarily foreclose its reliance on equitable subrogation, Henson, 29 N.E.2d at 561, it is also clear that a court must decide whether to invoke the doctrine based on the circumstances of the particular case, see Ticor Title Ins. Co. of Cal. v. Graham, 576 N.E.2d 1332, 1338 (Ind. Ct. App. 1991). Beyond these rather broad parameters, we are left to chart our own course, for the parties have been unable to unearth an Indiana case that does not differ in some material respect from the case now before us.

It is also not obvious at first glance where the equities lie. On the one hand, although it may be imprecise to characterize the government's elevation to first lienholder as a windfall, it is true that applying equitable subrogation would not make the government worse off than it was prior to the release of the first mortgage. See Progressive Consumers Fed. Credit Union v. United States [96-1 USTC ¶50,160], 79 F.3d 1228, 1237 (1st Cir. 1996) ("The point is that the government could not have anticipated its current priority status because from the outset its 1988-1990 liens were clearly junior to MSFCU's 1987 mortgage lien."). In a case where the original mortgagee has provided refinancing, see, e.g., id., or where third-party purchasers suddenly find their home encumbered by a tax lien, see, e.g., Han v. United States [91-2 USTC ¶50,486], 944 F.2d 526 (9th Cir. 1991), this factor may be sufficient to tip the scale in favor of equitable subrogation. On the other hand, as a sophisticated lender with no use for the mortgaged property other than as collateral, First Federal was able to obtain title insurance to contract against the risk of errors such as the one that occurred here. In this regard, it bears noting that the title insurer, whose negligence apparently caused this mess in the first place, presumably must bear the loss if we affirm the district court.

In the district court's view, the fact that First Federal is a commercial lender was dispositive. This focus upon a party's level of sophistication has at least some basis in Indiana law. See Universal Title Ins. Co. v. United States [92-1 USTC ¶50,106], 942 F.2d 1311, 1317 (8th Cir. 1991) (discussing Lawyers Title Ins. Corp. v. Capp, 369 N.E.2d 672, 674 (Ind. Ct. App. 1977)).

We believe that there is an additional factor that weighs against applying equitable subrogation on the facts of this case. In response to questioning at oral argument, counsel for First Federal acknowledged that the bank's title insurer was paying the costs of this litigation. This acknowledgment lends credence to the government's argument that the title insurer, and not First Federal, is the real party in interest here. Cf. Mort [96-1 USTC ¶50,315], 86 F.3d at 895 & n.5 ("There is no evidence of collusion between the Morts and [the title insurer]."). Significantly, Indiana courts have been more reluctant to invoke the doctrine of equitable subrogation in cases where to do so would benefit a negligent title insurer. "Subrogation," one Indiana court has explained,

is not an absolute right, but one which depends upon the equities and attending facts and circumstances of each case. It would be a gross misapplication of the doctrine of subrogation were we to hold that its cloak settles automatically upon one who has simply made a mistake, when it is a commercial transaction involving a consideration. . . . Further, it is difficult to think of a situation in which a title insurance company could not claim unjust enrichment as to someone who might inadvertently benefit by their negligence. Either they insure or they don't. It is not the province of the court to relieve a title insurance company of its contractual obligation.

Lawyers Title Ins. Corp., 369 N.E.2d at 674 (quoting Coy v. Raabe, 418 P.2d 728 ( Wash. 1966) (internal quotations omitted)). This reasoning controls the outcome of this case. ³

The judgment of the district court is Affirmed.

¹ In relevant part, sec. 7426(a)(1) provides as follows:

If a levy has been made on property or property has been sold pursuant to a levy, any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States in a district court of the United States....

26 U.S.C. sec. 7426(a)(1).

² Actually, the Mort plaintiffs were assignees of the second lender, but that detail isn't important, as the court of appeals deemed the assignees to be "vested with all the powers and rights of the assignor." [96-1 USTC ¶50,315], 86 F.3d at 894.

³ Any remaining doubt we might have as to how an Indiana court would rule is dispelled by our own assessment of the equities. We can assume that the title insurer, a profit maximizer like any other business, would agree to pay First Federal's legal fees only if the expected savings, in the form of reduced overall payouts resulting from successful litigation, exceeded the legal costs of pursuing these actions. The flip side of this calculus is that the government's overall recovery in these cases is reduced both by adverse judgments and by the costs of additional litigation. In other words, the fee-paying agreement amounts to an attempt by the insurer to shift some of its expected payout cost to the public fisc. It may be that a portion of this savings is passed along to the bank in the form of reduced insurance costs. Either way, we are not inclined in this case, where an equitable remedy is sought, to elevate form over substance by disregarding the insurer's interest in the outcome of this litigation. We note, however, that nothing in this opinion should be read to preclude a separate action against the Lantzes based on the terms of the mortgage agreement and the title insurance policy.

 

 

[96-2 USTC ¶50,357] United States of America , Appellant v. Fred A. Avila, Molly Avila, Security Pacific National Trust Co., James D. Diemer, Julia Diemer, Citizens First National Bank of New Jersey , Frances Sylvester. Frances Sylvester, Defendant/ /Third-Party Plaintiff v. Ticor Title Insurance Company, Chicago Title Insurance Company, Third-Party Defendants

(CA-3), U.S. Court of Appeals, 3rd Circuit, 95-5526, 7/1/96 , 88 F3d 229, 88 F3d 229. Reversing and remanding a District Court decision, 94-2 USTC ¶50,420 , 859 FSupp 126

[Code Sec. 6321 ]

Liens: Value of property: Right of survivorship: Subsequent purchasers.--The amount that the government could recover on an IRS tax lien against an individual's interest in real property was not limited to the taxpayer's equity in the property at the time he conveyed it to his wife. The wife sold the property, which the couple held as tenants by the entireties, and used the proceeds to pay the balances of several liens against the property with priority over the tax lien. Since the lien was determined by reference to the taxpayer's interest in the property and was unaffected by the sale of the property, there was no reason to fix the amount recoverable on the lien based on the property's value at the time of the sale. The amount of the lien was limited only by the debt that it secured and by the subsequent purchasers' right to equitable subrogation. However, further facts were needed to ascertain whether the lien remained attached to the wife's interest in the property based on the right of survivorship.

[Code Sec. 6323 ]

Liens: Validity of lien: Equitable subrogation: Subsequent purchasers.--The purchasers of real property upon which the IRS had filed a tax lien were subrogated to the position of superior lien holders who were paid when the property was sold, and a subsequent purchaser succeeded to the initial purchasers' right of equitable subrogation. The property was purchased from a wife who received the property as part of a divorce settlement and sold it to pay the balances of several other liens on the property that had priority over the tax lien. The initial purchasers mistakenly believed that the tax lien was invalid, and their purchase money was used to satisfy the senior liens. Although the subsequent purchasers had actual knowledge that the tax lien was valid, under state ( New Jersey ) law, the initial purchasers transferred their equitable subrogation rights to the subsequent purchasers.

Gary R. Allen, Marion E.M. Erickson, William S. Estabrook, Richard Farber, Department of Justice, Washington, D.C. 20530, for appellant. Donald L. Berlin, Berlin, Kaplan, Dembling & Burke, 161 Madison Ave. , Morristown , N.J. 07962-2037 , for appellees. Frederick L. Bernstein, 90 Main St. , Hackensack , N.J. 07601 , for Frances Sylvester.

Before: GREENBERG, ALITO, and MCKEE, Circuit Judges.

OPINION OF THE COURT

GREENBERG, Circuit Judge:

In this case we must determine whether the government's tax lien in real property is limited to a taxpayer's equity when he conveyed the property subject to the lien or whether the lien also attaches to the appreciation in the value of the property after the conveyance. Since nothing in the relevant statutes suggests that the government lien should be limited to the value of the taxpayer's equity in the property at the time of the conveyance and since the conveyance cannot affect the lien, we will reverse the district court's order based on its contrary conclusion. In addition, we find that determination of the property interest to which the lien attaches will depend on the relative longevities of Herbert and Frances Sylvester, who were the married owners of the property when the lien attached, and that James D. Diemer and Julia Diemer, the second purchasers of the property subject to the lien, properly can claim the benefits of equitable subrogation to encumbrances against the property with priority over the government lien.

A. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

The germane facts are not disputed. On November 5, 1979, the Internal Revenue Service made an assessment against Herbert Sylvester (but not against Frances Sylvester) in the amount of $62,523.21 pursuant to 26 U.S.C. §6672. App. 14. Mr. Sylvester did not pay the assessment so a tax lien arose pursuant to 26 U.S.C. §6321 and attached to all his property, including his interest in the real property involved in this case located at 500 Ridgeland Terrace, Leonia, Bergen County, New Jersey, which he and his wife owned as tenants by the entireties. App. 13-14. On June 26, 1980 , the Internal Revenue Service filed a Notice of Federal Tax Lien against Mr. Sylvester (but not against Mrs. Sylvester) in Bergen County , New Jersey , for the above liability. App. 14.

Mr. Sylvester did not satisfy the lien in whole or in part. Rather, he divested himself of any interest in the property on October 3, 1980 , when he conveyed it to Mrs. Sylvester for less than $100. App. 15. At that time, the property was worth $155,000 but was encumbered by liens with priority over the federal tax lien in the total amount of $154,318. These liens were: (1) mortgages held by Midlantic National Bank in the total amount of $100,566.26; (2) a mortgage held by Daniel Segal in the amount of $12,000; (3) a judgment in favor of Howard Strauss against Mr. Sylvester in the amount of $15,000; and (4) a judgment in favor of United Jersey Bank against Mr. Sylvester in the amount of $26,751.74. App. 104-05. The Internal Revenue Service refiled its lien on June 4, 1985 . On December 19, 1986 , the Sylvesters were divorced, and Mrs. Sylvester took the property under the terms of their property settlement agreement. The agreement required Mrs. Sylvester to sell the property and to pay the balance due on various liens against the property, including the federal tax lien, from the proceeds of the sale. ¹

On April 18, 1989 , Mrs. Sylvester sold the property for $580,000 to Fred Avila and Molly Avila who secured title insurance through Ticor Title Insurance Company. Ticor was aware of the IRS lien, but omitted it from its list of exceptions to title in the mistaken belief that the 1980 lien had expired and that the refiled 1985 lien was a new lien that had arisen after Mr. Sylvester no longer had an interest in the property. Thus, notwithstanding the settlement agreement, Mrs. Sylvester did not pay off the federal tax lien with the proceeds of the sale.

On December 27, 1991 , the United States filed a complaint in the district court against the Avilas and Security Pacific National Trust Company, their mortgagee, seeking to foreclose the tax lien on the property. App. 7-11. On January 29, 1993 , the Avilas sold the property to James D. Diemer and Julia Diemer for $480,000, following which, on November 3, 1993 , the United States filed an amended complaint joining the Diemers and their mortgagee, Citizens First National Bank of New Jersey , as foreclosure defendants. The government also sued Mrs. Sylvester for damages in the amended complaint asserting that it was a third-party beneficiary of her settlement agreement with her husband and that she had breached her duty under the agreement to pay the debt secured by its lien that Mr. Sylvester owed to it.

On February 2, 1994 , the Diemers filed a motion for partial summary judgment. They argued that the IRS lien attached to Mr. Sylvester's undivided one-half interest in the property subject to his wife's right to survivorship, and that the government's interest in the property never could exceed such an interest. They further argued that they were entitled to be equitably subrogated to the liens with priority over the IRS lien that were satisfied when the Avilas acquired the property and to that extent had a priority over the government lien. On or about February 25, 1994 , the United States filed a motion for partial summary judgment, arguing that Mrs. Sylvester's sale of the property to the Avilas had destroyed the right of survivorship and that the IRS lien therefore was attached to a one-half interest in the property unencumbered by Mrs. Sylvester's right of survivorship.

On August 1, 1994 , the district court denied the United States ' motion for partial summary judgment and granted the Diemers' and Citizens First National Bank of New Jersey 's motion for partial summary judgment. United States v. Diemer [94-2 USTC ¶50,420 ], 859 F. Supp. 126 (D.N.J. 1994). The court held that the IRS lien attached only to Mr. Sylvester's undivided one-half interest in the property and that the value of the lien was fixed at the time Mr. Sylvester transferred his interest to his wife on October 3, 1980 . Thus, the court held that the government could not benefit from the property's subsequent appreciation in value. The district court further held that while the Avilas could equitably subrogate to the four liens senior to the government lien, the Diemers could not subrogate because there was no subrogation agreement, the Avilas' conveyance to the Diemers did not include the Avilas' subrogation rights, and the Diemers had not satisfied those liens to protect their rights and interests in the property. Id. at 136. On August 3, 1994 , the court entered an order in accordance with its opinion.

On February 17, 1995 , the United States stipulated to dismissal of its action as to Mrs. Sylvester. App. 86. On March 30, 1995, the district court entered judgment for the Diemers and Citizens First National Bank of New Jersey because the parties agreed that the value of the property on October 3, 1980, $155,000, was only marginally above the value of the liens on the property with priority over the IRS lien, i.e. $154,318. ² App. 90-91. Thus, the IRS lien was viewed as having no value. However, the March 30, 1995 order did not end the litigation because Mrs. Sylvester had filed a third-party complaint against Ticor and Chicago Title Insurance Company and a cross-claim against the other defendants, the Avilas and the Diemers. Mrs. Sylvester sued Chicago Title because she alleged that it was either the successor to or agent of Ticor.

On March 7, 1995 , the district court entered an order, amended by an order entered on April 3, 1995 , staying and admin istratively terminating Mrs. Sylvester's third-party complaint and cross-claims until the completion of an appeal in a related case then pending before the Superior Court of New Jersey, Appellate Division. App. 87-89, 92-94. In the state court the Avilas sought an order compelling Mrs. Sylvester to satisfy the IRS lien or to obtain its release. While the Avilas had been successful in the trial court, on appeal the Appellate Division held that the Avilas waived their right to insist that Mrs. Sylvester satisfy the IRS lien inasmuch as they took the title with an awareness of the lien and thus voluntarily and affirmatively relinquished their right to have it satisfied or released. The Appellate Division held that Ticor's mistake regarding the validity of the lien did not dictate a different result. Avila v. Sylvester, No. A-3391-91T5 (N.J. Super. Ct. App. Div. July 12, 1993 ), certif. denied, 636 A.2d 522 (N.J. 1993).

The United States moved on May 17, 1995 , for a certification under Fed. R. Civ. P. 54(b) and entry of a final appealable judgment with respect to its claims against the Diemers and Citizens First National Bank of New Jersey . App. 95-101. On May 31, 1995 , the District Court granted the motion and entered a judgment in favor of the Diemers and the Citizens First National Bank of New Jersey in the foreclosure action and certified the case for immediate appeal. App. 102. The district court had jurisdiction pursuant to 28 U.S.C. §§1340 and 1345 and 26 U.S.C. §§7402 and 7403 , and, as the United States filed a timely notice of appeal, we have jurisdiction pursuant to 28 U.S.C. §1291 .

B. DISCUSSION

The district court found that the value that the government could recover on its tax lien was limited to Mr. Sylvester's equity in the property at the time that he conveyed it to his wife. The court explained:

The lien, in essence, vests the Government with the hope that in the debtor/taxpayer's hands his interest will appreciate in value, either due to an increase in his title or a rising real estate market. But that hope must be extinguished when the debtor/taxpayer no longer has any interest in the Property.

[94-2 USTC ¶50,420 ], 859 F. Supp. at 133. The court thus concluded, "the Government may receive a one-half interest in the Property valued at the time Mr. Sylvester transferred his title and interest to Mrs. Sylvester, subject to other liens or mortgages that had priority." Id. at 134. ³ We hold that the district court erred.

The Supreme Court long has held that:

[T]he transfer of property subsequent to the attachment of the lien does not affect the lien, for 'it is of the very nature and essence of a lien, that no matter into whose hands the property goes, it passes cum onere ....' Burton v. Smith, 13 Pet. 464, 483; see Michigan v. United States , 317 U.S. 338, 340.

United States v. Bess [58-2 USTC ¶9595 ], 357 U.S. 51, 57, 78 S.Ct. 1054, 1058 (1958). Fixing the value of the lien at the time the taxpayer transfers the property certainly "affect[s] the lien," and therefore Bess prohibits it. Consequently, we will reverse the district court's judgment.

In reaching our result we note that we are not the first court of appeals to consider the effect of changes in value after a lien has attached and the property transferred. Thus, the Court of Appeals for the Ninth Circuit in Han v. United States [91-2 USTC ¶50,486 ], 944 F.2d 526 (9th Cir. 1991), considered exactly the same claim as we consider here:

A tax lien 'shall continue until the liability for the amount so assessed ... is satisfied or becomes unenforceable by reason of lapse of time.' 26 U.S.C. §6322 (1988). The IRS is authorized to seize liened property even if it has been sold to a third party. 26 C.F.R. 301.6331-1 (1990). Nowhere in the statutory or regulatory scheme is there a provision limiting the IRS's recovery. A lien continues unabated regardless of sale, so long as it is properly recorded.

Id. at 528-29. We agree with the Han court that, "[b]ecause the lien is unaffected by sale, we see no basis for fixing the amount of the lien at the time of sale." Id. See also United States v. Blakeman [93-2 USTC ¶50,485 ], 997 F.2d 1084, 1092-93 (5th Cir. 1993) (rejecting defendant's argument that tax lien's value was limited to value at lien's attachment date), cert. denied, 114 S.Ct. 687 (1994).

We observe that neither the appellees nor the district court has cited any direct case law support for the district court's approach. Thus, we are aware of no case which says that the value of the property securing a tax lien must be frozen when the taxpayer transfers it. Overall, we are satisfied that the lien continues to attach to Mr. Sylvester's entire former interest in the property, limited only by the amount of the debt it secures and, as we shall see, by the Diemers' right to equitable subrogation.

Our conclusion that the lien attached to the appreciated value of Mr. Sylvester's former interest requires that we consider the scope of that interest because the $580,000 sale to the Avilas in 1989 reveals that the lien may be attached to a property interest worth far in excess of $155,000. It is established that state law determines the scope of the property interest to which the lien attaches. United States v. National Bank of Commerce [85-2 USTC ¶9482 ], 472 U.S. 713, 722, 105 S.Ct. 2919, 2925 (1985); United States v. Mitchell [71-1 USTC ¶9451 ], 403 U.S. 190, 197, 91 S.Ct. 1763, 1768 (1971).

We must therefore consider the scope of Mr. Sylester's former interest under New Jersey law. This inquiry raises three questions that stem from the unusual characteristics of a tenancy by the entirety when a non-debtor spouse who has acquired the debtor spouse's interest in encumbered property sells the property to a third party. We must determine whether: (1) the lien is subject to the non-debtor spouse's (Mrs. Sylvester's) right of survivorship after the property is transferred to a third party; (2) the lien remains attached to the debtor-spouse's (Mr. Sylvester's) right of survivorship after the property is transferred to a third party; and (3) the lien remains attached to only a one-half interest in the property or extends to the entire property after its transfer to a third party. As we shall see, the answers to these questions in this case depend on facts not of record and thus further proceedings will be required in the district court.

We start our analysis with King v. Greene, 153 A.2d 49 (N.J. 1959), in which the New Jersey Supreme Court, after an exhaustive survey of the common law, found that:

It is our view that the husband could, at common law, alienate his right of survivorship, or, more properly, his fee simple subject to defeasance.

Id. at 59. After analyzing the effect of the Married Women's Act of 1852 on Estates by the Entirety, the King court concluded that "the judgment creditors of either spouse may levy and execute upon their separate rights of survivorship." Id. at 60. Thus, New Jersey long has recognized that a lien may attach to the interest of one spouse in property held by the entireties. In Newman v. Chase, 359 A.2d 474, 477 (N.J. 1976), the New Jersey Supreme Court, discussing King, explained that "[e]ach tenant by the entirety is a tenant in common with the other during the joint lives of the spouses. Upon the death of a spouse, the survivor is then the sole owner."

More recently, the Supreme Court of New Jersey in Freda v. Commercial Trust Co., 570 A.2d 409 (N.J. 1990), made it clear that when the non-debtor spouse receives the debtor's interest in a property held as tenants by the entireties in a settlement pursuant to a divorce agreement, any lien previously attached to the debtor spouse's one-half interest in the property conveyed to the non-debtor spouse remains attached to that interest but that the non-debtor spouse retains a right of survivorship. As a result, if the debtor spouse predeceases the non-debtor spouse, the lien is extinguished upon the debtor's death. Moreover, it is clear from Freda that if the non-debtor spouse (who now owns the encumbered property after a divorce) predeceases the debtor spouse, the lien extends to the entire property based on the debtor spouse's right of survivorship. The Freda court explained that:

Because of the nature of a tenancy by the entirety, a mortgage given by one tenant can encumber only the interest that tenant can transfer. That interest includes a right to possession or its fair value. It also includes the right to become the sole owner on the death of the other tenant.

Id. at 414.

Freda also makes it clear that the non-debtor spouse's right of survivorship survives an equitable distribution following a divorce. The court explained that:

The conversion through divorce of a tenancy by the entirety to a tenancy in common, however, need not enhance the lien of a secured creditor. The non-debtor spouse's right of survivorship, like the restriction on the purchaser's right to partition the property ... will constrain the value of the interest subject to the lien. Termination by divorce of the tenancy by the entirety does not mean that the mortgagee should be allowed to improve its position.

Id. at 415 (citations omitted).

Applying Freda, it is clear that after the divorce and equitable distribution, the IRS continued to hold its lien subject to Mrs. Sylvester's right of survivorship. Consequently, if the government were attempting to foreclose while Mrs. Sylvester still owned the property, our ruling would be clear. We would find that the lien could extend only to a one-half interest in a life estate for the joint lives of the Sylvesters and to the value of Mr. Sylvester's right of survivorship. A sale of the property still would be subject to Mrs. Sylvester's possessory interest and right of survivorship.

As we noted above, however, this case raises the question of whether Mrs. Sylvester's transfer of her interests to the Avilas affects the scope of the lien and the rights of survivorship. There are several possibilities here. For example, transfer of the property to the Avilas might have extinguished the Sylvesters' rights of survivorship, thus leaving the lien attached to one-half interest in the property. There would be advantages in that result because it would eliminate uncertainty, definitively fix interests in property, and prevent the determination of property interests from depending upon the lives of persons who have no remaining connection to the property. We, however, are concerned with a state law question and we therefore must determine the impact of Mrs. Sylvester's conveyance to the Avilas on the scope of the lien and the right of survivorship on the basis of New Jersey law, and not on the basis of what we think is convenient, or even sensible.

It is true that, as the district court observed, under New Jersey law a sale of property held in a tenancy by the entireties to a third party ordinarily terminates the right of survivorship. United States v. Diemer [94-2 USTC ¶50,420 ], 859 F. Supp. at 132. Had the Sylvesters together, or Mrs. Sylvester individually, conveyed the property to a third party with all liens on the property being extinguished at the time of the conveyance, the Sylvesters' rights of survivorship would not have survived the conveyance.

But King and Freda make it clear that under New Jersey law, the rights of survivorship are alienable property interests and because the IRS lien attached to Mr. Sylvester's interest while he still had a right of survivorship, we cannot hold that Mrs. Sylvester's conveyance to the Avilas destroyed the right of survivorship. ⁴ If we held that Mrs. Sylvester's conveyance destroyed that right, we would be holding that the owner of a property subject to a lien could impair the lien by her action in conveying the property. Thus, in the unusual circumstances of this case the rights of survivorship survived the sale of the property to the third party, i.e. the Avilas.

In its brief the government argues that Mrs. Sylvester's right of survivorship was extinguished when she conveyed the property to the Avilas, but it does not mention Mr. Sylvester's right of survivorship. This argument is consistent with the government's contention that at the time of the sale to the Avilas, "the federal tax lien attached to an outright undivided one-half interest in the property." Br. 12. Accordingly, the government in its brief does not make the same analysis of New Jersey law that we make and it does not urge that Mr. Sylvester's survivorship interest always has remained viable because of its lien. We mention this point because we consider but reject the possibility that Mrs. Sylvester's right of survivorship could have been extinguished by her conveyance to the Avilas while Mr. Sylvester's survived. We are not aware of authority allowing such inconsistent treatment of the rights of survivorship and find that it will not arise as a matter of law.

We conclude, therefore, that to determine the property interest to which the government's lien is attached we have to know whether the Sylvesters have survived, a fact the record does not disclose. If both survive, then the lien remains attached to Mr. Sylvester's life estate and right of survivorship. If Mr. Sylvester predeceased Mrs. Sylvester the lien is extinguished. See United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 690-91 & n.16, 103 S.Ct. 2132, 2141 & n.16 (1983). If Mrs. Sylvester predeceased Mr. Sylvester the lien extends to the entire property. ⁵ Since the facts of Mr. and Mrs. Sylvesters' longevity are not in the record, we will remand the case to the district court for the determination of whether the lien is attached to the property and, if so, to what extent, or whether it has been extinguished. ⁶

The Diemers argue that they are entitled to equitably subrogate to the position of the lienors whose debts were satisfied when Mrs. Sylvester sold the property to the Avilas. The district court found that while the Avilas would have been entitled to equitably subrogate to the liens senior to the IRS lien, the Diemers were not so entitled, principally because they had not paid the debt of another with a view to protecting their rights and interests in the property and also because the Avilas' conveyance did not include their subrogation rights and there was no agreement to subrogate. ⁷ The significance of allowing equitable subrogation is that the IRS lien would remain subordinate to the liens satisfied at the time of the Avilas' purchase. ⁸

We start our equitable subrogation analysis with section 6323(i) of the Internal Revenue Code, which provides that "[w]here, under local law, one person is subrogated to the rights of another with respect to a lien or interest, such person shall be subrogated to such rights for purposes of any lien imposed by section 6321 or 6324 ." 26 U.S.C. §6323(i) . Therefore, we must determine whether, as a matter of New Jersey law, the Avilas could subrogate to the interests of the superior lien holders who were paid when the Avilas acquired property from Mrs. Sylvester, and, if so, whether the Diemers could succeed to the Avilas' right of equitable subrogation.

It is clear that if the Avilas were unaware of the tax lien, they would have been permitted to equitably subrogate to the position of the senior lienholders paid when they acquired the property. In fact, they purchased the property in the mistaken belief that the government tax lien was invalid and consequently their purchase money was used to discharge the liens senior to the IRS lien on the basis of this mistake. In effect, therefore, they were in the same position they would have been if their title search simply had not disclosed the properly filed IRS lien.

The New Jersey Superior Court, Appellate Division, described the doctrine of equitable subrogation:

There is no doubt that a mortgage[e] who negligently accepts a mortgage without knowledge of intervening encumbrances will subrogate to a first mortgage with priority over the intervening encumbrances to the extent that the proceeds of the new mortgage are used to satisfy the old mortgage. This result is reached so that the holders of the intervening encumbrances not be unjustly enriched at the expense of the new mortgagee.

Trus Joist Corp. v. National Union Fire Ins. Co., 462 A.2d 603, 609 (N.J. Super. Ct. App. Div. 1983), reversed on other grounds, 477 A.2d 817 (N.J. 1984). See also 29 Roger A. Cunningham & Saul Tischler, N.J. Practice, Law of Mortgages §145 at 669 (1975) ("If the grantee-payor did not know of the existence of a junior encumbrance when he purchased, and did not 'assume' or take 'subject to' all encumbrances, the better view is that he may be entitled to keep the mortgage alive and enforce it by subrogation. ..."). Thus, as the district court found, the Avilas equitably subrogated to the liens with priority over the IRS liens when they acquired the property and which were paid at that time.

The next question we must decide is whether the Avilas transferred their equitable subrogation rights to the Diemers. The Diemers, of course, were in a different position with respect to a direct right of equitable subrogation than the Avilas for two reasons. First, unlike the Avilas, they had actual knowledge when they acquired the property that the IRS lien was valid. Second, their purchase money was not used to satisfy the prior liens.

To begin our analysis, we note that N.J. Stat. Ann. §46 :3-13 (West 1989) states:

Every deed conveying lands shall, unless an exception be made therein, be construed to include all the estate, right, title, interest, use, possession, property, claim and demand whatsoever, both in law and equity, of the grantor ...

By its clear provisions this section includes any claims to equitable subrogation that a grantor might possess. In this case, it is clear that equitable subrogation was a claim in equity of the grantors, the Avilas. Thus, the deed from the Avilas to the Diemers included the Avilas' equitable subrogation rights. ⁹ Consequently, the Diemers' knowledge that the IRS lien was valid when they acquired the property, and the fact that their money was not used to satisfy the prior liens, simply are not germane with respect to whether they should be allowed to equitably subrogate. In short, principles governing the right to direct subrogation cannot be applied in this case which involves derivative subrogation. The issue here is simply whether the Diemers can exercise the Avilas' subrogation rights.

We also point out that the chief rationale for allowing equitable subrogation is to prevent the junior encumbrancer from being unjustly enriched at the expense of a new purchaser or mortgagee of the property. Thus, courts permit equitable subrogation even when the purchaser is negligent in not learning of the junior encumbrance. See Home Owners' Loan Corp. v. Collins, 184 A. 621, 623 (N.J. Ch. 1936). See also 29 N.J. Practice §145 at 669 ("And negligence which has not resulted in harm to anyone should not be invoked to permit unjust enrichment of the later lienors through their unearned and fortuitous advancement in priority by reason of the mistake of the grantee in paying and taking a discharge instead of an assignment.").

Accordingly, in our analysis of whether the right to equitable subrogation passed to the Diemers we focus on the effect of allowing subrogation on the IRS rather than on the Diemers' knowledge when they acquired the property or how their funds were used. It is clear that the IRS would be as unjustly enriched by denying equitable subrogation to the Diemers as it would have been if equitable subrogation had been denied the Avilas. The court in Han v. United States, which we quoted in our discussion in regard to the lien attaching to the enhanced value of the property after Mr. Sylvester conveyed his interest in it to Mrs. Sylvester, noted:

We are unimpressed by the IRS's repeated claims that its victory would neither unjustly enrich nor produce a windfall in favor of the United States . One cannot fail to see this case as an attempt by the IRS to require the [grantee] to pay a portion of [grantor]'s delinquent taxes. The IRS's claim that equitable subrogation would make it the victim of 'injustice' is thoroughly unconvincing.

Han v. United States [91-2 USTC ¶50,486 ], 944 F.2d at 530 n.3.

It is true that it has been said that "subrogation is effective only where the new mortgagee is without actual knowledge of the existence of junior encumbrances." Metrobank for Sav., FSB v. Nat'l Community Bank of New Jersey , 620 A.2d 433, 438 (N.J. Super. Ct. App. Div. 1993). But this rule exists to encourage explicit subrogation agreements when it is possible for the grantee to negotiate with the senior lien holders. Consequently, the relevant party's knowledge of junior encumbrances must be that of the initial grantees or mortgagees, i.e. the Avilas, and not that of their successors in interest, i.e. the Diemers. After all, a successor's knowledge of a junior encumbrance when the successor acquires the property could not assist the initial grantee or mortgagee in retroactively reaching an agreement for an assignment of a lien with a senior lien holder. Therefore, it makes no sense to prevent successor parties in interest to a property from benefiting from the equitable subrogation allowed their grantors. ¹⁰

We also note that unless property owners entitled to equitably subrogate can assign their equitable subrogation interests, in effect they lose their equitable subrogation interests when they convey the property. Thus, if the Avilas could not place the Diemers in their shoes, the Avilas owned a greater interest in the property than they could convey since their conveyance would impair the estate they conveyed. We are confident that the New Jersey Supreme Court would not reach such an anomalous result.

There is a persuasive analogy to the situation before us under the Uniform Commercial Code which ordinarily permits a holder in due course of an instrument to vest in the transferee "such rights as the transferor has therein." N.J. Stat. Ann. §12A:3-201(1) (West 1962). Thus, just as the purchaser of a note from a holder in due course can shelter behind the holder in due course even though the purchaser is aware of a maker's personal defenses when the purchaser acquires the note, the Diemers should be able to shelter behind the Avilas with respect to the latters' right to equitable subrogation. ¹¹ Overall we therefore conclude that once the district court reached the correct result that the Avilas could equitably subrogate, the court should have permitted the Diemers to exercise those same rights derivatively. Thus, we hold that the court's failure to allow the Diemers to exercise the right to equitably subordinate was an error regardless of whether we exercise plenary review or view the district court's ruling on a deferential abuse of discretion standard. ¹²

In its reply brief, the government argues that since the Diemers paid $480,000 for the property and the Avilas three years earlier paid $580,000, "the facts of the record strongly support the inference that the Diemers themselves did know of the existence of the federal tax lien, and discounted the purchase price to reflect the possibility that that lien, considered to be invalid by the title insurance company, might still remain against the property." Reply Br. 10. We have no doubt that the Diemers knew that the tax lien was valid because when they bought the property it was in foreclosure. We do not know if they received a discount by reason of the lien and the foreclosure proceedings, though we acknowledge that it is possible that they did because they were buying into a lawsuit with its risks, aggravation, and expenses. Yet even receipt of a discount in purchase price should not matter because the reasons for allowing the Diemers to subrogate are in no way compromised by any agreement they made with the Avilas since the Diemers' right to subrogate is derivative of the Avilas' subrogation rights. Thus, we need not remand for a determination of whether the $100,000 drop in the property's price between the Avilas' and the Diemers' purchases reflects changes in real estate values or other circumstances independent of any discount the Diemers may have obtained in recognition of the government lien. ¹³

C. CONCLUSION

The district court found that the value of the government tax lien could not exceed the equity that Mr. Sylvester, the taxpayer, possessed in the property when the taxpayer conveyed it. For the reasons we explain above, we reject this conclusion. The lien is limited by the extent of the taxpayer's interest in the property and not by the value of the taxpayer's interest when he conveys it. Under New Jersey law, the extent of this interest depends upon the relative longevities of Mr. and Mrs. Sylvester. We also conclude that the Diemers are entitled to equitable subrogation to the four liens on the property which Mrs. Sylvester satisfied when she sold the property to the Avilas. In view of our conclusions we will reverse the order of August 3, 1994, and the judgments of March 30, 1995, and May 31, 1995, and will remand that matter to that court for a determination of the interest, if any, in the property to which the lien is attached and, if necessary, to make an appropriate allowance for equitable subrogation, and to undertake further proceedings consistent with this opinion.

¹ The liens listed in the settlement agreement included the four instruments listed above with the change that Howard Strauss was listed in the agreement as holding a mortgage rather than a judgment. The parties have not noted this distinction in their briefs. Apparently, they regard the difference between a judgment and a mortgage as inconsequential and thus we do not consider the change from a judgment to a mortgage any further. In addition, a judgment for about $7,500 in favor of General Electric against Herbert Sylvester was listed in the agreement. The parties did not stipulate that this judgment had priority over the tax lien so we are not concerned with it.

² The judgment included a finding that Mr. Sylvester had no equity in the property when he transferred it to his wife.

³ Since the court found that Mr. Sylvester possessed no equity in the property above the value of the other liens at the time it was transferred, this interest was worthless. App. 90-91.

⁴ But see footnote 6, infra.

⁵ The government filed this action in 1991 and accordingly it is possible that either or both of the Sylvesters were alive then but have died. We have written this opinion without taking into account the possibility that upon the filing of the lawsuit or the happening of some other event the subsequent death of either Sylvester would no longer affect the outcome of this case. We have not addressed this possibility because the parties have not mentioned it in their briefs. Consequently if the facts warrant, this point may be considered on remand. We are not suggesting that if the property is sold during the joint lives of the Sylvesters pursuant to the procedure we describe in note 6, infra, that the subsequent death of either would have any materiality with respect to a division of the proceeds.

⁶ On April 3, 1996 , the court received a letter from Mrs. Sylvester's attorney indicating that she died on March 23, 1996 . The letter, however, does not inform us whether Mr. Sylvester predeceased Mrs. Sylvester or whether he survived her. Consequently, notwithstanding the letter, the case must be remanded for further proceedings. We also point out that conceivably a death after this litigation was commenced may not change the outcome of the case. See note 5, supra.

United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 103 S.Ct. 2132 (1982), makes it clear that if the government has a lien on a partial interest in a property the district court can order the property sold in fee simple and then compensate the owner or owners of the remaining interests from the proceeds of the sale for the value of their interests.

⁷ The government claims that the equitable subrogation argument was not appealed, apparently implying that we are bound to accept the district court's finding that equitable subrogation should not be allowed. Br. 9. We disagree with the implication. "[A]n appellee is entitled to rely on alternative arguments which had been raised in the district court supporting the judgment without filing a cross-appeal, so long as he or she is not seeking to expand his or her rights under the judgment or limit another's rights." Deisler v. McCormack Aggregates, Co., 54 F.3d 1074, 1081 n.12 (3d Cir. 1995). While equitable subrogation would allow the appellees a remedy that is not precisely analogous to the district court's judgment that the government's recovery was limited to the taxpayer's equity in the property, nevertheless the equitable subrogation argument can be raised without a cross-appeal because appellees raise it to support the judgment, at least to the extent that the government's priority will be limited, if not eliminated, if we accept the equitable subrogation argument.

⁸ Ultimately, of course, the district court's ruling not allowing equitable subrogation did not matter because of the parties' later agreement that the value of the property barely exceeded the amount of liens senior to the IRS lien when Mr. Sylvester conveyed his interest in the property to Mrs. Sylvester. The parties' agreement meant that the IRS lien was worthless because the district court froze the value of the property subject to the lien at the time Mr. Sylvester conveyed his interest in the property to his wife. But in view of our conclusion rejecting that holding, and depending on the longevity of the Sylvesters, the equitable subrogation issue again is significant.

⁹ The district court in its conclusion that the Diemers did not equitably subrogate observed that section 46 :3-13 "does not create a right of subrogation." United States v. Diemer [94-2 USTC ¶50,420 ], 859 F. Supp. at 136. While we agree with this observation we do not understand its significance because section 46 :3-13 is germane to whether the right of equitable subrogation was transferred, not created.

¹⁰ Cf. 29 N. J. Practice, Law of Mortgages §145 , at 672 ("If the grantee has no knowledge of junior encumbrances when he purchases mortgaged land, knowledge thereof at the time when he pays the mortgage debt should be immaterial unless he clearly manifests the intent to extinguish the mortgage for the benefit of the junior encumbrancers.").

¹¹ While we hold that the Diemers may equitably subrogate to the four liens senior to the IRS lien paid when the Avilas acquired the property, we do not determine how to calculate the value of the liens. The parties' briefs do not address this significant issue which can be addressed on remand.

¹² In Metrobank for Sav., F.S.B. v. Nat'l Community Bank of New Jersey, 620 A.2d at 439, the court pointed out that as "an equitable doctrine, subrogation is applied only in the exercise of the court's equitable discretion." We are uncertain whether the New Jersey courts therefore would apply an abuse of discretion standard in determining whether a purchaser of a property interest from a seller entitled to equitably subrogate could derivatively exercise the subrogation rights but in view of our conclusion that it was an abuse of discretion not to allow the Diemers to subrogate, we need not resolve the standard of review issue.

¹³ We make one final observation on the equitable subrogation point. As we have noted, the district court held that "the Government may receive a one-half interest in the Property valued at the time Mr. Sylvester transferred his title and interest to Mrs. Sylvester, subject to other liens or mortgages that had priority." United States v. Diemer [94-2 USTC ¶50,420 ], 859 F. Supp. at 134 (emphasis added). The "subject to" language related to the valuation of Mr. Sylvester's interest in the sense that the other liens and mortgages with priority would reduce the valuation. Consequently, the district court in effect did allow the Diemers to claim the value of these liens against the government's lien even though the court said that the Diemers could not subrogate to these liens.

 

 

[96-1 USTC ¶50,315] Jeffrey Mort, Pamela Mort, Fred Strefling, Jeffrey Tobian, Plaintiffs-Appellants v. United States of America, Defendant-Appellee

(CA-9), U.S. Court of Appeals, 9th Circuit, 95-15177, 6/17/96, Reversing and remanding a District Court decision, 94-2 USTC ¶50,539 , 874 FSupp 283

[Code Sec. 6323 ]

Liens: Validity: Equitable subrogation.--Assigness of a promissory note secured by a deed of trust on real property were entitled to be equitably subrogated to the priority position of the lender whose loan was paid off by the assignor. Contrary to the IRS's allegation, the assignees, as purchasers, were not mere volunteers. Because their purchase included an assignment of rights, they assumed all of the sellers' rights including the right to equitable subrogation of their interest. Also, equitable subrogation would not work an injustice on the government since it would leave the government in the same position it was in at the time the tax lien was filed. However, if equitable subrogation were denied, the government would move up to a better position than it originally had. Nor would equitable subrogation unjustly enrich the asignees and their title insurer, which failed to discover the properly filed tax lien. Although, under state ( Nevada ) law, the asignees may have had constructive notice of the tax lien, they were innocent parties, and in cases where a title company's negligence has barred equitable subrogation, the title company was the party seeking equitable subrogation.

[Code Sec. 7426 ]

Jurisdiction: Equitable jurisdiction: Legal remedy available.--The lower court abused its discretion in refusing to exercise equitable jurisdiction to determine whether purchasers of a deed of trust secured by real property were entitled to a declaratory judgment that their claim was superior to a tax lien. The purchasers were not required to first pursue their legal remedy against the title insurance company that failed to discover the properly filed tax lien. The title insurance company was not a party to the action, and the availability of a legal remedy against a third party was not a bar to equitable relief.

Stephen E. Anderson, Irvine , Calif. , for plaintiffs-appellants. Gary R. Allen, Anthony T. Sheehan, Department of Justice, Washington , D.C. 20530 , for defendant-appellee.

Before: BEEZER and HAWKINS, Circuit Judges, and ZILLY, District Judge.

ZILLY, District Judge:

Appellants Jeffrey and Pamela Mort, Jeffrey Tobian, and Fred Strefling (collectively, "the Morts"), assignees of a promissory note secured by a deed of trust, brought an action in the United States District Court, District of Nevada, for injunctive relief and a declaratory judgment that their trust deed interest was superior to a federal tax lien. The Morts acquired their interest after the Internal Revenue Service (IRS) filed a tax lien on the property, but argued that they were entitled to be equitably subrogated to the priority position of the lender whose loan was paid off by their assignor. The district court denied the parties' crossmotions for summary judgment and dismissed the Morts' action without prejudice, concluding that equity jurisdiction should not be exercised until the Morts first pursued any legal remedies they may have against their title insurer. The Morts argue on appeal that (1) the district court erred in not reaching the merits of its equitable subrogation claim, and (2) they are entitled to be equitably subrogated as a matter of law. We agree with both arguments and reverse.

BACKGROUND

On December 12, 1990 , Cathryn Myers (also known as Cathryn DeLee) signed a promissory note in the amount of $30,000 in favor of Elwin J. and Jeanne Kern. The note was secured by a deed of trust on certain real property in Nevada , which Myers owned as separate property. The deed of trust was recorded on December 18, 1990 .

On August 24, 1992 , the IRS filed a notice of federal tax lien with the Recorder for Clark County , Nevada in the amount of $33,083 to collect the unpaid income tax liabilities of Myers and her husband, Sol DeLee.

Sometime in late October 1992, Myers conveyed title to the property to the "Dannielle DeLee Irrevocable Trust of October 1989" ("DeLee Trust"). On November 13, 1992 , James and Carol Belmont made a loan to the DeLee Trust in the amount of $38,000, which was secured by a deed of trust on the property. The DeLee Trust used $30,500 of the Belmont loan to pay off the Kern loan, and another $2,086 to pay off an existing state property tax lien.