Subrogation Page3

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The Belmonts purchased title insurance on the property from Fidelity National Title Agency of Nevada ("Fidelity"). Fidelity failed to discover the federal tax lien and insured clear title. The Belmonts recorded their deed of trust on November 17, 1992 .

On December 21, 1992 , the Belmonts , in consideration of a payment of $38,000, conveyed their interest in the promissory note and the deed of trust to the Morts. The assignment was recorded on December 23, 1992 , and re-recorded on January 20, 1993 . The Belmonts ' title insurance policy with Fidelity was transferred to the Morts by endorsement.

The Morts first learned of the IRS lien in June or July, 1993. On August 12, 1993 , the IRS seized the DeLee land. The Morts then filed a complaint in the United States District Court for the District of Nevada seeking injunctive relief and a declaratory judgment that their trust deed interest was superior to the federal tax lien. The parties filed cross motions for summary judgment, which were denied by the district court on September 16, 1994 . The district court dismissed the Morts' complaint without prejudice, concluding that the Morts could not bring their claim for equitable subrogation without first pursuing their legal remedies against the title insurer. See Mort v. United States [94-2 USTC ¶50,539], 874 F. Supp. 283 (D. Nev. 1994).

STANDARD OF REVIEW

The district court's decision not to exercise its equitable jurisdiction is reviewed for an abuse of discretion. Cf. Ramsden v. United States , 2 F.3d 322, 324 (9th Cir. 1993) (district court's decision to exercise its equitable discretion under Fed. R. Crim. P. 41(e) reviewed for abuse of discretion), cert. denied, -- U.S. --, 114 S.Ct. 1624, 128 L.Ed.2d 349 (1994). ¹

DISCUSSION

I

The district court offered no authority in support of its decision not to exercise equity jurisdiction in this case, and we are unable to find any. "It is a basic doctrine of equity jurisprudence that courts of equity should not act ... when the moving party has an adequate remedy at law. ..." Morales v. Trans World Airlines, Inc., 504 U.S. 374, 381 (1992) (citation and internal quotation omitted). Equitable relief should not be denied, however, unless the available legal remedy is against the same person from whom equitable relief is sought. Barr v. Roderick, 11 F.2d 984, 986 (N.D. Cal. 1925) ("[t]he fundamental principle ... that equity will grant no relief where an adequate remedy at law exists, must be limited strictly to cases in which there is an adequate legal remedy against the defendants before the court."). ²

The Morts have no legal remedy against the IRS. Their only potential legal remedy is against Fidelity, which is not a party to this action in equity. Because the availability of a legal remedy against a third party does not bar equitable relief, the district court abused its discretion in refusing to exercise its equitable jurisdiction.

II

Because the district court declined to exercise jurisdiction, it did not reach the merits of the Morts' equitable subrogation claim. In these circumstances, we can either remand to the district court to consider the Morts' claim or dispose of it ourselves if possible to do so as a matter of law. Meinhold v. United States Dept. of Defense, 34 F.3d 1469, 1474 (9th Cir. 1994); RTC Transp. Inc. v. Conagra Poultry Co., 971 F.2d 368, 375 (9th Cir. 1992). In this case, the facts are undisputed and further factfinding is unnecessary to resolve the equitable subrogation issue. Thus, we can determine as easily as the district court whether the Morts are entitled to equitable subrogation, and we exercise our discretion to do so.

A. Applicable Law

Equitable subrogation is a state-law doctrine and therefore whether equitable subrogation applies in this case presents a question of Nevada law. The Internal Revenue Code recognizes that certain interests may be subrogated under state law and 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 or 6324 .

26 U.S.C. §6323(i)(2) (1994).

There is limited Nevada authority on the doctrine of equitable subrogation. The Nevada Supreme Court first applied the doctrine in Laffranchini v. Clark, 39 Nev. 48, 153 P. 250 (1915), where it held that the holder of an invalid mortgage was entitled to be equitably subrogated to the priority position of the lender whose loan she had paid. Though the Nevada courts have applied equitable subrogation in other contexts, AT&T Technologies, Inc. v. Reid, 109 Nev. 592, 855 P.2d 533 (1993) (workers' compensation benefits); Federal Ins. Co. v. Toiyabe Supply Co., 82 Nev. 14, 409 P.2d 623 (1966) (subrogation rights of surety against bank that paid on forged endorsement); Globe Indem. Co. v. Peterson-McCaslin Lumber Co., 72 Nev. 282, 303 P.2d 414 (1956) (surety subrogated to rights of State on highway construction performance bond), they have not addressed the equitable subrogation of mortgage or trust deed interests since Laffranchini. Where Nevada law is lacking, its courts have looked to the law of other jurisdictions, particularly California , for guidance. See, e.g., People for the Ethical Treatment of Animals v. Bobby Berosini, Ltd., 111 Nev. 615, 895 P.2d 1269, 1281-82 (1995); Dutt v. Kremp, 111 Nev. 567, 894 P.2d 354, 358 (1995). In accordance with this practice, we have looked to the law of other states when necessary to supplement Nevada 's law on equitable subrogation.

B. Equitable Subrogation

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. Han v. United States , 944 F.2d 526, 529 (9th Cir. 1991). Equitable subrogation is generally appropriate where (1) the subrogee made the payment to protect his or her own interest, (2) the subrogee did not act as a volunteer, (3) the subrogee was not primarily liable for the debt paid, (4) the subrogee paid off the entire encumbrance, and (5) subrogation would not work any injustice to the rights of the junior lienholder. Id. (applying California law). Equitable subrogation is a broad equitable remedy, and therefore it applies not only when these five factors are met, but also "whenever 'one person, not acting as a mere volunteer or intruder, pays a debt for which another is primarily liable, and which in equity and good conscience should have been discharged by the latter.'" Id. (quoting Caito v. United Cal. Bank, 20 Cal.3d 694, 704, 144 Cal. Rptr. 751, 756, 576 P.2d 466, 471 (1978)).

The IRS argues that the Morts have failed to satisfy the traditional requirements of equitable subrogation because they were mere volunteers who did not act to protect their own interests. The IRS further argues that permitting equitable subrogation here would work an injustice on the government.

1. Volunteer Status

A volunteer, stranger, or intermeddler is "one who thrusts himself into a situation on his own initiative, and not one who becomes a party to a transaction upon the urgent petition of a person who is vitally interested, and whose rights would be sacrificed did he not respond to the importunate appeal." Laffranchini, 39 Nev. 48, 153 P. at 252. Parties may be considered volunteers if, in making a payment, they have no interest of their own to protect, they act without any obligation, legal or moral, and they act without being requested to do so by the person liable on the original obligation. Henningsen v. United States Fidelity Guar. Co., 208 U.S. 404, 411 (1908); Smith v. State Sav. & Loan Ass'n, 175 Cal. App. 3d 1092, 1098, 223 Cal. Rptr. 298, 301 (1986); Norfolk & Dedham Fire Ins. Co. v. Aetna Casualty & Surety Co., 132 Vt. 341, 344, 318 A.2d 659, 661 (1974). A person who lends money to pay off an encumbrance on property and secures the loan with a deed of trust on that property is not a volunteer for purposes of equitable subrogation. Cf. Katsivalis v. Serrano Reconveyance Co., 70 Cal. App. 3d 200, 138 Cal. Rptr. 620, 625 (1977) (lender granted new mortgage was not a volunteer and entitled to equitable subrogation even though mortgage was invalid under California law). In contrast, a person who purchases property at a foreclosure sale is a volunteer and therefore not entitled to subrogation over a tax lien. Fidelity Nat'l Title Ins. Co. v. United States Dept. of Treasury [90-2 USTC ¶50,402 ], 907 F.2d 868 (9th Cir. 1990). ³

The government's argument that the Morts are mere volunteers is based in large part on the Morts' status as assignees of the Belmonts . The government emphasizes that the Belmonts , not the Morts, paid off the Kern note, and the Morts did not acquire the Belmont 's interest in the note and trust deed until after the senior encumbrances had been paid off. We reject the government's argument that the Morts are mere volunteers as a result of their assignee status.

Although Nevada courts have not considered whether an assignee assumes the assignor's equitable subrogation rights, the general rule in most states is that where a valid assignment of a mortgage has been consummated with proper consideration, the assignee is vested with all the powers and rights of the assignor. Hagan v. Gardner , 283 F.2d 643, 645 (9th Cir. 1960); Bartlett Estate Co. v. Fairhaven Land Co., 49 Wash. 58, 94 P. 900 (1908). In this case, the Morts purchased the note and deed of trust, with assignment of rights, from the Belmonts . The Belmonts made a loan to the DeLee Trust to pay off the senior Kern note, and thus, had the Belmonts retained their interest, they would have been entitled to be equitably subrogated to the Kerns' priority position. ⁴ The Morts, as assignees of the Belmonts , assumed all the rights the Belmonts had in the DeLee note and deed of trust including the Belmonts ' right to equitable subrogation of their interest. Thus, the Morts have the same rights to equitable subrogation as the Belmonts .

2. Injustice to the IRS

The IRS argues that even if the Morts may assert the Belmonts ' rights to equitable subrogation, the doctrine should still not be applied because it would work an injustice to the rights of the government. We reject that argument, finding it to be wholly without merit.

At the time the IRS filed its tax lien, the tax lien was subordinate to the Kern mortgage. If the Morts are equitably subrogated to the priority position of the Kern mortgage, the IRS will be in the same position it was in at the time the tax lien was filed. If equitable subrogation is denied, however, the government will receive a windfall, moving up to a better position than it originally had. Under these circumstances, there is no basis for the government's argument that it will suffer harm from equitably subrogating the Morts' interest.

We are equally unpersuaded by the government's argument that the Morts and their title insurer would be unjustly enriched if appellants are equitably subrogated. ⁵ The Morts are innocent parties. Though, they may have had, consistent with Nev. Rev. Stat. Ann. §111.353 (Michie 1993), constructive notice of the federal tax lien at the time they acquired their interest from the Belmonts , constructive knowledge does not by itself bar equitable subrogation. Han, 944 F.2d at 530. As to the unjust enrichment of the title insurance company, the appellee has cited several cases where the title insurance company's negligence has barred the application of equitable subrogation, but in each case the title insurance company itself was seeking equitable subrogation. See, e.g., Universal Title Ins. Co. v. United States [92-1 USTC ¶50,106 ], 942 F.2d 1311 (8th Cir. 1991); Coy v. Raabe, 69 Wash.2d 346, 418 P.2d 728, 730 (1966). The equities in those cases are substantially different and for that reason, the cases are inapposite.

CONCLUSION

We hold that the district court abused its discretion in ruling that the appellants must first seek relief from their title insurer before bringing an action for equitable subrogation against the IRS. We further hold that the Morts are entitled to be equitably subrogated to the priority position of the lender whose loan was paid off by the Belmonts . We reverse and remand for entry of judgment in favor of the Morts.

REVERSED and REMANDED.

¹ Though the district court stated it was dismissing the appellants' action on ripeness grounds, which would ordinarily be reviewed de novo, Dodd v. Hood River County, 59 F.3d 852, 857 (9th Cir. 1995), the basis for the court's dismissal of the Morts' equitable subrogation claim was its determination that equity jurisdiction should not be exercised. Under either standard, we would reverse the district court's decision.

² See also Katsivalis v. Serrano Reconveyance Co., 70 Cal. App. 3d 200, 138 Cal. Rptr. 620, 627 (1977) ("a legal remedy against one of several obligors cannot relieve another obligor of his equitable responsibility"); Dudley v. Keller, 33 Colo. App. 320, 325, 521 P.2d 175, 178 (1974) ("an adequate remedy at law must exist against the same person from whom the relief in equity is sought in order to bar the equitable action"); Hill v. Hill, 185 Kan. 389, 345 P.2d 1015, 1025 (1959) (remedy must exist against same person from whom the relief in equity is sought); TCF Banking & Sav. v. Loft Homes, Inc., 439 N.W.2d 735, 740 (Minn. Ct. App. 1989) (mortgagee eligible for equitable relief of rescission even though he had a legal remedy against another party); Buttinghausen v. Rappeport, 131 N.J. Eq. 252, 24 A.2d 877 (N.J. Ch. 1942) ("the legal remedy which may move equity to deny relief is a remedy against the same person from whom relief in equity is sought.").

³ In Han, 944 F.2d at 530 n.2, we made clear that cases involving purchasers at foreclosure sales are not applicable to equitable subrogation cases not involving forced sales. In forced sale cases, the purchasers are not paying off existing debts but rather extinguishing all liens by paying any purchase price. Purchasers at forced sales do not pay money in order to satisfy the debt of another, and therefore equitable subrogation does not apply. Forced sale cases are inapplicable here.

⁴ Government counsel conceded at oral argument that the Belmonts would have been entitled to equitable subrogation had they retained their interest in the note and deed of trust. It is undisputed that the Belmonts were not volunteers and acted to protect their own interests.

⁵ The IRS's argument that the title insurer is the real party of interest in this case is also without merit. There is no evidence of collusion between the Morts and Fidelity.

 

 

[94-2 USTC ¶50,405] Jonathan's Landing, Inc., Plaintiff v. Jack Townsend, Nancy Townsend, Blue Water Truss, Inc., and The United States of America , Defendants

U.S. District Court, So. Dist. Fla. , 88-8490-CIV-Gonzalez, 4/26/94

[Code Sec. 6323 ]

Tax liens: Priority: Equitable subrogation.--Under the doctrine of equitable subrogation, the secretary-treasurer of a corporation acquired the bank's undisputed superior interests in the corporation's accounts receivable when the bank seized the secretary-treasurer's certificate of deposit in satisfaction of a loan made by the bank to the corporation. Although federal tax liens were imposed against the property of the corporation, the secretary-treasurer's interest in the accounts receivable took priority over the government's liens when she paid the debt of the corporation. She stepped into the bank's shoes and became subrogated to all the rights the bank had against the corporation, including the superior interest in the accounts receivable.

ORDER

GONZALEZ, JR., District Judge:

THIS CAUSE has come before the Court upon defendant Nancy Townsend's Motion for Summary Judgment and defendant United States of America 's Cross-Motion for Summary Judgment.

Introduction

This case was commenced in state court as an interpleader action by Jonathan's Landing, Inc., a creditor of Blue Water Truss, Inc. Defendant United States removed the case to this Court. On May 23, 1990 , this Court awarded summary judgment in favor of the United States upon the parties' cross motions for summary judgment. The Court's decision was based upon application of the federal insolvency statute, 31 U.S.C. §3713. On May 13, 1992, the Eleventh Circuit Court of Appeals reversed that decision, holding that Blue Water Truss, Inc. must have been insolvent prior to the Internal Revenue Service levy in order for the United States to prevail under 31 U.S.C. §3713. The case was remanded to this Court.

On or about June 9, 1990 , Jack Townsend assigned all of his right and interest in any proceeds from these proceedings to his wife, Nancy Townsend. Consequently, Nancy Townsend and the United States are the only parties claiming an interest in the interpleaded funds. These parties have once again filed cross motions for summary judgment. However, the government no longer claims a right to the funds pursuant to the federal insolvency statute. It now relies solely upon Section 6323 of the Internal Revenue Code of 1986, 26 U.S.C., and related statutory provisions.

The Facts

Jack Townsend and Nancy Townsend were president and secretary-treasurer of the tax-payer, Blue Water Truss, Inc. Between February, 1988 and May, 1988, Blue Water Truss, Inc. borrowed money from Florida National Bank in the following amounts: $80,000 (February, 1988); $400,000 (April, 1988); and $64,342.40 (May, 1988). As collateral for each of these loans, Florida National Bank retained security interests in certain properties owned by either Blue Water Truss, Inc. or the Townsends, including Blue Water Truss, Inc.'s accounts receivable.

On the dates, and in the amounts set forth below, a delegate of the Secretary of the Treasury made assessments against Blue Water Truss, Inc., for federal income withholding and Federal Insurance Contributions Act taxes and penalties, plus interest thereon through each respective date of assessment, and gave notice thereof to Blue Water Truss, Inc.:

Date of                                                  Amount of

Assessment                                               Assessment

4/04/88
 ................................................ $64,405.24 Tax

                                                          11,592.94 Penalty

                                                           6,439.80 Penalty

                                                           3,509.82 Interest

                                                             292.65 Interest

6/30/88
 ................................................  79,782.85 Tax

                                                           3,496.32 Interest

                                                          17,951.14 Penalty

                                                           7,978.29 Penalty

6/30/88
 ................................................  62,466.79 Tax

                                                           1,049.69 Interest

                                                           5,622.01 Penalty

                                                           6,246.68 Penalty

7/05/88
 ................................................  76,049.76 Tax

                                                           7,604.98 Penalty

The liabilities referred to above have not been paid in full, and as of July 19, 1988 , there was due and owing to the United States by Blue Water Truss, Inc. the sum of $343,758.08, plus interest and statutory additions thereon. On July 19, 1988 a Notice of Federal Tax Lien with respect to these assessments was filed in the public records of Martin County, Florida.

On July 19, 1988 , the $400,000.00 loan from Florida National Bank to Blue Water Truss, Inc. was satisfied by the bank's seizure of a $400,000.00 certificate of deposit owned by Jack and Nancy Townsend. On August 29, 1988 , a UCC financing statement evidencing the assignment of Blue Water Truss, Inc.'s accounts receivable from Florida National Bank to Jack and Nancy Townsend was filed with the Florida Secretary of State.

On August 5, 1988 , plaintiff Jonathan's Landing, Inc. owed $46,483.87 to Blue Water Truss, Inc. for materials supplied by the company. On August 5, 1988 , a Notice of Levy was served on Jonathan's Landing, Inc., demanding surrender of the sum of $337,666.39 or such smaller amount of the property or rights to property of Blue Water Truss, Inc. as Jonathan's Landing, Inc. then possessed. Not knowing whom to pay, Jonathan's Landing, Inc. filed this interpleader action.

Discussion

The Court may grant summary judgment "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show 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). The burden of establishing that there is no genuine issue of material fact lies upon the moving party and it is a stringent one. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S. Ct. 2548, 2553 (1986). The Court should not grant summary judgment unless it is clear that a trial is unnecessary, Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 2514 (1986), and any doubt as to the existence of a genuine issue for trial should be resolved against the moving party, Adickes v. S.H. Kress & Co., 398 U.S. 144, 157, 90 S. Ct. 1598, 1608 (1970).

Section 6321 of the Internal Revenue Code of 1986, 26 U.S.C., provides as follows:

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.

The lien imposed by §6321 arises at the time of assessment and continues until the liability for the amount so assessed is satisfied or becomes unenforceable by reason of lapse of time. 26 U.S.C. §6322 . This lien may be perfected against specified competing interests in the property or rights to property of the taxpayer by proper filing pursuant to 26 U.S.C. §6323 . However, a lien imposed by §6322 is not valid against the holder of a security interest which has been perfected prior to the filing of the notice of the tax lien.

It is undisputed that Florida National Bank's security interests have priority over the federal tax liens. However, the parties disagree as to whether Nancy Townsend's interest in the accounts receivable also takes priority over the federal tax liens. Nancy Townsend argues that she has acquired Florida National Bank's superior interest in the accounts receivable through the doctrine of equitable subrogation. 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. Mortoro v. Maloney, 580 So.2d 822, 823 (Fla. 5 DCA 1991). The party who pays the debt "steps into the shoes" of the former creditor, and becomes subrogated to all the rights of the creditor against the principal debtor, including the security given to secure the debt. In re Blair Contracting Company, Inc., Bkrtcy., 21 B.R. 353, 354 (M.D. Fla. 1982); Allen v. See, 196 F.2d 608 (10th Cir. 1952).

According to Nancy Townsend, the Townsends became subrogated to the security interests of Florida National Bank in Blue Water Truss, Inc.'s accounts receivables when their certificate of deposit was used to satisfy the April, 1988 loan debt. The United States asserts three arguments in opposition to Nancy Townsend's claim.

First, the United States argues that the Townsends could not have become subrogated to the bank's interest in the accounts receivable because the April, 1988 loan was secured solely by the Townsends' $400,000 certificate of deposit. It is true that the Promissory Note for the $400,000.00 loan specifies only the certificate of deposit as collateral. However, the Promissory Note and Security Agreement executed by the Townsends provides in pertinent part:

Each obligor hereunder (which term includes the Maker and any endorser, surety, guarantors or other party signing this agreement or otherwise guaranteeing or ensuring the performance or payment by the Maker) pledges to the Bank and gives a security interest in all of the property of Maker and each other Obligor now or hereafter in the possession, custody or control of the bank whether held expressly as collateral security or otherwise, including but not limited to any balance or share of any deposit, trust or agency or special account in which any obligor has an interest. All of such property, together with any specific property listed above as pledged to bank by Maker(s) shall be referred to herein as the collateral.

When this Promissory Note was signed, the accounts receivable of Blue Water Truss, Inc. had already been assigned to Florida National Bank as security for a loan advanced in February, 1988. Thus, through the above-quoted provision, the accounts receivable of Blue Water Truss, Inc. also became collateral for the $400,000.00 loan. The United States ' first argument therefore fails.

Next, the United States argues that the Townsends may not be equitably subrogated to Florida National Bank's interest in the accounts receivable, because they were under no obligation to pledge their certificate of deposit as collateral for the loan to Blue Water Truss, Inc. The government cites Boley v. Daniel, 72 So. 644 ( Fla. 1916), in support of this argument. However, its reliance upon Boley is misplaced.

In Boley, the Court merely recognized the well established rule that legal subrogation is not available to a mere volunteer or intermeddler who, without any duty, moral or otherwise, pays the debt or discharges the obligation of another. Boley, at 645; 73 Am Jur 2d, Subrogation §23 . In the instant case, the Townsends were not mere volunteers who stepped in, without any obligation, to satisfy the debts of Blue Water Truss, Inc. As guarantors of Blue Water Truss, Inc.'s loan from Florida National Bank, they had a legal obligation to satisfy the debt. ¹ The Townsends' motivations for becoming guarantors are irrelevant.

Finally, the government argues that the Townsends are not entitled to equitable subrogation because they were aware of the tax lien when they satisfied the $400,000.00 debt. However, the Townsends' knowledge of the lien at the time when the debt was satisfied is inconsequential. They had already guaranteed the loan and pledged the certificate of deposit as collateral.

In conclusion, the Court finds, as a matter of law, that the Townsends became subrogated to Florida National Bank's interest in Blue Water Truss, Inc.'s accounts receivable when they satisfied the $400,000.00 debt. Nancy Townsend is therefore entitled to the funds originally deposited into the Registry of the Court by Jonathan's Landing, Inc., which are now held by the United States .

Accordingly, having reviewed the motion and the record, and being otherwise duly advised, it is hereby:

ORDERED and ADJUDGED that defendant Nancy Townsend's Motion for Summary Judgment is GRANTED. Defendant United States of America 's Cross-Motion for Summary Judgment is DENIED. Defendant Nancy Townsend shall file a form of judgment for entry in this cause within fifteen (15) days from the date of this Order.

DONE AND ORDERED in chambers at Fort Lauderdale , Florida , this 26th day of April, 1994.

¹ Although the government initially argued that the Townsends were not guarantors on the $400,000.00 loan, Nancy Townsend has submitted a copy of the executed guaranty agreement. Since, the government has not challenged the accuracy of this document, the Court concludes that the Townsends were, in fact, guarantors on this loan.

 

 

[92-1 USTC ¶50,106] Universal Title Insurance Company, a Minnesota corporation, Appellee v. United States of America , Appellant

(CA-8), U.S. Court of Appeals, 8th Circuit, 89-5330, 8/27/91, Reversing and remanding an unreported District Court decision

[Code Sec. 6323 ]

Liens: Federal tax lien: Subrogation.--A title insurance company was not entitled to be equitably subrogated to the rights of lienholders who were senior to a federal tax lien which the insurer failed to discover in performing a title search incident to issuing two insurance policies. The company failed to meet the prerequisites for asserting the equitable doctrine of subrogation under state ( Minnesota ) law. The company made no payment that would entitle it to subrogation. Its failure to detect the federal tax lien resulted from negligence, rather than an excusable mistake of fact. Finally, subrogation rights did not apply as against the government because the seller of the property, not the government, was responsible for the loss to the insured parties.

John M. Koneck, Jon C. Nuckles, Fredrikson & Byron, 900 2nd Ave. S., Minneapolis, Minn. 55402-3397, for appellee. Shirley D. Peterson, Assistant Attorney General, William S. Estabrook III, Gary R. Allen, Barbara I. Hodges, Department of Justice, Washington, D.C. 20530, for appellant.

Before MCMILLIAN, Circuit Judge, FRIEDMAN, ^* Senior Circuit Judge, and ARNOLD, Circuit Judge.

MCMILLIAN, Circuit Judge:

The government appeals from a final judgment entered in the United States District Court for the District of Minnesota in favor of Universal Title Insurance Company ("Universal"), finding that Universal was entitled to be equitably subrogated to the rights of lienholders who were senior to a federal tax lien, which the insurer failed to discover in performing a title search incident to issuing two insurance policies. Universal Title Insurance Co. v. United States , No. 3-87-835 (D. Minn. Apr. 26, 1989) (Universal Title). For reversal, the government argues that the district court erred in subrogating Universal to the position of the prior lienholders because Universal has not met the prerequisites for asserting this equitable doctrine under Minnesota law. For the reasons discussed below, we reverse the judgment of the district court and remand the case to the district court to enter judgment in favor of the government.

I.

The facts of the instant case are undisputed. On April 29, 1985 , Rodney and Martha Hjelms purchased residential property, located in Richfield , Minnesota , from Diane Warner by way of warranty deed. At the time of purchase, the property was encumbered with the following liens: (1) a mortgage lien in favor of Midwest Federal Savings and Loan Association dated January 31, 1974, in the amount of $26,920.82; (2) a judgment lien in favor of Dwain W. Warner Jr. filed July 30, 1979, in the amount of $22,590.16; (3) county real estate taxes in the amount of $810.34; (4) a water and sewer charge lien in the amount of $379.81; and (5) a United States tax lien filed September 14, 1981, in the amount of $31,027.54. The Hjelmses borrowed the purchase money from Investors Savings Bank ("Investors"), which secured the loan by a mortgage deed. Prior to the sale, Universal conducted a title search of the property, but failed to discover the properly recorded federal tax lien, and the Hjelmses and Investors had no knowledge of the tax lien prior to closing. At the direction of the Hjelmses, Investors and Diane Warner, all of the liens and encumbrances, except the federal tax lien, were satisfied at the time of closing. After payment of consideration, Universal issued two title insurance policies, one to the Hjelmses insuring clear title and another to Investors insuring its first mortgage. Under the policies, Universal is responsible for the removal of the tax lien. The policies also provide that if Universal paid to remove claims or liens from the title, Universal would be subrogated to the rights of its insureds (the Hjelmses and Investors).

The day after closing, the Hjelmses received notice from the Internal Revenue Service ("IRS") advising them of the existence of the tax lien against their property. Universal offered the IRS $12,865.01 as full payment of the lien, an amount equal to the seller's net proceeds, or, in other words, the purchase price minus the amounts paid to satisfy the prior liens and closing expenses. The IRS stipulated that it had a practice of releasing its tax liens if it is paid all of the seller's proceeds after payment of prior liens and customary closing costs. However, the IRS refused to accept Universal's tender of payment equal to the amount of the seller's net proceeds in the instant case. The IRS and Universal agreed that Universal would deposit $76,000, the full market value of the property, into an escrow account in exchange for release of the tax lien. The parties also agreed that their rights and claims against the property would be transferred to the escrow account, pending resolution of their dispute by a court of competent jurisdiction.

On December 14, 1987, Universal filed a complaint in the United States District Court for the District of Minnesota, seeking a ruling that it was entitled to a full release of the federal tax lien upon payment of $12,865.01, the net proceeds of the sale paid to Diane Warner. Universal argued that the practice of the IRS was to accept the seller's net proceeds from the sale in exchange for full release of the lien, that the IRS would be unjustly enriched if it received an amount greater than the net proceeds, and that Universal was entitled to be equitably subrogated to the rights of the prior senior lienholders, which the Hjelmses and Investors paid off at the time of closing. Following a bench trial, the district court concluded that Universal was "equitably subrogated to the rights of the owners of the prior mortgage liens and encumbrances," and that the government was entitled to $12,865.01 of the escrowed funds, with the balance distributed to Universal. Universal Title, slip op. at 5. This appeal followed.

II.

We note initially that, although we defer to the district court's findings of fact, setting them aside only if "clearly erroneous," Fed. R. Civ. P. 52(a), we review its conclusions of law de novo. SEC v. Comserv Corp., 908 F.2d 1407, 1411 (8th Cir. 1990). "Rule 52(a) does not inhibit an appellate court's power to correct errors of law, including those that may infect a so-called mixed finding of law and fact, or a finding of fact that is predicated on a misunderstanding of the governing rule of law." Bose Corp. v. Consumers Union of United States, Inc., 466 U.S. 485, 501 (1984). In addition, we engage in an independent review of the district court's interpretation of the appropriate state law, which in the instant case is Minnesota law. Salve Regina College v. Russell, 111 S. Ct. 1217, 1221 (1991). Finally, we note that neither party has presented controlling precedents for our consideration, and this court has found none that exactly match the unusual factual setting of this case.

On appeal, the government argues that the equitable doctrine of subrogation is inapposite to the instant case for three reasons. First, the government claims that Universal made no payment that would entitle it to subrogation. Second, the government contends that Universal is precluded from the equitable remedy of legal subrogation because its failure to discover the properly recorded federal tax lien was not an "excusable mistake of fact." Finally, the government argues that Universal is not entitled to be subrogated to the rights of the senior lienholders because an insurer's subrogation rights extend only to one causing the loss to its insureds, in this case Diane Warner, the seller of the property who breached her warranty of good title. ¹ We agree, and will address each point in turn.

In addition to its substantive arguments with respect to each of the issues raised by the government, Universal argues that the government should be precluded from raising all but its second argument on appeal because they were not raised before the district court. See American General Finance Corp. v. Parkway Bank & Trust Co., 520 F.2d 607, 608 (8th Cir. 1975). The government counters that its argument before the district court, which essentially addressed the issue of whether the equities supported Universal's claim for subrogation, was broad enough to encompass all of its arguments on appeal. We agree.

Although, as a general rule, we do not consider issues not presented to the district court, "a blanket statement condemning new arguments is far too broad." In re Osweiler, 346 F.2d 617, 621 (C.C.P.A. 1965).

The real question should be whether the new argument is such as to raise a new issue . . .. [W]e think it would be in disharmony with one of the primary purposes of appellate review were we to refuse to consider each nuance or shift in approach urged by a party simply because it was not similarly urged below.

Id. We also have the discretion to consider an issue for the first time on appeal "where the proper resolution is beyond any doubt, or 'where injustice might otherwise result,' " Sanders v. Clemco Industries, 823 F.2d 214, 217 (8th Cir. 1987) (quoting Hormel v. Helvering [41-1 USTC ¶9322 ], 312 U.S. 552, 557 (1941)), or when the argument involves a purely legal issue in which no additional evidence or argument would affect the outcome of the case, Donovan v. Williams Enterprises, Inc., 744 F.2d 170, 176 (D.C. Cir. 1984).

III.

Before addressing the points raised by the government on appeal, some discussion of the law of subrogation is appropriate. While subrogation is generally defined as "the substitution of one person in the place of another with reference to a lawful claim or right," 73 Am. Jur. 2d Subrogation §1 (1974), there are actually two distinct types of subrogation, ² "conventional subrogation" and "legal subrogation," which is often confusingly called "equitable subrogation," due to its origin and basis in equity. ³ Conventional subrogation "occurs where one having no interest or any relation to the matter pays the debt of another, and by agreement is entitled to the rights and securities of the creditor so paid." Id. §9. Legal subrogation, however, "has for its purpose the working out of an equitable adjustment and the doing of complete and perfect justice between the parties by securing the ultimate discharge of a debt by the person who in equity and good conscience ought to pay it." Id. §3 (footnotes omitted). Unlike conventional subrogation, legal subrogation does not depend on contract, assignment, or privity. Id. In either case, however, the right to subrogation is predicated on the full payment of the debt or claim of another by one who is not a mere volunteer or intermeddler. See City of Red Wing v. Eichinger, 203 N.W. 622, 623 ( Minn. 1925); 73 Am. Jur. 2d Subrogation §11 .

Although legal subrogation is a highly favored doctrine, it is not an absolute right, but rather, one that depends on the equities and attending facts and circumstances of each case. See e.g., Compania Anonima Venezolana de Navegacion v. A.J. Perez Export Co., 303 F.2d 692, 697 (5th Cir. 1962). In general, the equity of the party seeking subrogation must be clear and substantial, and superior to that of other claimants. Finally, subrogation cannot be invoked where it would work an injustice, violate sound public policy, or result in harm to innocent third persons.

IV.

A. "Full Payment of the Debt or Claim"

The government argues that Universal is not entitled to be subrogated to the rights of the lienholders who were senior to the federal tax lien because they were not paid by Universal. The government contends that the district court erroneously concluded that "the prior mortgage liens and encumbrances . . . [were] released after being paid in full by Universal." Universal Title, slip op. at 5. The government notes, to the contrary, that the liens were extinguished at closing by payment with money advanced by the Hjelmses and Investors, the Hjelmses' mortgagee. Universal responds that, despite the statement by the district court, the government misconstrues the origin of its right to subrogation. Universal contends, in essence, that Investors and the Hjelmses were entitled to be legally subrogated to the prior liens by virtue of the fact that they paid them at closing in good faith and with the intention of establishing the primary claim to the property, and that this right was conventionally subrogated to Universal under the subrogation clause in the title insurance policy when it effected the release of the federal tax lien. In short, Universal argues that it now stands in the place of the Hjelmses and Investors. For the purposes of this discussion, we accept Universal's characterization of its claim to subrogation.

Although we recognize that an insured may contractually assign his or her right to subrogation to an insurer who pays the claim under which the right arises, there is nothing in the stipulated facts of the instant case to support Universal's contention that it discharged the federal tax lien. Universal has paid the Hjelmses nothing; neither has it expended anything that would constitute a payment of the government's lien. According to the escrow agreement, the government's lien was merely transferred from the Hjelmses' property to the escrow fund, pending resolution of the dispute by a court of competent jurisdiction. The escrow agreement expressly retained all of the rights and claims of each party with respect to the disputed lien. In other words, the federal tax lien has not been extinguished; it continues in existence attached to the funds in the escrow account. ⁴ Therefore, we hold that the mere transfer of the lien from the property to the escrow account was insufficient to entitle Universal to be conventionally or legally subrogated to the rights of the prior lienholders.

B. "Excusable Mistake of Fact"

The government also argues that Minnesota law precludes the application of legal subrogation in the instant case because Universal failed to undertake prudent business measures in searching for potential encumbrances to the Hjelms property. In other words, the government contends that Universal's failure to discover the properly recorded federal tax lien was not an "excusable mistake of fact," as required by Minnesota case law. We agree.

In Heisler v. C. Aultman & Co., 57 N.W. 1053 (Minn. 1894) (Heisler), the Minnesota Supreme Court articulated a two-pronged standard for determining whether a party, who has discharged another's obligations without knowledge of an intervening lien, should be subrogated to the rights of the superior discharged lien. It stated that, under such circumstances, the interests of substantial justice dictate that a court "may relieve one who has acted under a justifiable or excusable mistake of fact . . . where . . . no injury to innocent parties will result." Id. at 1053-54. In Heisler, the plaintiff was an individual surety on a note made by her son and secured by a second mortgage on land purchased by him. After the son defaulted on the note, the plaintiff paid the note in full without knowledge of the existence of a judgment lien, which was third in priority to the second mortgage. The Minnesota Supreme Court affirmed the trial court judgment, which subrogated the plaintiff to the rights of the second mortgage, and accorded her priority over the judgment lienholder to the proceeds of the sheriff's sale of the land. In reaching its decision, the court noted:

Having caused [the mortgage] to be satisfied and discharged in ignorance of the existence of the judgment lien, under circumstances authorizing an inference of a mistake of fact, equity will . . . give the party who made it the benefit of the equitable right of subrogation. To do so in this case is to prevent manifest injustice and hardship, and no superior intervening equities are interfered with.

Id. at 1054. The Minnesota Supreme Court also noted that the defendant was not placed in a worse position by subrogating the plaintiff to the rights of the mortgagee because it had notice of the plaintiff's cause of action, which was filed before the sheriff's sale. Id.

A more recent Minnesota Supreme Court decision reiterated the Heisler standard for the application of legal subrogation. Carl H. Peterson Co. v. Zero Estates, 261 N.W.2d 346, 348 ( Minn. 1977) (Peterson). In Peterson, the Minnesota Supreme Court rejected a bank's argument that a 1973 mortgage should be subrogated to a 1970 mortgage for the purpose of gaining priority over intervening mechanics liens, despite the fact that the proceeds of the second loan were used to pay the balance of the first loan, as well as certain delinquent taxes, and that the bank had no actual knowledge of intervening mechanics liens on the same property. Id. In assessing whether the bank acted under an "excusable mistake of fact," the court distinguished the factual situation from Heisler, stating

[t]he bank in this case has not demonstrated such equities in its favor. Unlike the unsophisticated individual wholly unaware of a judgment lien, the bank is a professional lender with knowledge of construction in progress giving rise to inchoate liens for contractors and materialmen. Its failure to consider potential priority conflicts and to obtain subordination agreements from them, as well as its failure to ascertain that its mortgagor was maintaining insurance in force, cannot be deemed justifiable as an excusable mistake.

Id. ⁵

We believe that the Peterson case indicates that the Minnesota courts impose stricter standards on professionals than lay persons in assessing whether mistakes are "excusable" for purposes of the doctrine of legal subrogation, especially when the professional relationship arises out of a commercial transaction involving consideration. It is unreasonable to believe that the Minnesota Supreme Court would distinguish a title insurer from a bank; both are professional enterprises experienced in the area of secured transactions involving real property.

Our interpretation of Peterson is consistent with other jurisdictions, which have imposed stricter standards on professionals in contexts similar to the instant case. For example, the Washington Supreme Court distinguished between purchasers of real estate and a title insurer, noting that "[t]he former are bona fide purchasers to the extent that they were entitled to rely upon others who were paid to give an expert opinion and insure title. The latter are engaged in giving those expert opinions for a consideration. In equity, [the purchasers] and [the title insurer] are poles apart." Coy v. Raabe, 418 P.2d 728, 731 ( Wash. 1966) (Raabe). In elaborating on this dual standard, the court stated:

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 consideration. [The title insurer's] relationship is governed by the law of contracts. 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. [The insurer] has not cited us authority to the contrary.

Id.

The Indiana Court of Appeals also indicated a less deferential standard in a decision affirming the denial of subrogation to a title insurer, who by "mistake" failed to exempt from coverage a strip of land, which had previously been sold. Lawyers Title Insurance Corp. v. Capp, 369 N.E.2d 672, 674 (Ind. Ct. App. 1977) (Capp). In its opinion, the Capp court noted that the insurer's mistake arose out of a "commercial transaction involving a consideration. . . . [which] is governed by the law of contracts." Id. (quoting Raabe, 418 P.2d at 731). In addition, the New Mexico Court of Appeals held that a title insurer's failure to conduct a more thorough title search to determine whether a federal tax lien was recorded against insured property constituted negligence, which precluded it from being subrogated to the IRS lien, despite the owner's assurances that the property was unencumbered. USLIFE Title Insurance Co. v. Romero, 652 P.2d 249, 252-53 (N.M. Ct. App. 1982) (Romero) (citing Capp, 369 N.E. 2d at 674; Raabe, 418 P.2d at 731).

Having considered the relevant Minnesota case law, we believe that the instant case is more analogous to Peterson than Heisler. Universal is a professional enterprise, which is in the business of insuring marketable title to real property. Although Universal contends that it exercised prudent business practices in investigating the title to the Hjelms property, it fails to explain what precautions it took or why it failed to discover the properly recorded federal tax lien. Its claim that it sought and received assurances from the seller that there were no liens, other than those discharged at closing, is patently insufficient. It has long been recognized that purchasers of real property are expected "to consult available records in regard to contemplated real property transactions . . . [to minimize] the effect of any uncertainty of representation between vendor and vendee concerning existing incumbrances of record." Belcher v. Belcher, 87 P.2d 762, 765 (Or. 1939). We can expect no less from a title insurer.

Universal's inability to explain its failure to find the properly recorded federal tax lien is significant, because Universal had the burden of persuasion at trial of demonstrating its entitlement to subrogation. See Peterson, 261 N.W.2d at 348. In light of the Minnesota Supreme Court's decision in Peterson, we hold that the district court erred in finding that Universal's failure to discover the federal tax lien was an excusable mistake of fact. On the contrary, we must conclude, under these circumstances, that Universal's failure to detect the federal tax lien resulted from negligence, and therefore, it is not entitled to be legally subrogated to the rights of the prior senior lienholders. ⁶

C. "Innocent Third Party"

The government's third argument is that Universal is not entitled to the benefits of legal subrogation because, under Minnesota law, its right to subrogation, if any, extends only to its insureds' (Investors and the Hjelmses) claims against individuals whose negligence or wrongful act caused a compensable loss. The government contends that, because it was not notified of the sale between Warner and the Hjelmses and did not conceal, either actively or passively, the existence of the federal tax lien, it could not have caused the loss to Investors or the Hjelmses. Rather, the government contends that the loss resulted from the seller's breach of her warranty of good title under the warranty deed, as well as Universal's failure to discover the federal tax lien. We agree.

In Board of First Congregational Church v. Cream City Mutual Insurance Co., 96 N.W.2d 690 (Minn. 1959) (Cream City), the Minnesota Supreme Court held, in part, that an insurer who contracts to provide insurance coverage in exchange for fair consideration, without knowledge of the insured's collateral rights, is not entitled to be subrogated to the rights of the insured against a third person who did not cause the compensable loss. While the Minnesota Supreme Court acknowledged the general rule that an insurer is entitled to be subrogated to the insured's rights against one who wrongfully caused a compensable loss, it noted:

[T]here is no such agreement of authorities as to the right of an insurer to be subrogated to collateral contract rights which the insured has against a third person who did not cause the loss. . . . [T]o give the insurer the benefit of the collateral obligation through subrogation ignores the plain terms of the insuring agreement and provides the insurer with a windfall. Its premiums are assumed to represent the fair equivalent of the obligation it contracted to incur without knowledge of the existence of collateral remedies.

Id. at 695-96 (emphasis added). Although the facts of Cream City are not exactly on point, we believe the Minnesota Supreme Court's holding supports the government's contention that an insurer has no right of subrogation as against a third party who has not caused the insured's loss.

Universal argues that the subrogation clause of the title insurance policies evidence the fact that it anticipated a right to legal subrogation in the event undiscovered liens existed against the Hjelms property, a consequence that was also reflected in the premiums. Although Universal concedes that the seller, and not the IRS, caused the loss in the instant case, it argues that its right of subrogation is not limited to application against the seller. Universal contends that it makes no equitable difference if it is allowed to assert its insureds' subrogation rights against the government, because the government would still receive the amount of the seller's net proceeds in satisfaction of the tax lien, and thus the status quo would be preserved. Rather, Universal argues that denying it the right to subrogation under these circumstances would allow the government to benefit from Universal's mistake, resulting in a windfall to the government. We disagree.

Universal's argument begs the question. Universal erroneously assumes that the conclusion to its argument is true--that is, that the IRS is limited to recovering $12,865.01, the seller's net proceeds, because of the IRS's past practice of releasing tax liens upon receipt of the seller's net proceeds. We also reject Universal's contention that denying it the right of subrogation will result in a windfall to the government. On the contrary, the government will simply receive that which it is entitled--full payment of the federal tax lien. The IRS properly recorded its tax lien, and the government is legally entitled to be paid the full amount of that lien. The fact that the IRS has, in the past, gratuitously released liens in exchange for payment of less than the full amount of the lien is immaterial. The government has the discretion to decide whether to insist upon full payment of its lien or to accept a lesser amount.

Even if we accept Universal's argument that the IRS would have settled for the seller's net proceeds had it been informed of the sale, it does not change our holding here. The doctrine of legal subrogation requires more than a showing that a junior lienholder will be placed in a better position than the lienholder would be in if legal subrogation applied. See Fidelity National Title Insurance Co. v. Department of the Treasury [90-2 USTC ¶50,402 ], 907 F.2d 868, 871 (9th Cir. 1990) ("neither [buyer] nor [title insurer] is entitled to [legal] subrogation merely because the IRS might now recover more on its tax lien than it could have had it been a party to the foreclosure sale").

Universal agreed to insure marketable title to the Hjelms property, for which it received valuable consideration. It is uncontested that, by virtue of this contract, Universal incurred the obligation to discharge the underlying federal tax lien. Universal cannot now minimize this obligation by resorting to the equitable doctrine of legal subrogation at the expense of the government's preexisting legal right. " 'Subrogation is the creature of equity, and will not be permitted where it will work injustice to the rights of those having equal or superior equities, or where it will operate to defeat a legal right.' " Benson v. Saffert-Gugisberg Cement Construction Co., 198 N.W. 297, 299 ( Minn. 1924) (citation omitted). We therefore hold that Universal is not entitled to invoke legal subrogation, as against the government, under the facts and circumstances of the instant case. ⁷

V.

In sum, we hold that Universal is not entitled to be subrogated to the rights of the prior lienholders, under Minnesota law, because it made no payment that would entitle it to subrogation, its failure to discover the federal tax lien was not an "excusable mistake of fact," and its subrogation rights, if any, do not apply as against the government, which was not responsible for Investors' and the Hjelmses' loss. Accordingly, we reverse the judgment of the district court and remand the instant case to the district court with directions to grant judgment in favor of the government.

^* The Honorable Daniel M. Friedman, Senior United States Circuit Judge for the Federal Circuit, sitting by designation.

¹ In addition, the government argues that, even if the doctrine of subrogation applied to the facts of the instant case, Universal should be precluded from its benefits because the equities are not in its favor. Because we hold that Universal is not entitled to be subrogated to the rights of the prior lienholders for the above-mentioned reasons, we need not address the issue of balancing the relative equities of the parties here.

² Some legal authorities regard assignment as a third type of subrogation. See 73 Am. Jur. 2d Subrogation §2 n.6 (1974).

³ For the sake of consistency and clarity, we note that we will use the term "legal subrogation" in reference to the equitable remedy.

⁴ The fact that the District Director of the Internal Revenue Service issued a certificate of discharge on the Hjelms property does not alter our holding in this case. We do not limit our examination to mere forms or technicalities, but rather, consider the substance of a given transaction. See, e.g, United States v. Pegg, 782 F.2d 1498, 1501 (9th Cir. 1986) ("equity will disregard mere form, and will ascertain and act on the substance of things"); see also 73 Am. Jur. 2d Subrogation §13 ("in applying the doctrine of subrogation, the court will disregard mere form and technicality"). In the instant case, the certificate of discharge was issued pursuant to the escrow agreement, which transferred all of the government's rights and claims to the escrow fund.

⁵ Contrary to Universal's claim, the Minnesota Supreme Court did not indicate that the trial court found that the bank had actual knowledge of the inchoate liens, but rather, that the bank "failed to consider potential priority conflicts and to obtain subordination agreements from them." Carl H. Peterson Co. v. Zero Estates, 261 N.W.2d 346, 348 ( Minn. 1977) (Peterson).

⁶ We also hold that the district court erred in relying on London & N.W. Am. Mortgage Co. v. Tracy, 59 N.W. 1001 (Minn. 1894) (Tracy), and Emmert v. Thompson, 52 N.W. 31 (Minn. 1892) (Emmert), as controlling law in the factual situation of the instant case. We believe the more recent Peterson case takes precedence over these nineteenth century cases. The fact that Universal insured clear title to property for valuable consideration also distinguishes the instant case from Tracy and Emmert. See discussion IV C infra.

⁷ Our holding does not leave Universal entirely without a remedy. After paying the federal tax lien in full, Universal could seek legal subrogation to the rights of the IRS as against the seller, who was unjustly enriched by her breach of warranty of good title. "There is ample authority for the proposition that one, who has paid taxes to protect his own rights and not as a volunteer or intermeddler, may be subrogated to the rights of the state or of the one who had acquired the state's rights." Sucker v. Cranmer, 149 N.W. 16, 18 ( Minn. 1914); see also 73 Am. Jur. 2d Subrogation §66 ("it is quite generally held that where a person having an interest in the property pays the taxes or assessments due from another, he is subrogated to the lien of the state or other public body") (citations omitted).

 

 

[91-2 USTC ¶50,486] Jea Min Han, Jae Soon Han, Plaintiffs-Appellants v. United States of America , Defendant-Appellee

(CA-9), U.S. Court of Appeals, 9th Circuit, 90-55804, 9/11/91, Reversing and remanding an unreported District Court decision

[Code Secs. 6323 and 7426 ]

Equitable subrogation: Notice: Federal tax lien.--Unknowingly, a couple purchased real property subject to a properly recorded federal tax lien. However, equitable subrogation applied to limit the amount for which the purchasers were liable despite their constructive knowledge of the lien. At the time they purchased the property, the seller's lender held a mortgage that was recorded prior to the recording of the IRS lien on the property; this loan was paid in escrow. Under the doctrine of equitable subrogation, the purchasers assumed the priority lien position of the lender because they discharged the deed. The purchasers were not barred from this equitable remedy by their constructive knowledge of the lien.

Allan B. Cooper, Ervin, Cohen & Jessup, P.C., 9401 Wilshire Blvd., Beverly Hills, Calif. 90212-2974, for plaintiffs-appellants. Calvin Carl Curtis, Nancy G. Morgan, Department of Justice, Washington , D.C. 20530 , for defendant-appellee.

Before NELSON, O'SCANNLAIN and TROTT, Circuit Judges.

Opinion

TROTT, Circuit Judge:

Jea Min Han and Jae Soon Han purchased a piece of residential property from Yue Khang Lok. The Hans were not aware that the property was encumbered by a federal tax lien. After the purchase, the Internal Revenue Service ("IRS") levied upon the property to satisfy the lien. In an attempt to stave off the foreclosure sale and to protect their investment, the Hans filed a complaint for wrongful levy and for injunctive relief against the IRS. The district court granted summary judgment against the Hans, holding essentially that the IRS was entitled to the full value of the property. The Hans argue on appeal that the IRS is entitled to recover only the previous owner's equity in the property, and in the alternative, that the Hans should be equitably subrogated to the priority position of the lender whose existing loan they paid off when they purchased the property. ¹ We agree with the second argument, and we reverse.

I

Yue Khang Lok owned a house in Arcadia , California , which he sold to the Hans. Because Lok failed to pay $2.3 million in income taxes for 1985-87, the IRS filed a lien against the Arcadia house. Although this lien was properly recorded before escrow opened on the house, the Hans were unaware of it until after escrow closed. Their real estate agent, Kay Shin, knew of the tax lien, but Lok represented to her that it would be paid off before close of escrow. Ms. Shin did not advise the Hans of this problem.

Lok sold the Arcadia property to the Hans for $550,000. At the time of sale, World Savings and Loan Association ("World Savings") held a first trust deed for $367,000 that was recorded prior to the tax lien's recordation. This loan was paid off in escrow. After $38,000 was paid for settlement charges and other miscellaneous debts, Lok's net from the sale was approximately $145,000.

Escrow closed on January 5, 1988 , and the IRS levied on the property on March 24, 1989 . The levy was served on the Hans, putting the IRS in constructive possession of the property. The IRS has never taken actual possession, although it declared its intention to sell the property at a public auction on May 17, 1989 . The plan to sell was withdrawn pending resolution of this lawsuit.

The Hans filed this action, seeking declaratory relief limiting the IRS to what it would have yielded from foreclosure if the property still belonged to Lok. The Hans asserted the IRS is only entitled to $145,000, which represents the difference between the sale price of $550,000, and the $405,000 in liens and other obligations paid in escrow. Alternatively, they argued that they are entitled to equitable subrogation, which would give them a priority position on the property in front of the IRS in the amount of World Savings's first trust deed. Equitable subrogation permits a person who pays off an existing encumbrance to assume the same priority position as the holder of that encumbrance. Under this argument, they assert that if the property is now sold, they are entitled to the first $367,000 yielded by the transaction, as World Savings would have been if it still held the first trust deed.

The district court rejected the Hans' first argument, finding no basis for limiting the IRS to what it would have received if Lok had still owned the property at the time of a foreclosure sale. "[T]he government may enforce its entire tax lien without limitation." The court also rejected the equitable subrogation argument, but it did so only because a purchaser with actual knowledge of a previously existing lien is ineligible for this equitable remedy, and it found that the Hans had the equivalent of actual knowledge of the tax lien. The Hans' agent, Kay Shin, had actual knowledge of the tax lien, leading the court to conclude that the Hans had imputed actual knowledge, based on agency principles that impute the knowledge of the agent to the principal. In every other respect, however, the court concluded that the Hans qualified for equitable subrogation.

III

The Hans assert that the IRS should be limited in its recovery to the value of Lok's interest in the Arcadia house. They claim that the IRS is only entitled to $145,000, the amount netted by Lok. The Hans argue that because the California rule is that title is transferred to the holder of a deed of trust, see Hohn v. Riverside County Flood Control & Water Conservation Dist., 228 Cal.App.2d 605, 611, 39 Cal. Rptr. 647, 651 (1964), World Savings held title to the entire property at the time of sale, except the $145,000 unencumbered portion. Lok held title only to the $145,000 portion. They further rely on United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 690-91 (1983), which holds that a tax lien cannot extend beyond the interest held by the taxpayer. If Lok only had title to the $145,000, and the IRS cannot levy beyond his interest, then the IRS would be limited to recovering only Lok's equity.

The fatal defect in this line of reasoning is that it assumes the extent of Lok's liability to the IRS secured by the lien was somehow fixed at the moment of sale. Assuming for the moment that World Savings held actual title, the IRS nonetheless is not limited to the value of Lok's interest at the moment of sale. 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. Because the lien is unaffected by sale, we see no basis for fixing the amount of the lien at the time of sale. We decline to legislate where Congress has failed to do so.

Furthermore, the fact that the IRS may recoup more than it would have if it had foreclosed while Lok still held the property does not affect our analysis. In Fidelity National Title Insurance Co. v. United States Department of the Treasury [90-2 USTC ¶50,402 ], 907 F.2d 868 (9th Cir. 1990), we permitted the IRS to recover a greater sum due to a foreclosure sale than it would have received if the property had still been held by the delinquent taxpayer. "It is true that the IRS was placed in a better position after the foreclosure sale than it was in prior to sale. However, no California court has said that equitable subrogation should apply solely because an existing lienholder is put in a better position." Id. at 871. Additionally, where the IRS receives a "bonus" because of a sale, if the extra proceeds are applied to reduce a legitimate tax lien, the IRS has not necessarily been unjustly enriched. Simon v. United States [85-1 USTC ¶9371 ], 756 F.2d 696, 699 (9th Cir. 1985).

IV

The Hans' more persuasive argument is that they are entitled to be equitably subrogated to World Savings's position as first-place lienholder because they paid and discharged World Savings's first trust deed. Under the doctrine of equitable subrogation, the Hans would stand in the shoes of World Savings and retain the same priority that World Savings had on its trust deed. If this argument prevails, and the property were now sold to satisfy the tax lien, the Hans would recover the $367,000 they paid to World Savings in escrow when they purchased the property.

Equitable subrogation is appropriate where:

"(1) Payment [was] made by the subrogee to protect his own interest. (2) The subrogee [has] not ... acted as a volunteer. (3) The debt paid [was] one for which the subrogee was not primarily liable. (4) The entire debt [has] been paid. (5) Subrogation [would] not work any injustice to the rights of others."

Caito v. United California Bank, 20 Cal. 3d 694, 704, 576 P.2d 466, 471, 144 Cal. Rptr. 751, 756 (1978) (quoting Grant v. de Otte, 122 Cal. App. 2d 724, 728, 265 P.2d 952 (1954)). Equitable subrogation is a broad equitable remedy, not limited to circumstances where these five factors are met, but is appropriate whenever "one person, not acting as a mere volunteer or intruder, pays a debt for which another is primarily liable, and which in equity and good conscience should have been discharged by the latter." Id. at 704, 576 P.2d at 471, 144 Cal. Rptr. at 756 (internal quotations omitted). The California courts have applied this doctrine liberally.

The doctrine of [equitable] subrogation is not a fixed and inflexible rule of law or of equity. It is not static, but is sufficiently elastic to take within its remedy cases of first instance which fairly fall within it. Equity first applied the doctrine strictly and sparingly. It was later liberalized, and its development has been the natural consequence of a call for the application of justice and equity to particular situations. Since the doctrine was first ingrafted on equity jurisprudence, it has been steadily expanding and growing in importance and extent, and is ... now broad and expansive and has a very liberal application.

In re Estate of Johnson, 240 Cal. App. 2d 742, 744-45, 50 Cal. Rptr. 147, 149 (1966) (internal quotation omitted).

Although the district court explicitly found the other elements of equitable subrogation satisfied, it denied relief because it determined that the Hans had what the court initially characterized as "actual" knowledge of the lien. During a subsequent hearing, the district court retreated from its finding of actual knowledge, holding instead that the Hans had no actual knowledge of the lien before the sale. Nevertheless, the district court "deemed" Shin's actual knowledge to be the Hans' knowledge. Thus, the court imputed Kay Shin's actual knowledge to the Hans, and found they were ineligible for equitable relief because of that knowledge. The court relied on Smith v. State Savings & Loan Association, 175 Cal. App. 3d 1092, 1098, 223 Cal. Rptr. 298, 301 (1985), which holds that equitable subrogation is denied to a party who has "actual" knowledge of an existing encumbrance.

Although the district court was correct in citing Smith, we conclude it erred in determining that Shin's knowledge of the lien barred equitable subrogation. By statute, knowledge that is imputed by action of law is constructive knowledge, not actual knowledge. Cal. Civ. Code §18 (West 1982). Under Smith, constructive knowledge does not bar equitable relief. "[T]he fact the junior encumbrance was recorded will not by itself bar equitable subrogation." Smith, 175 Cal. App. 3d at 1098, 223 Cal. Rptr. at 301. It is well settled that recording gives only constructive notice, not actual notice. Since the Hans had only constructive knowledge, the court erred in denying equitable relief on this basis.

Although the district court erred in imputing Shin's knowledge to the Hans, we agree with its conclusion that equitable subrogation is otherwise appropriate. The closest issue is whether the first two factors are satisfied: that the Hans were protecting their own interest, and that they were not "volunteers" or "intermeddlers." See Johnson, 240 Cal. App. 2d at 745, 50 Cal. Rptr. at 149. Having decided to purchase the property without knowledge of the IRS lien, the Hans paid off World Savings's trust deed to establish and to protect their own interest, rather than simply to meddle officiously in World Savings's relations with Lok. ²

The other three factors also favor the Hans. The Hans were not primarily liable on the debt; Lok incurred the debt when he purchased the property. See Grant, 122 Cal. App. 2d at 729, 265 P.2d at 955 (1954) (equitable subrogation proper where a party pays a debt which he was under no obligation to pay). The entire debt was paid. See Caito, 20 Cal. 3d at 704, 576 P.2d at 471, 144 Cal. Rptr. at 756 (listing five elements of equitable subrogation). The IRS will not suffer any injustice as a result of equitable subrogation, see id., 576 P.2d at 471, 144 Cal. Rptr. at 756, since it will recoup as much as if Lok had still owned the property. ³ Furthermore, the Hans are innocent parties: it is undisputed that they had no actual knowledge of the tax lien, and no claim is made that they were delinquent in failing to discover the lien. They obtained title insurance, and they relied on their real estate agent to keep them informed, as would any home buyer.

Accordingly, we reverse the grant of summary judgment in favor of the IRS. We hold that the Hans are equitably subrogated to all liens and encumbrances recorded prior to the July 15, 1987 tax lien in question that were paid from the proceeds of the sale to the Hans. We remand to the district court for further proceedings consistent with this opinion.

REVERSED and REMANDED.

¹ The Hans also argue for the first time on appeal that they will be denied due process if the IRS is allowed to recover more than the previous owner's interest. As this argument was not before the district court and is raised here only briefly, with no citation and little argument, we decline to reach its merits. See United States v. Verdugo-Urquidez, No. 88-5462, slip op. 9063, 9074 n.2 (9th Cir. July 22, 1991 ).

² In Simon and Fidelity National, we indicated that new purchasers of property were "volunteers" for purposes of equitable subrogation under California law. See Fidelity National [90-2 USTC ¶50,402 ], 907 F.2d at 870-71; Simon [85-1 USTC ¶9371 ], 756 F.2d at 699. However, in both of those cases the purchases were made at forced sales and the purchasers were not paying off existing debts, but simply extinguishing all liens by obtaining the property at any price. As we stressed in Fidelity National, "[w]hat is important is that [the purchasers] knew that the forced sale of the property would extinguish any lien regardless of how much they paid as a purchase price. Therefore, neither [of the purchasers] paid money in order to satisfy the debt of another." [90-2 USTC ¶50,402 ], 907 F.2d at 870; see also id. ("The critical factor in this transaction is that [the purchaser] purchased the land at a foreclosure sale."). In contrast, the Hans were well aware that the Home Savings lien needed to be paid off from the purchase price, and would not be extinguished automatically by virtue of a sale. It was simply not the case that "[i]t did not matter to [the Hans] how the trustee subsequently distributed the purchase price since [the Hans] expected to have a clean title to the property regardless of the trustee's actions." Id.

³ 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 Hans to pay a portion of Lok's delinquent taxes. The IRS's claim that equitable subrogation would make it the victim of "injustice" is thoroughly unconvincing.

 

 

[91-1 USTC ¶50,170] Rob ert E. Weiss, Inc., Plaintiff v. United States , et al., Defendants

U.S. District Court, No. Dist. Calif. , C 89-20691 JW, 3/12/91

[Code Sec. 6323 ]

Validity of lien: Subrogation: Tax liens under state law.--Under state (California) law, a lender became equitably subrogated to the priority rights of the initial lender for the amount of its payment when it paid off the senior indebtedness on the property and concurrently secured a new loan by recording a new first deed of trust on the property in its favor. Therefore, the lender's lien had priority over the federal tax lien in the amount of the principal sum it paid the initial lender to retire the senior loan, plus any interest that accrued before the IRS recorded its tax lien. The IRS's tax lien was recorded after the initial lender's first deed of trust but before the new lender's new first deed of trust.

ORDER GRANTING SUMMARY JUDGMENT

WARE, District Judge:

Defendant United States through the Department of Treasury, Internal Revenue Service (IRS) moves for summary judgment in this interpleader action on the ground that the IRS has a right to the interpled funds superior to codefendant ITT Consumer Financial Corporation (ITT).

FACTS

The funds at issue are proceeds from a trustee's sale of real property located at 6564 Pemba Drive , San Jose . Ms. Fong Yu Wang acquired title to the Pemba Drive property by Individual Grant Deed recorded with the Santa Clara County Recorder's Office on October 15, 1982 . Wang acquired the property subject to a deed of trust in favor of Arden Mortgage Service Corporation. This deed was recorded on March 31, 1979 . Wang obtained a loan from Home Federal Savings & Loan Association and provided the association with a deed of trust on the Pemba Drive property. The deed was recorded on July 26, 1984 . On September 16, 1985 , the IRS recorded a Notice of Federal Tax Lien with the Santa Clara County Recorder's Office. The IRS states that the current balance of the tax assessments is $127,676.30. On January 3, 1986 , Wang obtained a $36,767.26 loan from defendant ITT. On the same date, ITT paid Home Federal $23,317.74 to retire Wang's loan with that institution. To secure the loan, Wang provided ITT with a deed of trust on the Pemba Drive property. This deed was recorded on January 6, 1986 .

On February 14, 1989 , the Pemba Drive property was sold pursuant to a power of sale contained in the Arden Mortgage trust deed. Plaintiff Rob ert Weiss, Inc. holds proceeds from the sale.

ANALYSIS

1. Legal Standard

Summary judgment is appropriate when there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). The court must view inferences based on underlying facts in the light most favorable to the non-moving party. Matsushita Elec. Industrial Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) (citing United States v. Diebold, Inc., 369 U.S. 654, 655 (1962)).

2. Merits

The IRS contends that its tax lien was properly recorded prior to ITT's loan to Wang and prior to the recording of ITT's trust deed. Therefore, the IRS concludes that its lien has priority over ITT to the interpled funds. ITT contends that it is entitled to equitable subrogation of the IRS tax lien.

Priority of a federal tax lien is determined on a "first in time, first in right" basis. United States v. New Britain [54-1 USTC ¶9191 ], 347 U.S. 81, 85 (1954). Federal law, however, recognizes state law subrogation rights. 26 U.S.C. §6323(i)(2) ; Fidelity National Title Ins. Co. v. United States [90-2 USTC ¶50,402 ], 907 F.2d 868, 870 (9th Cir. 1990). Under California law, the doctrine of equitable subrogation applies when five criteria are met: (1) the claimant must pay the debt owed to the lienholder in order to protect the claimant's own interest; (2) the claimant must not act as a volunteer; (3) the claimant must not be primarily liable for the debt paid; (4) the claimant must pay the entire debt owed the lienholder; and (5) subrogation must not work an injustice to others' rights. Caito v. United California Bank, 20 Cal.3d 694, 704, 576 P.2d 466, 144 Cal.Rptr. 751 (1978); Fidelity [90-2 USTC ¶50,402 ], 907 F.2d at 870. Where a lender pays off a senior encumbrance in order to secure a new loan with a first trust deed, the lender has sufficient interest to entitle it to subrogation to the rights of the senior encumbrance. Smith v. State Savings & Loan Assn., 175 Cal.App.3d 1092, 1099, 223 Cal.Rptr. 298 (1985).

Here, the IRS lien was recorded on September 16, 1985. Home Federal's deed was recorded on July 26, 1984. ITT's deed was recorded on January 3, 1986. Because the IRS lien was recorded before ITT's deed, the IRS lien has priority unless ITT is entitled to equitable subrogation. See Fidelity [90-2 USTC ¶50,402 ], 907 F.2d at 869-70.

With respect to equitable subrogation, the only issue here is whether ITT paid Wang's debt to Home Federal in order to protect ITT's own interest. On January 3, 1986 , ITT granted a $36,767.26 loan to Wang and on the same day paid Home Federal $23,317.74 from the loan proceeds. ITT stated that the primary purpose of its payment to Home Federal was to obtain a first lien position to protect its note, and that another purpose was to pay off and retire Wang's loan. ITT further stated that prior to the January 3, 1986 trust deed, it did not have any right, title or interest in the Pemba Drive property.

The Court finds that upon paying Home Federal $23,317.74 and concurrently recording the deed or trust in favor of ITT, ITT became equitably subrogated to the priority rights of Home Federal Savings and Loan Association to the amount of its payment. See Smith, 175 Cal.App.3d at 1095.

Therefore, consistent with the requirement that equitable subrogation not work an injustice to the rights of others, see Caito, 20 Cal.3d at 704, ITT is entitled to the principal sum it paid to Home Federal plus any interest that accrued before the IRS recorded its tax lien on September 16, 1985. Accordingly, the IRS's motion for summary judgment is granted except to the extent that ITT paid Home Federal to retire Wang's loan and the interest that accrued on that loan before the IRS recorded its lien.

The stakeholder's motion for attorney's fees is granted. The stakeholder is entitled to $3,306.25 attorney's fees to be awarded only from ITT's share of the interpled funds. See C.I.T. Corp. v. United States [72-2 USTC ¶9544], 344 F.Supp. 1272, 1277 (N.D.Cal. 1972).

The stakeholder's request for costs in the amount of $654.20 is denied. The stakeholder is not entitled to costs for those expenses attributed to transportation. Accordingly, the stakeholder is hereby awarded $146.20 costs from ITT's share of the interpled funds.

IT IS SO ORDERED.

JUDGMENT

Pursuant to the Court's order of this date granting summary judgment, judgment is hereby entered in favor of the Internal Revenue Service, except to the extent that ITT Consumer Financial Corporation paid Home Federal Savings & Loan Association to retire Ms. Fong Yu Wang's loan and the interest that accrued on Wang's loan before the IRS recorded its tax lien.

IT IS SO ORDERED.

 

 

[90-2 USTC ¶50,402] Fidelity National Title Insurance Company, Philip Ruiz, Plaintiffs-Appellants v. United States of America, Department of the Treasury, Internal Revenue Service, Defendants-Appellees

(CA-9), U.S. Court of Appeals, 9th Circuit, 89-55209, 7/2/90, 907 F2d 868, Affirming an unreported District Court decision

[Code Secs. 6323 and 7425 ]

Discharge of lien: Foreclosure sale: Notice to IRS: Subrogation.--An unknowing purchaser took property subject to an IRS lien because the lien had not been extinguished at an earlier foreclosure sale and because the purchaser could not establish that his seller was entitled to be subrogated to the IRS rights when he purchased the property at the foreclosure sale. The IRS lien survived the foreclosure sale because no notice had been given it of the sale. The purchaser at foreclosure, the seller here, was not entitled to take advantage of the doctrine of equitable subrogation because his payment for the property was for a foreclosure deed and not for the purpose of paying the IRS. The subsequent purchaser was entitled to no more interest than his seller had. The fact that the IRS advanced from being a subordinate lien holder to first lien holder was immaterial since it did not obtain its lien through false means.

Barry R. Laubscher, Mark A. Schadrack, Pettis, Tester, Druse & Krinsky, 1881 Von Karman Ave., Irvine, Calif. 92715. Jeffrey W. Dondanville, Rob ert S. Davis, Fidelity Natl. Title Ins. Co., Irvine , Calif. , for plaintiffs-appellants. Mason C. Lewis, Assistant United States Attorney, Los Angeles , Calif. 90012 , Gary R. Allen, David English Carmack, Doris D. Coles, Department of Justice, Washington , D.C. 20530 , for defendants-appellees.

Before BROWNING, NOONAN, JR. and FERNANDEZ, Circuit Judges.

OPINION

FERNANDEZ, Circuit Judge:

Fidelity National Title Insurance Company and Phillip Ruiz (collectively referred to as "Ruiz") appeal the district court's grant of summary judgment in favor of the United States Internal Revenue Service ("IRS"). The district court ruled that the IRS had a legitimate tax lien on Ruiz' property. The court further held that Ruiz could not establish any priority over the IRS' lien under a theory of equitable subrogation. We affirm.

BACKGROUND FACTS

The property at issue in this case is located in West Covina , California . In 1979, the property was owned by Patrick and Lorraine Reyes. When the Reyes purchased the property, they executed a deed of trust on the property in favor of Homestead Savings & Loan Association (" Homestead "). Subsequently, three other liens were recorded on the property. The first lienholder was Environmental Engineering Company ("Environmental"), the second lienholder was the State of California and the final lienholder was the IRS. During 1986, the Reyes failed to make some loan payments to Homestead . In response, Homestead exercised its power of sale under the deed of trust. The trustee held a nonjudicial foreclosure sale on the property and neither it nor Homestead discovered the IRS lien prior to the sale. Therefore, the IRS was not given any notice of the foreclosure sale. At the sale, the property was purchased by Morton Dorman. The trustee conveyed the property to Dorman via a trustee's deed. The proceeds of the sale were used to satisfy the Reyes' debt to Homestead and also to satisfy Environmental's lien and the tax lien held by the State of California . After those encumbrances were satisfied, there remained $10,000. That was distributed to the Reyes. The IRS received nothing from the sale.

In 1987, Dorman sold the property to Ruiz. The IRS then notified Ruiz that the property was still encumbered by the IRS lien. The IRS informed Ruiz that it planned to sell the property to satisfy the lien. Ruiz filed suit to block the IRS.

JURISDICTION AND STANDARD OF REVIEW

This court has jurisdiction pursuant to 28 U.S.C. §1291 .

We review de novo a district court's grant of summary judgment. Kruso v. International Tel. & Tel. Corp., 872 F.2d 1416, 1421 (9th Cir. 1989).

DISCUSSION

The district court correctly ruled that Ruiz was not entitled to equitable subrogation. Ruiz attempts to invoke the doctrine of equitable subrogation in order to avoid the impact of an IRS lien on his property. ¹ The IRS lien was not extinguished at the earlier foreclosure sale because the IRS had not been given notice of the sale. See 26 U.S.C. §7425(b) (foreclosure sale extinguishes federal lien unless United States not given notice of sale). However, the Internal Revenue Code also provides that the federal government will recognize a person's state law subrogation rights. 26 U.S.C. §6323(i)(2) .

California recognizes the doctrine of equitable subrogation. Caito v. United California Bank, 20 Cal. 3d 694, 576 P.2d 466, 144 Cal. Rptr. 751 (1978). California applies equitable subrogation when five criteria are met. First, the claimant must have paid the debt owed to the lienholder in order to protect the claimant's own interest. Second, the claimant must not have acted as a volunteer. Third, the claimant could not have been primarily liable for the debt he paid. Fourth, the claimant must have paid the entire debt owed to the lienholder. And, fifth, the subrogation must not work an injustice to the rights of others. 20 Cal. 3d at 704.

In this case, Dorman cannot show that he was protecting his own interest in the property when he paid the purchase price. Dorman also cannot show that he was acting as anything but a volunteer when he purchased the property. The critical factor in this transaction is that Dorman purchased the land at a foreclosure sale. Dorman expected that the trustee would provide him title to the land and that title would be free and clear of any claims of Homestead or any lienholder junior to Homestead. See generally 3 B.E. Witkin, Summary of California Law 648-49 (9th ed. 1987). Dorman had only to pay the trustee an appropriate purchase price. It did not matter to Dorman how the trustee subsequently distributed the purchase price since Dorman expected to have a clean title to the property regardless of the trustee's actions.

Dorman was in a position similar to that of the purchasers in Simon v. United States [85-1 USTC ¶9371 ], 756 F.2d 696 (9th Cir. 1985). There, the purchasers bought some property at a county tax sale. The property had an IRS tax lien on it. The lien had not been extinguished by the county's sale because the county had failed to notify the IRS of the sale. The Simons argued that they were entitled to be equitably subrogated to the rights of the government. However, the court rejected their argument because it found that when the Simons purchased the property, they were not acting to protect an existing interest, nor did they believe that they were paying the debt of another. 756 F.2d at 699. Furthermore, since the Simons were merely purchasing the property, the court held that they were volunteers. Id. Finally, the purchase price paid by the Simons did not satisfy all of the IRS lien. Therefore, the Simons had not paid off the entire debt of the lienholder to whom they wished to be subrogated. Id.

In principle, Dorman is no different from the Simons. Dorman paid money to the trustee in order to purchase some property. Dorman can be said to have paid the debts of another only to the extent that Dorman certainly knew that his payment to the trustee would be used to satisfy a debt owed to Homestead and any other junior lienholders. However, the Simons also certainly knew that their purchase money would go to satisfy various government taxes. What is important is that both the Simons and Dorman knew that the forced sale of the property would extinguish any liens regardless of how much they paid as a purchase price. Therefore, neither the Simons nor Dorman paid money in order to satisfy the debt of another. They paid money solely as volunteer purchasers of property. See also Little v. United States [83-1 USTC ¶9367 ], 709 F.2d 517 (9th Cir. 1983) (court reached similar result although it relied on state statutes since repealed). ²

This is not a case where a current owner pays a debt owed to a senior lienholder in order to protect the owner's interest in the property. See First Amer. Title Ins. Co. v. United States [88-2 USTC ¶9408 ], 848 F.2d 969, 972 (9th Cir. 1988); Darrough v. Herbert Kraft Co. Bank, 125 Cal. 272 (1899). If Dorman had been the owner of the property and had paid off the debt owed to Homestead , the courts generally would have allowed Dorman to maintain the same rights as those held by the lienor, Homestead . First Amer. Title Ins. Co., 848 F.2d at 973-74; Darrough, 125 Cal. at 274-75.

However, the right granted to owners who pay off debts is not a right also granted to purchasers in Dorman's position. Dorman cannot benefit from any of the rights once held by Homestead or the other lienholders senior to the IRS. Therefore, Dorman's rights in the property were subject to the valid IRS lien. The most that Dorman could transfer to Ruiz was the same property rights that Dorman had purchased at the foreclosure sale. Therefore, Ruiz is no more entitled to equitable subrogation than was Dorman. Ruiz has the right to the property subject to the IRS lien.

It is true that the IRS was placed in a better position after the foreclosure sale than it was in prior to the sale. However, no California court has said that equitable subrogation should apply solely because an existing lienholder is put in a better position. Furthermore, the IRS did not obtain its lien through false means. It duly assessed taxes against the Reyes and properly recorded its lien. Any potential purchaser would have been on notice regarding the IRS lien if that purchaser had performed a careful title search. The doctrine of equitable subrogation requires a person to show something more than the fact that a junior lienholder will be put in a better position than the lienholder would be in if equitable subrogation applied. Since Dorman was a volunteer purchaser and he did not pay money at the foreclosure sale in order to protect his own interest in the property, neither Dorman nor Ruiz is entitled to equitable subrogation merely because the IRS might now recover more on its tax lien than it could have had it been a party to the foreclosure sale.

CONCLUSION

The district court's judgment in favor of the Internal Revenue Service is AFFIRMED.

¹ Ruiz claims that Dorman was entitled to equitable subrogation. Ruiz then argues that he is entitled to Dorman's right of equitable subrogation because Ruiz purchased all of Dorman's rights in the property. We focus our analysis on the threshold issue -- Dorman's right to equitable subrogation.

² The only case that Ruiz cites that truly supports his position is a case from Florida . Trueman Fertilizer Co. v. Lester, 155 Fla. 338, 20 So. 2d 349 (1944). Clearly, Florida case law does not bind the California courts. Furthermore, the Trueman court did not provide any analysis for its position and it is unclear whether Florida uses a test for equitable subrogation that is in any way similar to California 's test. It would be unwise for us to adopt Florida 's approach in light of both California and Ninth Circuit case law.

 

 

[80-2 USTC ¶9790]In the Matter of Earl R. Meyers and Karin E. Meyers, Bankrupts. Internal Revenue Service, Defendant-Appellant v. Earl R. Meyers and Karin E. Meyers, Plaintiffs-Appellees

U. S. District Court, East. Dist. Calif. , No. CV F 80-165-EDP, 7 BR 503, 10/20/80

[Code Sec. 6323]

Unpaid taxes: Collection of: Bankrupt taxpayers: Priority of Claims: Subrogation of claims of unsecured creditors: Exempt property.--The District Court reversed an order issued from the Bankruptcy Court subrogating the bankrupt's priority claim of the government to those of other creditors. The taxpayers contended that because they had paid a portion of ther unpaid taxes with property that was exempt from the jurisdiction and control of the bankruptcy court, the general creditors in bankruptcy would receive a windfall unless they were entitled to subrogation. The court, however, rejected this contention, and held that while this was true, it was the result of the taxpayers' own mismanagement of funds and did not entitle them to equitable subrogation.

Herman Sillas, United States Attorney, Fresno, Calif. 93721, Rob ert L. Baker, Department of Justice, Washington, D. C. 20530, for defendant-appellant. W. A. McGugin, McGugin & Ryder, 1012 Security Bank Bldg., Fresno, Calif. 93721, Frank H. Lang, Jr. Fullerton, Lang, Richert and Patch, 2030 Fresno St., Fresno, Calif. 93721, for plaintiffs-appellees.

Memorandum Decision

PRICE, District Judge:

At the time of filing their petition in bankruptcy on February 15, 1979 , Earl R. Meyers and Karin E. Meyers (hereinafter referred to as Petitioners) were substantially indebted to the United States for past due and unpaid taxes of various types.

Claims were filed covering this tax liability both by the United States and petitioners pursuant to Rule 303 of the then applicable Bankruptcy Rules.

In issue here are two different tax claims:

The claim of the United States for income taxes due for the calendar year 1977, including penalties, in the amount of $7,287.36. These taxes, the parties concede, would have been entitled to priority over general unsecured creditors in the bankruptcy proceedings. For reasons that do not appear too clear from the record on appeal, Petitioners paid these taxes with property that would have otherwise been exempt from the jurisdiction and control of the bankruptcy court and its trustee.

In addition, Petitioners owe the United States F. I. C. A. and F. U. T. A. taxes totaling, with accrued interest, $3,653.88. These taxes the parties concede have not been paid, and that further, they too are entitled to priority over the general unsecured creditors.

On December 7, 1979 , the bankruptcy court made and entered its order in this matter, in pertinent part, as follows:

"IT IS HEREBY ORDERED, ADJUDGED AND DECREED THAT said bankrupts be, and they hereby are, subrogated with the priority claim of the UNITED STATES OF AMERICA and the INTERNAL REVENUE SERVICE OF THE UNITED STATES OF AMERICA for and on account of the claim filed by said respondent for income tax for the period ending December 31, 1977 in the amount of $7,287.36, and for the amount of $7,244.00 for income tax for the tax period ending December 31, 1978.

"IT IS FURTHER ORDERED THAT said bankrupts be paid any dividend due said INTERNAL REVENUE SERVICE for said two periods for and on account of such income taxes owed for said period and that the Trustee in bankruptcy in the above-entitled proceedings pay, turn over and deliver to said two bankrupts the dividends entitled to the said INTERNAL REVENUE SERVICE for income taxes for the tax period ending December 31, 1977 in an amount not to exceed $7,287.32, and to pay said bankrupts any taxes due the INTERNAL REVENUE SERVICE for the tax period ending December 31, 1978 for income taxes for the said period in an amount not to exceed $7,244.00; that such payments be made with the same priority to which the INTERNAL REVENUE SERVICE was entitled for such payments."

Petitioners founded their right and title to this order under the general equitable rules of subrogation. ¹

The United States now appeals from that order, contending that the order subrogating the bankrupts to the United States priority tax claim was in error. By way of explanation, the sum involved was the petitioner's payment for income taxes for the calendar year 1977 which the petitioners paid with exempt property.

The government argued successively:

(1) Subrogation is not allowed until the creditor to whose claim the subrogee seeks to be subrogated is paid in full.

(2) Debtors, as the primary obligors on the 1977 taxes, cannot be subrogated to the United States claim for those taxes.

(3) Denial of subrogation to the United States government's priority tax claim is consistent with the new bankruptcy code which went into effect October 1, 1979 .

Petitioner's reply to the government consists of the following citations:

(1) Section 57(n) of the Bankruptcy Act of 1938;

(2) Rule 302(e), former Rules of Bankruptcy Procedure;

(3) Rule 303, Rules of Bankruptcy Procedure.

"The right of subrogation is a creature of equity, applicable where one person is required to pay a debt for which another is primarily responsible, and which the latter should in equity discharge. In theory one person is substituted to the claim of another, but only when the equities as between the parties preponderate in favor of the plaintiff." American Surety Co. v. Bank of California , 160 F. 2d 160, 162 (19th Cir. 1943).

The principles embodied in the equitable doctrine of subrogation well illustrate the dilemma which the court faces in considering this opinion. Simply stated, that dilemma is as follows:

The government could have, employing the various remedies available to it to collect taxes due to the United States , satisfied its claim for the 1977 taxes without any voluntary payment or other cooperation on the part of the Petitioners. The property used by the Petitioners to pay these taxes, though exempt pursuant to the bankruptcy laws from the claims of general creditors, was not so exempt from execution or levy for satisfaction of taxes. ²

Petitioners, on the other hand, argue that by their payment of these taxes with exempt property, the general creditors in bankruptcy will realize a windfall that they would not have realized but for the petitioner's voluntary payment of these taxes out of exempt funds.

Both statements are manifestly true, at least in substantial part.

The government cites as statutory authority for its position 31 U. S. C. §191 and 31 U. S. C. §193. It further cites as case authority two cases which construed the latter section, namely, United States v. National Surety Co., 254 U. S. 73, 65 L. Ed. 143, 41 S. Ct. 29 (1920), and In re William J. Newman Co., 101 F. 2d 661 (7th Cir. 1938). Both of these cases dealt with the relationship between the government and the surety company wherein the surety company had discharged its obligation upon the part of its principal debtor. In each instance, the surety was seeking to be subrogated to a priority position of the government which, in effect, would enable the surety to share equally in the limited assets available to pay other obligations owed to the government. In each instance the court provided that 31 U. S. C. §191, as it then read, precluded such a result. In addition to such authority it should be noted that 31 U. S. C. 191, effective October 1, 1979, to provide the "priority established under this section does not apply, however, in a case under Title 11 of the United States Code." ³

The case of A. Gusmer, Inc. v. McGrath [52-1 USTC ¶9297], 196 F. 2d 860 (D. C. Cir. 1952), in the court's opinion, states the real basis why the bankruptcy judge erred in this case.

That case presents the following facts: In 1933 the plaintiff entered into an arrangement with an alien German corporation for the right to use a secret process and trademark. For this right, plaintiff paid $3,000 outright to the German corporation, and further agreed to pay sales license fees calculated on gross sales. From 1933 to 1941 it paid sales license fees, but failed to withhold any part thereof for income tax purposes as required by the applicable statutes of the United States . Remittances to the alien corporation were discontinued in 1941 pursuant to the outbreak of hostilities in World War II with the German nation. These unremitted fees accrued to the alien's credit in the hands of the plaintiff. In May of 1946, the alien property custodian was vested with the German corporation's interest, and the accrued fees owed to the German corporation were paid over by the plaintiff to the Alien Property Custodian. At the time of the delivery of these funds plaintiff withheld and shortly thereafter paid to the United States all income taxes due on these accrued fees, i. e., the amounts accrued between December, 1941 and May, 1946.

Thereafter, in 1947, the Commissioner of Internal Revenue determined that the plaintiff owed a substantial deficiency for income taxes for the years 1933 to 1941 on the fees it had remitted to the alien corporation during that period and which plaintiff had neglected to withhold or pay any income taxes thereon. The plaintiff paid these deficiencies claimed due by the Commissioner of Internal Revenue, and then filed its claim for the amounts so paid against the assets of the German corporation in the hands of the Alien Property Custodian. Upon having its claim rejected, plaintiff instituted this action in District Court.

Plaintiff contends that upon payment of the amount due the Commissioner of Internal Revenue, it became subrogated to the rights of the government as against the alien taxpayer on whose behalf the taxes were paid. The court rejected this contention and affirmed the judgment of the district court dismissing the action, stating:

"We do not reach the question whether the control which has been exercised by Congress over properties of enemy aliens, including the War Claims Act of 1948, infra, precludes subrogation, because in any event the right to subrogation is unavailable to the plaintiff in the circumstances of this case. Subrogation is governed by equitable principles as applied to the facts of each case. Gray v. Jacobsen, 1926, 56 App. DC 353, 13 F. 2d 959, 48 A. L. R. 583. See American Surety Co. v. Bethlehem Nat. Bank, 1941, 314 U. S. 314, at page 317, 62 S. Ct. 226, 86 L. Ed. 241. While the plaintiff paid taxes for which the alien as well as itself was liable, and while prior to the vesting the assets which plaintiff seeks to reach were owned by the alien, nevertheless it was plaintiff's own omission of a statutory duty to withhold the taxes from the funds in its hands which created the problem. To require that they bear also those due for the years 1933-1941 would result in their depletion because of plaintiff's omission."

There, as here, petitioner's dilemma of which they now complain is solely due to their own omission. While it is clearly true that because of peculiar facts in this case, the general creditors will receive a windfall, ⁴ such arises only because of the mismanagement of petitioner's own affairs. To state it slightly differently, plaintiff's hands are not sufficiently clean to entitle them to relief in equity.

Accordingly, the order subrogating bankrupt's priority claim of the Internal Revenue Service is reversed, and the Bankruptcy Court is ordered to make distribution of the estate in accordance with this decision.

¹ The extent to which Petitioners rely on the "equitable conscience" of the court is demonstrated by the fact that Petitioners did not cite a single authority in their brief on appeal.

² There was a suggestion by counsel for the government during oral argument that they were using this case as a vehicle to obtain a judicial determination that the principles of subrogation are never applicable to the law. For reasons stated in the body of this decision, we do not reach that position.

³ Title 11, of course, contains the Bankruptcy Code.

⁴ It should be noted that the Court of Appeals in A. Gusmer, Inc. supra, also was faced with a "windfall" argument advanced by plaintiff. They disposed of it with the following language:

"Allowance of plaintiff's claim would diminish pro tanto the properties available for those purposes. In all these circumstances the dominant equities preclude a right of subrogation against these funds, even if the statute itself does not, as a substitute for plaintiff's failure to perform a statutory duty which if performed would have obviated its present claim." A. Gusmer, Inc. v. McGrath [52-1 USTC ¶9297], 196 F. 2d 860, 862-863.

 

 

[73-2 USTC ¶9684]J. William Gallup, Plaintiff v. United States of America ¹, Defendant

U. S. District Court, Dist. Neb., Civil No. 73-0-187, 4/16/73

[Code Sec. 6323]

Tax liens: Priority: Automobile: Purchaser of: Subrogation.--A tax lien on a delinquent taxpayer's automobile had priority over the rights of the purchaser of the automobile. Although the purchaser did not actually know the lien had been filed at the time the purchase was consummated, he knew of the lien's existence. However, he was entitled to recover a payment he made on the automobile, because, under state law, the payment subrogated him to the rights of the taxpayer.

J. William Gallup, 1100 Farm Credit Bldg., Omaha, Neb., Carl I. Klekers, Ralston Bank, Ralston, Neb., for plaintiff. William K. Schaphorst, United States Attorney, Raldall A. Rinquest, Assistant United States Attorney, Omaha, Neb., for defendant.

Memorandum Decision

DENNEY, District Judge:

This matter comes before the Court for decision following a hearing upon plaintiff's application that the Court enter a preliminary injunction, restraining the Internal Revenue Service (hereafter I. R. S.) from selling a certain 1973 Cadillac automobile. Jurisdiction has been established pursuant to 26 U. S. C. A. §7426 ². This opinion shall constitute the Court's findings of fact and conclusions of law, pursuant to Rule 52 of the Federal Rules of Civil Procedure.

[Facts]

Shortly before or on March 28, 1973 , Joseph Thomas, a/k/a Joe Patterson, was arrested during a drug raid by local authorities and incarcerated in the Douglas County Jail, Omaha , Nebraska . Unable to post the bail set in the case, Thomas has remained incarcerated since that date. Thomas has recently been before this Court for aiding and abetting the distribution of heroin. Plaintiff is a local attorney who represented Thomas in that case and is representing Thomas in similar other prosecutions. On March 28, 1973 , the Acting District I. R. S. Director, pursuant to the authority contained in 26 U. S. C. A. §6851, determined that there was a threat that Thomas would act to conceal or remove his property. The Director therefore terminated Thomas' 1973 taxable year and an immediate assessment of $21,540.75 was made against Thomas for the period January 1, 1973 to March 28, 1973, in accordance with 26 U. S. C. A. §6201.

On the night of March 28, 1973 , the I. R. S. served Thomas in jail with notice of the termination, told Thomas that the amount of $21,540.75 was immediately due and payable, and demanded payment. In addition, the I. R. S. agents advised Thomas that the assessment created a tax lien in favor of the Government and levy would be made upon all property of Thomas, real or personal, tangible or intangible, in order to satisfy the assessment. Plaintiff was present during the service of notice by the I. R. S.

Either on that date or the next day, plaintiff talked to Thomas about the actions of the I. R. S. and as to how Thomas would pay the legal fees owed the plaintiff. It was agreed that plaintiff would purchase an automobile in which Thomas had an equity. The agreement was that the plaintiff would pay off the outstanding loan on the automobile and take Thomas' equity for the legal fees owed. The automobile was a 1973 Cadillac Fleetwood and had been sold on November 1, 1972 , by West Omaha Auto Brokers, Inc., Omaha , Nebraska , to Milton Greenburg, Bernice Devers and Joseph Thomas. Milton Greenburg is one of the two owners of West Omaha Auto Brokers, Inc. He testified herein that his name appeared as a purchaser only because the finance company, Creditel Corporation, would not otherwise finance the $4,000 of the $10,920.24 purchase price remaining unpaid by Thomas because of the lack of a favorable credit standing by Thomas. ³

On November 7, 1972 , a certificate of title was issued by the State of Nebraska for the vehicle, in the name of Milton J. Greenburg. The title was thereafter held in the possession of Creditel Corporation. During the period from November 1, 1972 , when delivery was made by West Omaha Auto Brokers, Inc. to Bernice Devers and Joseph Thomas, to the date of Thomas' incarceration, the automobile was in the possession of Thomas. Milton Greenburg testified he has no interest in the automobile. Bernice Devers has not been made a party to this lawsuit.

On March 29, 1973, in accordance with the appropriate Nebraska statute, Neb. Rev. Stat. 52-1001(b) and federal statute, 26 U. S. C. A. §6323(f), the I. R. S. filed notice of a tax lien in the amount of $21,540.75 with the Register of Deeds of Douglas County, Omaha, Nebraska.

On March 30, 1973 , plaintiff, pursuant to the agreement with Thomas, went to Creditel Corporation and paid off the $2,700.00 remaining owed on the financing agreement and obtained possession of the title. Plaintiff took the title to Milton Greenburg, who endorsed it. Thereafter, plaintiff went to the Douglas County Court House where, upon the expenditure of some $300 for sales, property tax, and other fees, a Certificate of Title was issued in plaintiff's name.

On April 3, 1973 , without notice to or hearing for the plaintiff, I. R. S. agents went to plaintiff's residence while plaintiff was at work and towed the automobile away from plaintiff's driveway. The automobile has remained in the possession of the I. R. S. since that date. ⁴

Later that same day, plaintiff filed the complaint in this lawsuit. Upon the posting of a property bond of twice the value of the automobile, this Court entered a temporary restraining order in this case, restraining the I. R. S. from selling or disposing of the automobile pending the outcome of the hearing on the preliminary injunction.

[Priority]

A tax lien generally arises on the date of the assessment, 26 U. S. C. A. §6321, which herein would be March 28, 1973 . However, Congress has provided that for that lien to be valid against a purchaser of the property, notice of the tax lien must be filed in accordance with state law. ⁵ 26 U. S. C. A. §6323(a), (f). The filing of the notice of tax lien on March 29, 1973 , was the requisite filing under applicable Nebraska law. Neb. Rev. Stat. §52-1001(b). The interest of the I. R. S. was thus fully perfected and entitled to priority at least as of March 29, 1973 . ⁶

At the hearing, plaintiff testified that on March 30, 1973 , when he purchased the automobile, he was fully aware that the I. R. S. had terminated the tax year of Thomas and had made the $21,540.75 assessment. Plaintiff stated, however, he had no actual knowledge that notice of the tax lien had been filed and had labored under the impression that so long as the automobile's title was clear he could beat the I. R. S. to the property and prevail in Court under Nebraska law.

Plaintiff's reliance on state law was misplaced. Although state law controls whether the taxpayer has property to which a federal tax lien can attach, the priority of the federal tax lien is a matter of federal law. See, e.g. United States v. Overman [70-1 USTC ¶9342], 424 F.2d 1142 [9th Cir. 1970]. Plaintiff cannot be heard to contend that Thomas had no property interest in the automobile on March 29, 1973 , the date the tax lien was perfected, since it is that interest that plaintiff contends he purchased on March 30, 1973 . The tax lien is thus entitled to priority to that of plaintiff, unless plaintiff can come within the saving provision of 26 U. S. C. A. §6323(b)(2), which provides:

Even though notice of a lien imposed by section 6321 has been filed, such lien shall not be valid--

(2) Motor vehicles.--With respect to a motor vehicle (as defined in subsection (h)(3)), as against a purchaser of such motor vehicle, if--

(A) at the time of the purchase such purchaser did not have actual notice or knowledge of the existence of such lien, and

(B) before the purchaser obtains such notice or knowledge, he has acquired possession of such motor vehicle and has not thereafter relinquished possession of such motor vehicle to the seller or his agent.

As discussed above, on March 30, 1973 , plaintiff had no actual knowledge that notice of the tax lien had been filed. However, 26 U. S. C. A. §6323(b)(2) does not refer to actual knowledge of the filing of the notice of the tax lien, but requires instead that the purchaser be free of actual knowledge of the existence of the lien. Plaintiff was present when the I. R. S. told Thomas of the assessment and the existence of the lien and that levy would be made on all of Thomas' property. Plaintiff and Thomas later discussed the tax situation. Although plaintiff was successful in depriving himself of actual knowledge of the notice of the tax lien by not searching the records of the Register of Deeds prior to the purchase of the automobile, the Court finds that he had actual notice of the existence of the tax lien itself. Plaintiff is not entitled to the protection of 26 U. S. C. A. §6323(b)(2).

[Subrogation]

Without more, the interest of plaintiff in the automobile would be entirely junior to that of the Government and, since the tax assessment far exceeds the value of the vehicle, plaintiff would have little hope of recovering the $2700 he paid, let alone his legal fees.

However, 26 U. S. C. A. §6323(i)(2) also provides that:

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.

Nebraska has recognized the established doctrine that where a purchaser, as part of the purchase price of property, discharges a specific encumbrance on that property upon failure of title in the purchaser, the purchaser is subrogated to and equitably entitled to the amount of the encumbrance he has discharged. Betts v. Sims, 35 Neb. 840, 53 N. W. 1005 [1892]. The encumbrance that plaintiff discharged was that owing Creditel Corporation in the amount of $2700.00. As to the $2700.00, plaintiff will prevail over the Government. ⁷

An order pursuant to this memorandum will be entered this date.

¹ This action was originally filed by naming as defendants Richard Vinal and Lowell Harris, agents of the I. R. S. The Court has substituted the United States of America as the defendant, pursuant to 26 U. S. C. A. §7426(e).

² Plaintiff's complaint fails to allege any jurisdictional basis for this suit. The Court will grant plaintiff leave to amend his complaint to allege jurisdiction as found by the Court.

³ The installment sales contract that was the basis of the financing arrangement provided for 12 payments of $360.02 each, commencing December 1, 1972 , and continuing until paid. The annual percentage rate of interest was 14.46%. Thomas paid $1500 in cash and was credited with $5100 for a 1971 Cadillac trade-in towards the purchase price.

⁴ Plaintiff, in his complaint, alleged that he was deprived of possession of the vehicle without due process of law. Plaintiff originally sought as relief in this suit that he be restored to possession. However, plaintiff interlineated his complaint and seeks now only that the I. R. S. be enjoined from selling the automobile. The Court has the power to grant the relief sought pursuant to 26 U. S. C. A. §7426, and thus does not need to reach the troublesome constitutional question presented. However, it should be noted that the Court is greatly disturbed by the summary procedures used by the I. R. S. to obtain possession of the vehicle. Whatever justification remains for these procedures, in view of Fuentes v. Shevin, 407 U. S. 67 [1972], is seriously diluted where the property is no longer in the custody or control of the taxpayer but has passed under color of title to a solvent third party. Surely, the Phillips v. Commissioner [2 USTC ¶743], 283 U. S. 589 [1927], essential needs of the Government in collection of its revenues, can be secured without total disregard of the fundamental rights of the third party possessor of property to have notice and an opportunity to be heard before he is deprived of that possession.

⁵ Defendant contends that plaintiff may not take advantage of 26 U. S. C. A. §6323 because he is not a purchaser within the meaning of 26 U. S. C. A. §6323(h)(6), since he paid only $2700 for an automobile worth at least $8500. 26 U. S. C. A. §6323(h)(6) defines a purchaser as one who for adequate and full consideration acquires an interest in property which would be valid under local law. Nebraska has enacted the Uniform Commercial Code, which abrogates the common law rule that any antecedent debt will not provide present consideration. 6 Neb. Rev. Stat. §1-201(44). Defendant has not contested that the value of plaintiffs' legal services was at least the difference between the $2700 and the market value of the automobile.

⁶ The Court is not required to reach whether or not the priority of the tax lien upon filing of notice relates back to the March 27, 1973 , date of the assessment to cut off intervening purchasers, since plaintiff did not purchase until March 30, 1973 , and was subsequent in time.

⁷ The Government has not contested the priority of the security interest of Creditel Corporation. Security interests in automobiles are treated separately and distinctly from all other security interests under Nebraska law. It could be argued that under Nebraska state law Creditel Corporation might not prevail over a subsequent purchaser or lien holder. See First Nat. Bank of Omaha v. Provident Finance Co., 176 Neb. 45, 125 N. W. 2d 78 [1963]. It does not, however, appear settled whether a tax lien would similarly fare. The Court is of the opinion that the Government cannot claim the benefits of Neb. Rev. Stat. §60-110, Cum. Supp. 1972, without the burden of conceding that its lien was also not noted on the vehicle's title as required by the statute, which would make both Creditel's and the Government's interests unperfected and Creditel would prevail as first in time. Moreover, the subrogation doctrine applied herein is of an equitable nature and the Court is of the opinion that the equities in this case dictate its application. Plaintiff still loses all his legal fees and the $300 he expended in licensing and titling the vehicle.

 

 

[63-2 USTC ¶9619]Anna Smith, Plaintiff v. Alfred John Smith, etc., et al., Defendants

Superior Court N. J., Chancery Div., Hudson County , Docket No. C-409-61, 1/14/63

[1954 Code Sec. 6323]

Liens: Determination of priorities: Divorce proceedings: Wife's right to subrogation for mortgage and tax payments: When judgment lien perfected: Priority of lien for counsel fees.--A wife, a party to divorce proceedings, who has made mortgage and tax payments, prior to the date of entry of a final decree of divorce, with respect to property originally held by her and her husband as tenants by the entirety, is entitled to a right of subrogation for one-half such payments, which has priority over a lien on the same property for income taxes owing by her husband. However, payments made by the wife, under the same circumstances, for necessary repairs to the property involved stand on a different footing, and, as to such payments, the wife's claim is subordinate to the government's lien. The government's lien was also superior to a lien claimed under an assigned judgment, as, in such case, the judgment lien is not perfected until the levy of execution on specific property. A claim for counsel fees, however, if allowed, is prior to a federal tax lien with respect to a fund in court (as here, resulting from the partition of the property involved), where, as in this instance, the legal proceeding will not solely benefit the interest of the plaintiff.

Sol. D. Kapelsohn, Kapelsohn, Lerner, Leuchter & Reitman, 24 Commerce St., Newark, N. J., for plaintiff. David M. Satz, Jr., United States Attorney, Post Office Bldg., Rob ert D. Carroll, Assistant United States Attorney, 744 Broad St. , Newark , N. J., for defendants.

Opinion

PASHMAN, Superior Court Judge:

This was a suit by plaintiff, Anna Smith, to quiet title to certain premises and for a partition thereof. A consent judgment for sale was entered on June 28, 1962 , the sale was held on August 9, 1962 , and an order confirming sale was entered on August 28, 1962 . The sale price was $4,000; after deduction of commissions and fees, a total of $3,675.53 was deposited with the court subject to a determination as to the relative priorities among various claimants against that portion of the proceeds (50% or $1,837.77) which represents the share of defendant, Alfred Smith.

The claims against these proceeds are as follows: (1) the law firm of Kapelsohn, Lerner, Leuchter & Reitman, one-half of the total counsel fee allowed, if any, for the conduct of the litigation, (2) Abraham Kapelsohn, as assignee of a judgment against Alfred Smith, docketed on October 4, 1955--this judgment in the amount of $602.40 with interest computed at 6% from October 4, 1955 to October 4, 1962, totals $855.41, (3) plaintiff Anna Smith for $805.23, one-half of the monies paid by her to the Howard Savings Institution as adjudicated by the entry of a divorce judgment nisi entered in her favor on January 13, 1961, (4) plaintiff Anna Smith for $162.69, one-half of monies paid by her to the Howard Savings Institution subsequent to the judgment nisi (before final judgment) which paid off the balance of a mortgage against the premises. (I should note there is a dispute about this sum based upon a contention by the United States of America , that only those payments totaling $100.19 made by plaintiff subsequent to the entry of a final judgment of divorce should be considered; one-half of this is $50.60. The United States concedes that this latter amount is a prior lien.) (5) plaintiff Anna Smith for $122.75, one-half of the amount paid by her to the City of Jersey City for real estate taxes after the mortgage was paid, (6) plaintiff Anna Smith for $265.00, one-half of the monies paid by her for necessary repairs to the premises since the date of her defendant husband's desertion as adjudicated by the judgment nisi, and (7) the United States of America for federal tax liens upon the premises which were assessed against defendant Alfred Smith and recorded in the Office of the County Clerk of Hudson. This last item consists of three liens: the first entered on March 18, 1958 in the sum of $1,127.10; the second entered on June 3, 1958 in the sum of $875.78; and the third entered on November 24, 1959 in the sum of $894.45 which, concededly, includes the second lien of $875.78. The total which the United States claims as a lien against the proceeds, subject only to the $50.60 figure under item 4 above, is $2,021.55.

The facts have been stipulated. The sole questions remaining are the priorities to be accorded the seven items hereinbefore mentioned.

On January 13, 1962 and April 14, 1962 , a judgment nisi and final judgment, respectively, were entered in plaintiff's favor in a divorce proceeding instituted by said plaintiff against defendant Alfred Smith on the ground of desertion. Incident to a determination of priorities, is the resolution of the question of the point of time at which plaintiff and defendant Alfred Smith, owners of the premises as tenants by the entirety, became owners as tenants in common.

In Eberle v. Somonek, 24 N. J. Super. 366 (Chan. Div. 1953) affirmed per curiam 27 N. J. Super. 279 (App. Div. 1953), the lower court said at page 374:

"So long as the marriage existed between defendant and his former wife, they continued to hold an estate by the entireties and such an estate is not subject to partition. . . . But a final decree of divorce dissolving the marriage between a man and his wife will . . . operate to convert an estate held by them as tenants by the entirety to a tenancy in common. Buttlar v. Buttlar, 67 N. J. Eq. 136 ( Ch. 1904); Baker v. Kennerup, 102 N. J. Eq. 367 ( Ch. 1928)." (Italics added)

In this case, the judgment nisi did not terminate the marriage since it is only a conditional judgment of divorce. Not until final judgment was entered on April 14, 1962 did the plaintiff and defendant Alfred Smith become tenants in common; prior to that time the marital status remained. See, e.g., Dacunzo v. Edgye, 33 N. J. Sup. 504 (App. Div. 1955), affirmed 19 N. J. 443, 449 (1955).

The government has conceded, under the authority of Weh v. Weh, 63 N. J. Super. 238 (Chan. Div. 1960), that the plaintiff is entitled to priority over the United States in the sum of $50.60 which represents one-half the amount paid by her to reduce and satisfy the mortgage indebtedness subsequent to April 14, 1962 (final judgment of divorce).

In Weh, Judge Mintz held that a divorced wife was entitled to subrogation for one-half of payments made on her account subsequent to the final divorce. No determination was made as to payments made by her prior to that time. The court did state that in determining whether the divorced wife was entitled to be subrogated to the lien of the prior mortgage, the criterion to be applied is what `will best serve the purposes of justice and the actual and just intention of the party.' Kinkead v. Ryan, 65 N. J. Eq. 726, 728 (E. & A. 1903.)" Weh v. Weh, supra at 244. Judge Mintz found that the obvious intent of the plaintiff in Weh was to obtain contribution and subrogation.

The first determination to be made is the priority between the Federal lien and the (a) mortgage payments ($805.23) made by plaintiff prior to entry of the final divorce judgment as adjudicated by the judgment nisi; (b) real property taxes ($122.75) paid by plaintiff subsequent to the satisfaction of the mortgage; and (c) payments made by plaintiff for maintenance and repairs ($265.00) as adjudicated by the judgment nisi. Plaintiff claims that a wife who discharges a mortgage lien and pays taxes on, and necessary repair costs for mutually owned property prior to a divorce, has a right of contribution from her husband although the parties are not living together. Her right to contribution is unquestioned. Ross v. Ross, 35 N. J. Super, 242 (Chan. Div. 1955). The question is whether she has priority over the United States ' lien from this "fund" in court.

Admittedly, plaintiff was personally obligated to make these mortgage payments, she being a principal obligor on the bond and mortgage. The competing rationales herein involved--the obligation of plaintiff to pay against the benefit bestowed on defendant Alfred Smith and plaintiff's equitable right to subrogation--call for the application of an equitable determination. Although the decision in Weh is, I repeat, of no independent significance because it made no holding as to pre-divorce payments of the mortgage indebtedness, the rationale of that case is peculiarly applicable to the case sub judice. Although plaintiff was obligated to make the mortgage payments, by doing so she preserved the property from loss, prevented foreclosure, and indeed, made possible this "fund" in court. Conceding the fact that plaintiff was preserving her own property as a tenant by the entirety, she in no sense can be presumed to have intended a gift to her husband in view of his desertion. Any love or marital affection which might, under different circumstances, support a presumption of gift by the wife to her husband, is completely negated by this fact. See Ross v. Ross, supra; Michalski v. Michalski, 20 N. J. Super. 258, 263 (Chan. Div. 1952); Van Inwegen v. Van Inwegen, 4 N. J. 46, 51, 52 (1950). It may be observed further that "the interest of a wife in an estate by entirety is here separate property which she may hold free of her husband's debts." Carlisle v. Parker, 38 Del. 83, 188 Atl. 67, 71 (Super. Ct. 1936). The inexorable conclusion to be drawn, as in Weh, is that plaintiff made these mortgage payments with the intention of obtaining contribution and subrogation. It would be inequitable to permit the plaintiff's mortgage payments to be subordinated to the government's personal tax lien against defendant under the circumstances heretofore presented. I conclude, therefore, that plaintiff is entitled to priority over the government to one-half of the monies paid to Howard Savings Institution as adjudicated by the judgment nisi.

The payment by plaintiff of one-half of the real estate taxes ($122.75) after the mortgage obligation was fulfilled is also entitled to priority over the Federal tax lien for the same reasons that the mortgage payments are so entitled. It is true that had plaintiff not paid these taxes a municipal tax lien would have been subordinate to the Federal tax lien. However, this is merely hypothetical and of no import since the fact remains that plaintiff did pay the real estate taxes and no municipal tax lien ever arose.

One-half of the money expended by plaintiff for necessary repairs ($265.00) stands on a different footing from the mortgage and tax payments. As to this item, I find that the plaintiff's claim is subordinate to the government's lien. While the decision in Baird v. Moore, 50 N. J. Super. 156 (App. Div. 1958) severely curtailed the prior holding in Polumbo v. Polumbo, 48 N. J. Super. 13 (Chan. Div. 1957) as to the right to a credit for payments made on account of necessary repairs by a co-tenant in exclusive possession, it does not override the government's priority under the circumstances of this case. The mortgage and the tax payments were fixed as to amount and plaintiff was obligated to pay them. However, the question of expenditures for repairs to the premises rested in the discretion of the plaintiff. I recognize that a failure to repair may have been a breach of a covenant in the mortgage. But the extent and amount of repairs necessary to preserve the premises were not fixed. A determination as to what expenditures were to be made and in what amount was certainly equivocal and subject to discussion. In this respect the money expended on repairs differs from the mortgage and tax payments. It must also be noted that plaintiff was in sole possession of the property when she made these payments. The expenditures were of exclusive benefit to her comfort and convenience in the enjoyment of the property.

As to the priority between the government lien and the assignee of the October 4, 1955 judgment ($605.40), I find that the government is entitled to priority. The Federal tax lien was perfected, in the Federal sense, when filed in the County Clerk 's Office in March 1958. At that time the state court judgment was not perfected by levy and execution and is, therefore, inchoate in the Federal sense and inferior. I believe that reading of the United States Supreme Court cases cited by the government comples this finding. The "first in time is the first in right" doctrine enunciated in United States v. City of New Britain [54-1 USTC ¶9191], 347 U. S. 81, 74 S. Ct. 367, 98 L. Ed. 520 (1954) is not the first and last word on the subject. Subsequent decisions have demonstrated that to enjoy priority over a Federal tax lien, a competing lien must be "choate" in the Federal sense. This means, at least, that the competing lien must have attached to specific property. United States v. Bond [60-2 USTC ¶9532], 279 F. 2d 837 (4th Cir. 1960) cert. denied 364 U. S. 895 (1960) and cases cited therein. This determination is reinforced by the clear import of our own State decisions which hold that a junior creditor who first levies upon the property of the debtor is accorded priority over a senior creditor who has not levied. Swift & Co. v. First Nat. Bank of Hightstown, 114 N. J. Eq. 417 ( Ch. 1933); Vineland Savings & Loan Assn. v. Felmy, 12 N. J. Super. 384 (Chan. Div. 1950).

Plaintiff's attorney has entered a claim against the proceeds for a counsel fee (one-half of the amount to be allowed). There can be no doubt that the proceeds of the partition represent a fund in court within the purview of R. R. 4:55 -7(b). See Katz v. Farber, 4 N. J. 333 (1950); Baird v. Moore , supra, at p. 176; Lipin v. Ziff, 53 N. J. Super. 443, 445 (Chan. Div. 1959). That such a counsel fee, if allowed, would be prior to the payment of the Federal tax lien was answered in the affirmative in Farley v. Manning, 4 N. J. 571 (1950) and reiterated very recently in Washington Cons't Co. v. United States of America, 75 N. J. Super. 536 (Chan. Div. 1962). These two latter decisions involved interpleader actions where there was an "innocent stakeholder." This distinction should be noted for the record since I am of the opinion that it does not foreclose an allowance of counsel fees in this case. The rationale of our Supreme Court's decision in Sunset Beach Amusement Corp. v. Belk, 33 N. J. 162 (1960) applies to all requests for counsel fees from a "fund" in court. Simply stated, "allowances are payable from a 'fund' when it would be unfair to saddle the full cost upon the litigant for the reason that the litigant is doing more than merely advancing his own interests." Sunset Beach Amusement Corp. v. Belk, supra at p. 168. The basic criterion is not whether more than the plaintiff's interests were advanced; rather it is whether the suit was for the purpose of advancing those interests. I am of the opinion that the nature and purpose of this partition was to advance more than the sole interest of the plaintiff, and counsel is, therefore, entitled to a reasonable allowance out of the fund. That the United States "happens to be a party to the litigation" and its recovery will be limited to that extent is of no special moment. See Washington Cons't Co. v. United States of America , supra, at p. 540. Therefore, counsel is entitled to a counsel fee, one-half of which is chargeable against the present "fund." Counsel should submit an affidavit as to his services and the amount to which he is entitled will be entered in the court.

To recapitulate, the order of priority shall be:

(1) Counsel fee to plaintiff's attorney;

(2) Payment of $50.60 to plaintiff for one-half of payments made by her to the Howard Savings Institution subsequent to the final judgment of divorce to satisfy the mortgage indebtedness;

(3) Payment of $805.23 to plaintiff for one-half of payments made by her to the Howard Savings Institution as adjudicated by the entry of a judgment nisi entered in her favor on January 13, 1961 ;

(4) Payment of $122.75 to plaintiff for one-half of payments made to the City of Jersey City for real estate taxes after the mortgage was paid;

(5) Payment of $2,021.55 to the United States of America in satisfaction of its tax liens against defendant Alfred Smith.

Since these five items more than deplete the available proceeds, the subsequent priorities are rendered moot and need not be set forth. The $2,021.55 payment to the United States of America will be reduced by the total of the payments made under priorities #1 through #4.

Counsel for plaintiff will submit an affidavit per my request; thereafter a judgment may be submitted, consented to as to form or settled on notice.

 

 

[53-1 USTC ¶9323]Charles W. Potter v. United States of America , et al.

In the District Court of the United States for the District of Rhode Island, Civil Action No. 1313, 111 FSupp 585, March 31, 1953

Lien for taxes: Validity against mortgagees: Right of subrogation.--Where plaintiff, being ignorant of existence of the tax lien, loaned money to a corporation to pay off a mortgage and took a new mortgage on the same personal property, he was subrogated to the rights of the old mortgagee and his new mortgage had priority to the Government's tax lien which was recorded after the old mortgage but before the new. The Government's position now was not worse than before the discharge of the old mortgage, because plaintiff could have taken an assignment of the old mortgage. However, that portion of the new mortgage which represented a prior unsecured debt to plaintiff should not be entitled to priority.

Morris S. Waldman and William C. H. Brand, both of Providence , R. I., for plaintiff. Thomas J. Capalbo, Assistant United States Attorney for the District of R. I., for defendants.

Opinion

LEAHY, District Judge:

This is an action brought by Charles W. Potter, of East Providence, Rhode Island, against the United States of America, by which the plaintiff, a mortgagee, is attempting to establish the priority of a mortgage held by him from Harry Crawshaw's Grill, Inc., over certain federal tax liens filed by the defendant for taxes due from said Harry Crawshaw's Grill, Inc. The complaint prays for a declaratory judgment, pursuant to the provisions of 28 U. S. C. A. §2201, determining the rights of the parties and their respective priorities to the property of said corporation.

In its answer the defendant asks that it be granted judgment establishing the priority of its lien as against the claim of the plaintiff; that its lien be foreclosed pursuant to the provisions of §3678 of the Internal Revenue Code and §2410(c) of Title 28 U. S. C. A.; and that the amount due the defendant for said taxes be ordered paid.

[The Facts]

The matter was submitted to the Court for decision on an agreed statement of facts and on oral arguments. The essential facts are substantially as follows: On June 29, 1949 , Harry Crawshaw's Grill, Inc., a Rhode Island corporation, executed and delivered a promissory note to Margaret Crawshaw in the sum of $11,000.00, bearing interest at the rate of Five Per Cent (5%) Per Annum on the unpaid balance. The note was payable in monthly installments of $329.68, the first payment being due on July 9, 1949 . This promissory note was also signed by Harry L. Wilcox, who was the President and Treasurer of the corporation. To secure payment of this note, the corporation executed a mortgage on certain personal property, consisting of restaurant equipment, located at 22 Waterman Avenue , East Providence , Rhode Island . This mortgage was duly recorded in the Town Clerk's Office in said Town of East Providence . Assessment lists were received by the Collector of Internal Revenue, at Providence , Rhode Island , on May 22, 1950 , December 4, 1950 , and March 7, 1951 , disclosing that the above corporation, Harry Crawshaw's Grill, Inc., owed to the defendant the amount of $2201.17 in withholding and F. I. C. A. taxes. Following the receipt of each assessment list, the Collector of Internal Revenue notified the taxpayer, Harry Crawshaw's Grill, Inc., of the tax due, and requested payment thereof.

On April 12, 1951, the defendant, under its Internal Revenue Laws, filed with the Town Clerk of the Town of East Providence , an original notice of a tax lien dated April 11, 1951, against said Harry Crawshaw's Grill, Inc.

The corporation defaulted in the payment of its mortgage note to Margaret Crawshaw, and the latter, through her attorneys, commenced foreclosure proceedings against the personal property which had served as security for the mortgage.

[Plaintiff's Loan Paid off the Mortgage]

Thereupon Harry L. Wilcox and Doris L. Wilcox approached the plaintiff, to whom they were already personally indebted in the sum of $1,000.00, and requested and importuned him to advance to the corporation sufficient funds to pay off the balance due to Margaret Crawshaw on said promissory note. At that time the balance on the note, including costs and counsel fees, amounted to $3,867.00.

The plaintiff, being completely ignorant of the existence of the tax lien filed by the defendant, advanced to the corporation the above sum of $3,867.00, which was then used to pay the balance of the note of June 29, 1949. As a result of this payment, the foreclosure proceedings against the corporation's personal property were stopped, and the said mortgage was discharged.

The corporation then delivered to the plaintiff a note, dated August 3, 1951, in the sum of $4,867.00. This sum included not only the $3,867.00 which had been advanced by the plaintiff to discharge the original mortgage, but included an additional sum of $1,000.00 which represented the unsecured debt owed by Harry L. Wilcox and Doris L. Wilcox to the plaintiff. This new note for $4,867.00 was payable to the plaintiff on demand, with interest at the rate of Eight Per Cent (8%), and was signed by the corporation and by Harry L. Wilcox and Doris L. Wilcox. As security for this new note the corporation executed a mortgage to the plaintiff on the same personal property which had previously served as security for the earlier note. This personal property mortgage was duly recorded on August 6, 1951 with the Town Clerk of the Town of East Providence .

[Plaintiff Had No Knowledge of Tax Lien]

At the time the plaintiff received the above note and mortgage, he had no personal knowledge concerning the lien filed on April 12, 1951 by the defendant, and the mortgage on the said personal property contained a warranty that it was free and clear of all encumbrances.

No payments on the corporation's note of August 3, 1951, either of principal or interest, were ever made to the plaintiff, and in the early part of October 1951, the attorneys for the plaintiff made a written demand on the debtors for payment of the note. This demand was not complied with, and on November 20, 1951 , the plaintiff, through his attorneys, commenced foreclosure proceedings against the mortgaged personal property.

It was also on November 20, 1951, that the defendant, under a duly issued warrant for distraint, based upon the lien it had filed on April 12, 1951, seized said personal property in East Providence, for non-payment of the taxes above referred to, the balance of said taxes at that time being $1,857.42.

On December 5, 1951 the plaintiff commenced his action in this Court, and by a stipulation entered into by the parties, the defendant was authorized to sell the mortgaged personal property under its seizure and distraint, and to deposit the net receipts of the sale in the Registry of the Court to await the final judgment and determination by the Court of the respective rights of the parties in this matter. In accordance with the terms of this stipulation the personal property above referred to was sold on December 17, 1951 , and the sum of $3,400.00 which was realized from the sale was deposited in the Registry of the Court.

[Plaintiff Relied on Theory of Subrogation]

To establish the priority of his claim over that of the defendant, the plaintiff relies on the theory of conventional subrogation. Priority is claimed, however, only to the extent of $3,867.00, that being the amount advanced by the plaintiff to discharge the previous mortgage on the corporation's personal property. This was the same property upon which the defendant had filed its lien, unknown to the plaintiff. The plaintiff contends that the defendant is in no worse position now than it was before the discharge of the old mortgage, and that the plaintiff, having advanced the funds to discharge that mortgage, and having become the new mortgagee of the property, is subrogated to the rights of the previous mortgagee.

The contention of the defendant is that under the provisions of §§ 3670, 3671, and 3672 of the Internal Revenue Code its claim has priority to that of the plaintiff, because its lien was placed on the mortgaged property before the plaintiff's mortgage was executed.

A person under no obligation who undertakes by agreement with an obligor to pay the latter's debt, with the understanding that he will have the same or equivalent security to that held by the original creditor, and subsequently pays that obligation, will be subrogated to the rights of the original creditor, provided that the entire transaction places no innocent third party in a position more unfavorable than that in which he originally stood. Industrial Trust Company v. Hanley, 53 R. I. 180, 165 A. 223 (1933); Burgoon v. Lavezzo, 92 Fed. (2d) 726 (App. D. C. 1937); Stowers v. Wheat, 78 Fed. (2d) 25 (5 Cir. 1935); Barnes v. Cady, 232 Fed. 318 (6 Cir. 1916); Rachal v. Smith, 101 Fed. 159 (5 Cir. 1900); Edwards v. Devenport, 20 Fed. 756 (1883).

Constructive notice of the junior lien is insufficient to defeat his right of subrogation, and his failure to find the junior encumbrance on the record will not be sufficient reason to deny him relief in equity. Burgoon v. Lavezzo, supra; Industrial Trust Company v. Hanley, supra. Mistake is considered a proper ground for relief in equity. Industrial Trust Company v. Hanley, supra; Conti v. Fisher, 134 Atl. 849 (R. I. 1926).

[New Mortgagee as Equitable Assignee]

The allowance of subrogation does not restrict the effect of the record of the junior lien, but merely replaces it in its original position, junior to the lien with respect to which subrogation is allowed. Thus when a person who advances funds to discharge a mortgage lien on property with respect to which he receives a new mortgage, fails, merely through ignorance of a junior lien thereon, to take an actual assignment of the mortgage, thereby completely securing his position, equity will regard the substance rather than the form of the transaction, and will treat the new mortgagee as equitable assignee of the original mortgagee's rights, in the absence of intervening equities. Burgoon v. Lavezzo, supra; Industrial Trust Company v. Hanley, supra.

[The Government's Contentions]

The Government contends that, because of considerations applicable to the unusual facts of the instant case, these principles of subrogation law ought not to be applied here. One reason urged for their inapplicability is that no agreement existed between the plaintiff and the mortgagor providing that the plaintiff was to stand first among all lien holders. It appears, however, that the mortgage held by the plaintiff, relative to the property in question, contained a warranty that it was free and clear of all encumbrances. Clearly this is sufficient to remove the plaintiff from the category of volunteer; and not being a volunteer he is entitled to subrogation, unless other sufficient reasons exist to deprive him of this right. Burgoon v. Lavezzo, supra; Rachal v. Smith, supra.

Another reason advanced by the Government for disallowing subrogation in this case is that the property involved here is personal property rather than real estate. But no case has been cited in support of making such a distinction, and the Court is not aware of any reason sufficient to warrant a distinction being made on this ground. In applying the doctrine of subrogation, "no attention should be paid to technicalities which are not of an insuperable character, but the broad equities should always be sought out as far as possible." Merchants' & M. T. Co. v. Rob inson-Baxter, Etc., Co. , 191 Fed. 769, 772 (1 Cir. 1911). If justice will be served by allowing subrogation, conceptual and formalistic arguments will not bar the granting of relief.

Perhaps the strongest argument urged by the Government for distinguishing the case at bar from others in which subrogation has been allowed, is that the note for the loan advanced by the plaintiff to the mortgagor here was for a different amount and carried a different rate of interest than did the original mortgage. The Government contends that because of this difference, the amount of the new note cannot be divided so as to allow subrogation for a part thereof and not for another part. Therefore, the Government contends, the full amount of the plaintiff's claim must be adjudged to be subsequent to the Government's lien.

[Plaintiff Could Have Taken an Assignment]

The contention of the Government in this regard places undue emphasis on form, and not enough on substance. Viewing the matter more in terms of substance, it can be seen that if the plaintiff had full knowledge of the Government's lien here, he could have made certain that he would have been protected, by taking an assignment of the old mortgage, and by taking a new mortgage to cover only the $1,000.00 already owed him. The rate of interest on this new mortgage could have been adjusted so as to provide plaintiff with a combined rate of return equal to that which prevails on the present note.

Inasmuch as it was at the mortgagor's request that the plaintiff here advanced the money to discharge the old mortgage, that mortgage would unquestionably have been assigned to the plaintiff, instead of being discharged and a new mortgage issued, if plaintiff had requested such assignment. The reason plaintiff failed to obtain an assignment, thus completely securing his position, was his ignorance of the Government's junior lien. Equity will regard the substance of the transaction, however, rather than its form, and in the absence of intervening considerations, will rectify the mistake, by treating the plaintiff as an equitable assignee of the original mortgage. Burgoon v. Lavezzo, supra; Industrial Trust Company v. Hanley, supra.

[Priority Limited to Amount of Old Mortgage]

Why the amount of the new note, as it stands now, cannot be so divided as to allow subrogation for that portion which represents the amount of the old mortgage has not been satisfactorily explained by the defendant. The Court would have little difficulty in dividing the amount of plaintiff's claim so as to allow him priority for only the amount of the old mortgage and at the rate of interest specified therein, if such division were required. Because the fund realized from the sale of the mortgaged property is inadequate to pay even the amount of the old mortgage, however, no such division is required here.

The allowance of subrogation under these circumstances places the Government in no worse position than it was in before the discharge of the old mortgage, and it is not entitled to be unjustly enriched by the plaintiff's mistake. Industrial Trust Company v. Hanley, supra.

Upon consideration of all the circumstances of the case, the Court finds that the claim of the plaintiff is entitled to priority over that of the defendant.

Counsel for the plaintiff may prepare for the signature of the Court an appropriate form of final judgment in accordance with this opinion.