Opinion
NO. 2013-CA-001492-MR
04-24-2015
POLICE AND FIRE RETIREMENT SYSTEM OF THE CITY OF DETROIT APPELLANT v. MIDWEST BUSINESS CREDIT, LLC APPELLEE
BRIEFS FOR APPELLANT: Matthew F. Coogle Louisville, Kentucky BRIEF FOR APPELLEE: Griffin Terry Sumner Peter M. Cummins LeAnders L. Jones Louisville, Kentucky
NOT TO BE PUBLISHED APPEAL FROM LYON CIRCUIT COURT
HONORABLE CLARENCE A. WOODALL, III, JUDGE
ACTION NO. 11-CI-00146
OPINION
REVERSING AND REMANDING
BEFORE: DIXON, MAZE, AND TAYLOR, JUDGES. TAYLOR, JUDGE: Police and Fire Retirement System of the City of Detroit (PFRS) brings this appeal from an order entered August 5, 2013, by the Lyon Circuit Court following a foreclosure action upon certain real property and a determination that a mortgage of Midwest Business Credit, LLC (Midwest) was superior in priority to a mortgage held by PFRS. We reverse and remand.
The underlying facts of this case are largely undisputed, and we only recite those facts necessary to disposition of this appeal. Dott Acquisition Kuttawa RE, LLC (Dott) is a limited liability company organized in Michigan, in the business of manufacturing plastic parts for automobiles. Dott owned real property located at 501 Lakeshore Drive, Kuttawa, Kentucky (Lakeshore property). Dott executed two separate mortgages upon the Lakeshore property; one mortgage to PFRS in 2008, and the other mortgage to Midwest in 2009. PFRS recorded its mortgage (PFRS mortgage) first in time on July 25, 2008, in the Lyon County Clerk's Office. The PFRS mortgage was partial security for a $6,000,000 advance to Dott. Midwest recorded its mortgage (Midwest mortgage) second in time on June 23, 2009, in the Lyon County Clerk's Office. The Midwest mortgage secured a promissory note in the principal amount of $500,000. Dott eventually defaulted upon its payments under the promissory note to Midwest.
Consequently, on August 31, 2011, Midwest filed a foreclosure action in the Lyon Circuit Court upon the Lakeshore property. Midwest named as defendants, inter alios, Dott and PFRS. Midwest claimed that its mortgage was superior in priority to the PFRS mortgage and pointed to subordination clauses contained in the PFRS mortgage. Midwest sought a sale of the Lakeshore property by the master commissioner.
PFRS answered and filed a counterclaim against Midwest. PFRS asserted that its mortgage was superior in priority to the Midwest mortgage as it was recorded first in time. PFRS disputed that its mortgage contained valid subordination clauses.
Dott failed to enter an appearance, and the circuit court rendered default judgment against Dott. Both Midwest and PFRS filed motions for summary judgment upon the priority of their respective mortgages. By summary judgment entered May 29, 2013, the circuit court concluded that the Midwest mortgage was superior in priority to the PFRS mortgage. In reaching this conclusion, the circuit court interpreted the PFRS mortgage as containing valid and enforceable subordination clauses in favor of the Midwest mortgage. Later, by order entered August 5, 2013, the court ordered the master commissioner to sell the Lakeshore property. This appeal follows.
The May 29, 2013, summary judgment did not include finality language under Kentucky Rules of Civil Procedure 54.02.
PFRS contends that the circuit court erroneously rendered summary judgment adjudicating the Midwest mortgage was superior in priority to its mortgage. PFRS argues that the circuit court erred by interpreting its mortgage as containing valid subordination clauses. PFRS maintains that its mortgage was recorded first in time and that it is entitled to priority over the later recorded Midwest mortgage.
Summary judgment is proper where there exists no material issue of fact and movant is entitled to judgment as a matter of law. Kentucky Rules of Civil Procedure 56; Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d 476 (Ky. 1991). The material facts herein are undisputed and resolution of this appeal centers upon issues of law. For the following reasons, we conclude that the PFRS mortgage was superior in priority to the Midwest mortgage and that the subordination clauses in the PFRS mortgage were invalid and unenforceable for lack of reasonable specificity.
In this Commonwealth, the priority of a mortgage is controlled by Kentucky Revised Statutes (KRS) 382.270, which reads:
No deed or deed of trust or mortgage conveying a legal or equitable title to real property shall be lodged for record and, thus, valid against a purchaser for a valuable consideration, without notice thereof, or against creditors, until such deed or mortgage is acknowledged or proved according to law. However, if a deed or deed of trust or mortgage conveying a legal or equitable title to real property is not so acknowledged or proved according to law, but is or has been otherwise lodged for record, such deed or deed of trust or mortgage conveying a legal or equitable title to real property or creating a mortgage lien on real property shall be deemed to be validly lodged for record for purposes of KRS Chapter 382, and all interested parties shall be on constructive notice of the contents thereof. As used in this section "creditors" includes all creditors irrespective of whether or not they have acquired a lien by legal or equitable proceedings or by voluntary conveyance.Under KRS 382.270, a mortgage has priority if it was recorded first in time and recorded without notice of a prior mortgage. Minix v. Maggard, 652 S.W.2d 93 (Ky. App. 1983). Hence, Kentucky is viewed as a race-notice jurisdiction. State Street Bank & Trust Co. of Boston v. Heck's, Inc., 963 S.W.2d 626 (Ky. 1998).
Even though the PFRS mortgage was recorded first in time and undisputedly without notice of a prior mortgage, the circuit court interpreted the PFRS mortgage as containing valid subordination clauses that effectively waived the priority of its mortgage in favor of the Midwest mortgage. In other words, concluded that the Midwest mortgage was superior in priority to the PFRS mortgage because of the subordination clauses in the PFRS mortgage.
It is well-recognized that a "mortgage subordination has the effect of reducing the mortgage's priority below that of some other interests . . . in the real estate to which the mortgage would otherwise be superior." Restatement (Third) of Property § 7:7 cmt. a, intro. note (1997). To be a valid and enforceable subordination clause, the mortgage gaining priority must be described with "reasonable specificity." This rule is aptly set forth in Restatement (Third) of Property § 7:7 (1997):
We are persuaded that the Restatement (Third) of Property § 7:7 (1997) represents an accurate statement of the law in this Commonwealth and adopt same herein.
A mortgage, by a declaration of its mortgagee, may be made subordinate in priority to another interest in the mortgaged real estate, whether existing or to be created in the future, if the interest to which the mortgage is being subordinated is described with reasonable specificity in the declaration. A subordination that would materially prejudice the mortgagor or the person whose interest is advanced in priority is ineffective without the consent of the person prejudiced. (Emphasis added.)By agreement of the mortgagee, a mortgage may be subordinated in priority if the mortgage gaining priority is described with reasonable specificity. If the mortgage gaining priority is not in existence at the time of subordination, the requirement of reasonable specificity takes on added significance as the terms of such future mortgage are not readily discernable. Restatement (Third) of Property § 7:7 cmt. b (1997).
It is thus necessary to disclose the essential financial terms of a prospective debt underlying a future mortgage in a subordination clause or subordination instrument to meet the requirement of reasonable specificity. More particularly, the requirement of reasonable specificity mandates that the maximum amount of the debt, maximum interest rate, and maximum term of the debt underlying a future mortgage be set forth in the subordination clause or subordination instrument. Restatement (Third) of Property § 7:7 cmt. b (1997). If these essential financial terms are not set forth in the subordination clause or subordination instrument, the subordination is fundamentally unconscionable, invalid, and unenforceable. Restatement (Third) of Property § 7:7 cmt. b (1997).
In our case, the PFRS mortgage contained the following subordination clauses:
WHEREAS, Mortgagee has agreed to subordinate, at Mortgagor's election, this Mortgage to the interest of a subsequent mortgage to be determined. As used herein, the term "Senior Lender" shall mean the person subsequently identified by Mortgagor; the term "Senior Loan" shall mean the first mortgage loan made by Senior Lender to Mortgagor; the term "Senior Mortgage" shall mean the mortgage given by Mortgagor to Senior Lender to secure the Senior Loan; and the term "Senior Debt" shall mean the indebtedness secured by the Senior Mortgage.
. . . .
1.02 General Covenants and Representations. Subject to the Senior Mortgage: Mortgagor covenants and represents that as of the date hereof and at all times thereafter during the term hereof: (a) Mortgagor is the owner of an indefeasible estate in that portion of the Mortgaged Property which is real property, and Mortgagor has good and marketable fee simple absolute title to it and the balance of the Mortgaged Property free and clear of all liens, security interests, charges and encumbrances whatsoever except the Permitted Exceptions described on Exhibit "B" attached hereto and made a part hereof; (b) Mortgagor has good right, full power and lawful authority to mortgage and pledge the Mortgaged Property as provided herein and does fully warrant the Mortgagor's fee simple absolute title to the Mortgaged Property and will defend same against the claims of all persons whomsoever; (c) upon the occurrence of an Event of Default (hereafter defined). Mortgagee may at all times peaceably and quietly enter upon, hold, occupy and enjoy the Mortgaged Property in accordance with the terms hereof; (d) Mortgagor will maintain and preserve the lien of this Mortgage as a priority lien subject only to the Senior Mortgage (unless released by Mortgagee) until Mortgagor's Liabilities have been paid in full; (e) Mortgagor owns the Improvements free and clear of all liens and claims except as otherwise disclosed in writing to Mortgagee; (f) except for the Senior Lender, no consent of any other person or entity and no consent, license, approval or authorization of, exemption or registration or declaration is required by Mortgagor in connection with the execution, delivery or performance of this Mortgage or any portion thereof; and (g) there is no action or proceeding pending or, to Mortgagor's best knowledge, threatened against Mortgagor which might adversely affect the rights of Mortgagee under the Transaction Documents, the ability of Mortgagor to perform its obligations under This Mortgage or the Mortgaged Property or any portion thereof.
. . . .
1.18 Payment of Superior Liens. To the extent that Mortgagee, after the date hereof, pays any sum due under any provisions of law or instrument or document creating any lien superior or equal in priority in whole or in part to the lien of the Mortgage, Mortgagee shall have and be entitled to a lien on the Mortgaged Property equal in parity with that discharged, and Mortgagee shall be subrogated to and receive and enjoy all rights which shall remain in existence and benefit Mortgagee to secure all obligations and liabilities secured hereby. Mortgagee shall be subrogated, notwithstanding their release of record, to mortgages, trust deeds, superior titles, vendors' liens, construction liens, mechanics' and materialman's liens, charges, encumbrances, rights and equities on the Mortgaged Property to the extent that any obligation under any of the foregoing is paid or discharged with funds of Mortgagee.
. . . .
2.12 If Mortgagee fails to have a legal, valid and binding second priority mortgage lien, or a valid and enforceable, second priority, perfected security interest, in any collateral covered by this Mortgage or the Transaction Documents, subject only to the Senior Loan. The Default Rate shall apply from the date of occurrence of the foregoing.
4.14 Subordination To Senior Mortgage: Non-Merger. Subject to the provisions of this Mortgage, Mortgagor and Mortgagee hereby expressly agree that this Mortgage and the liens created hereby are fully subordinate and junior to the Senior Mortgage and the liens created thereby and the rights of the Senior Lender set forth therein. It is expressly understood and agreed that the Senior Mortgage and this Mortgage are separate instruments and create separate liens, and it is the express intention of Mortgagor and Mortgagee that the Senior Mortgage and this Mortgage shall remain separate liens and under no circumstances shall they be deemed merged into one instrument or lien.
The subordination clauses in the PFRS mortgage did not set forth any specific terms or otherwise identify the "Senior Mortgage." In fact, the term "Senior Mortgage" was generally defined as "the mortgage given by Mortgagor to Senior Lender to secure the Senior Loan." "Senior Lender" is merely defined as "the person subsequently identified by Mortgagor," and the "Senior Loan" is defined as the "first mortgage loan made by Senior Lender to Mortgagor."
As is apparent from the PFRS mortgage, the subordination clauses did not describe the future mortgage (or Senior Mortgage) with reasonable specificity. It did not set forth the maximum amount of the prospective debt underlying the future mortgage, the maximum interest rate, or the maximum term of the debt. Rather, the Senior Mortgage, the Senior Lender, and the Senior Loan were substantively undefined by the subordination clauses in the PFRS mortgage.
Upon review of the subordination clauses in the PFRS mortgage, it is apparent that the requirement of reasonable specificity was not satisfied. The subordination clauses did not specify the maximum prospective debt owed under the future mortgage (Senior Mortgage), the maximum interest rate, or the maximum term. In fact, there was no substantive description of the future mortgage (Senior Mortgage) or of the underlying debt in the subordination clauses of the PFRS mortgage. Hence, we conclude that the subordination clauses in the PFRS mortgage are not valid in this case and thus unenforceable as lacking reasonable specificity.
Accordingly, we hold that the subordination clauses in the PFRS mortgage were invalid as lacking reasonable specificity. We are of the opinion that the circuit court erred by rendering summary judgment concluding that the subordination clauses in the PFRS mortgage were enforceable.
The circuit court rendered summary judgment upon the issue of the validity of the subordination clauses in the Police & Fire Retirement System of the City of Detroit (PFRS) mortgage. Midwest Business Credit, LLC, has invited this Court to reach issues not yet decided by the circuit court (whether the PFRS mortgage was valid per Kentucky Revised Statutes 382.330). We decline to do so and believe the circuit court must initially reach a decision upon such issue. We are a court of review, and our decisions are limited to review of issues properly presented and decided by the lower court.
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For the foregoing reasons, the order of the Lyon Circuit Court is reversed and this cause remanded for proceedings consistent with this opinion.
ALL CONCUR. BRIEFS FOR APPELLANT: Matthew F. Coogle
Louisville, Kentucky
BRIEF FOR APPELLEE: Griffin Terry Sumner
Peter M. Cummins
LeAnders L. Jones
Louisville, Kentucky