LAMB EXCAVATION v. TORREJON

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IN THE COURT OF APPEALS STATE OF ARIZONA DIVISION TWO ) ) ) Plaintiff/Appellee, ) ) ) v. ) ) CHASE MANHATTAN MORTGAGE ) CORPORATION, ) ) Defend ant/Appe llant, ) ) and ) ) INTEG RA W INDOW & DOO R, INC.; ATKO BU ILDING MAT ERIALS, INC.; and ) ) U.S. CO MPON ENTS L .L.C., ) ) Defendants/Cross-Claimants/Appellees. ) LAMB EX CAVATION , INC., an Arizona corporation, 2 CA-CV 2002-0139 DEPARTMENT B O P I N IO N APPEAL FROM THE SUPERIOR COURT OF PIMA COUNTY Cause No. C-20010928 Honorable Jane L. Eikleberry, Judge REVERSED AND REMANDED Durazzo & Eckle, P.C. By Patric E. Durazzo Tucson Attorneys for Plaintiff/Appellee Snell & Wilmer, L.L.P. By Marc G. Simon and Wade R. Swanson Tucson Attorneys for Defendant/Appellant Chase Manhattan Mortgage Corporation Slutes, Sakrison & Hill, P.C. By James M. Sakrison Tucson Attorneys for Defendant/CrossClaimant/Appellee Integra Window & Door, Inc. Tucson Attorney for Defendant/CrossClaimant/Appellee U.S. Com ponents L.L.C . Norman R. Freeman II, P.C. Anderson, Brody, Levinson, Weiser & Horwitz, P.A. By Jeffrey H . Levinso n & Janessa E. Koenig Phoenix Attorneys for Defendant/CrossClaimant/Appellee ATKO Building Materials, Inc. E S P I N O S A, Acting Presiding Judge. ¶1 In this mechanics lien foreclosure action, appellant Chase Manhattan Mortgage Corporation (Chase) a ppeals from the trial court s g rant of summary judgment in favor of appellee Lamb Excavation, Inc. (Lamb). Chase contends the court erred in declining to apply the doctrine of equitable subrogation in its favor, which would have placed Chase in the primary lien position occupied by the construction lender after Chase provided permanent 2 financing for the subject project and satisfied the construction loan. We agree and reverse the grant of summary judgment in favor of Lamb and remand the case to the trial court for further proceedings consistent with this decision. Facts and Procedural Background The essential facts are undisputed. In February 2000 Edwin and Catherine ¶2 Torrejon obtained a construction loan from Commercial Federal Bank (CFB) to build a house on a parce l of prop erty they ha d purch ased. T he loan was se cured b y a deed of trust. The Torrejons employed several subcontractors during construction, including Lamb, ATKO Building Materials (ATKO), U.S. Co mponents, and Integra Window & D oor (Integra). Those four subcontractors subsequently served on CFB and the Torrejons preliminary twenty-day notices of mechanics and materialmen s liens pursuant to A.R.S. § 33-992.01. In November 2000, the Torrejons obtained permanent financing from Chase to satisfy the CFB construction loan, executing a promissory note and deed of trust to the property, which Chase recorded on December 15, 2000.1 Shortly thereafter, Lamb, ATKO, Integra, and U.S. Compo nents (collectively referred to as mechan ics lienholde rs), who h ad not bee n fully paid for their w ork, all recorde d mech anics lie ns against the p roperty. 1 The construction loan and th e permane nt financing differed in their terms: the CFB loan, by its temporary nature, had a one-year term, while the Chase loan was for thirty years; the CFB interest rate was 8.25% a nd the Ch ase financin g, an adju stable rate note, carried an 11.275% interest rate; and the CFB loan was for the amount of $240,000, while the Chase n ote listed $248,000 as the principal balance. 3 In February 2001, Lamb filed an action to foreclose its lien, naming as ¶3 defendan ts the Torrejons, CFB, Chase, and the three other mechanics lienholders.2 The three answered and filed cross-claims asserting lien priority positions identical to L amb s. In November 2001 C hase mov ed for summ ary judgme nt, arguing its lien should be subrogated to the extent of the CFB lien. Lamb filed a countermotion for summary judgment, which the other three mechanics lienholders j oined, contending th at Chase w as not entitled to equitable subrogation because the CFB lien had been extinguished and thus there was no agreement or intent to subrogate. Lamb also argued that subrogation would work a substantial injustice on the lienholders. The trial court denied Chase s motion and granted the lienholders motion instead. In granting Lamb s motion for summary judgment, the trial court rejected ¶4 Chase s argument that it was entitled to equitable subrogation, finding that Chase was a sophisticated lender an d had c onstructive notice of the potential for the filing of a mechanic s liens [sic] against the property when it made the loan. Citing Mosher v. Conway, 45 Ariz. 463, 46 P .2d 110 (1935 ), the trial court also found that the decisio n to apply eq uitable subrogation depends on the particular circumstances of each case and that applying the doctrine here would produce an inequitable result and be contrary to public policy. In 2 In addition to the lien-foreclosure claim, Lamb s complaint and the subsequent amended complaint contained three additional counts for breach of contract, unjust enrichment and equita ble lien, and quantum meruit. 4 addition, the court rea soned that subrogation did not ap ply because the terms of the CFB and Chase loans were not identical. This appeal followed. Standard of Review ¶5 A trial court properly grants summary judgmen t if the moving party is entitled to judgmen t as a matter of la w. Ariz. R. Civ. P . 56(c)(1), 1 6 A.R. S., Pt. 2; Orme School v. Reeves, 166 Ariz. 301, 802 P.2d 1000 (1990). Because determining whether Chase was entitled to equitable s ubrogation involves a question of law, we review de novo the issue of whether that relief is appropriate. See Johnson v. Hispanic Broadcasters of Tucson, Inc., 196 Ariz. 597, 2 P.3d 687 (App. 2000) (entry of summary judgment reviewed de novo); see also Andrews v. Blake, 205 Ariz. 236, 69 P.3d 7 (2003) (availability and propriety of equ itable relief reviewed de novo). Equitable Subrogation ¶6 The doctrine of equitable subrogation permits the substitution of one lienholder into the lien-priority position of a prior lienholder. Subrogation is an equitable remedy designed to avoid a person s receiving an unearne d windfall at the expen se of another. Restatement (Third) of Property (Mortgages) (hereinafter Restatement ) § 7.6 cmt. a. In general, previously recorded liens have priority over subsequent mechanics liens recorded after labor has begun or materials have been furnished. The mechanics liens then have priority over later-recorded encu mbrances. See A.R.S. § 33-992; E. Sav. Bank v. Pappas, 829 A.2d 953 (D.C. 2003); see generally Restatement § 7.6. But application of the doctrine of equitable subrogation allows a subsequent lender who sup plies funds used to pay off a p rimary 5 and superior encumbrance to be substituted into the priority position of the primary lienholder, despite the recordin g of an intervening lien. See Mosher; Peter man-D onnelly Eng rs & Contractors Corp. v. First Nat l Bank of Ariz., 2 Ariz. App. 3 21, 408 P.2d 841 (1965); see also Mort v. United States, 86 F.3d 890 (9th Cir. 1996). ¶7 On appeal, Chase co ntends it w as entitled to eq uitable subrogation based on the two-part test enunciated in Peterma n-Donn elly, which considers (1) whether an express or implied agreement to subrogate existed and (2) wheth er any prejudice to the lien claimants resulted. Conversely, Lamb u rges us to up hold the trial co urt s ruling, asserting the trial co urt, in denying subrogation, properly considered factors such as Chase s actual or constructive notice of the interve ning liens, its sta tus as a soph isticated lender, and public policy issues. Thus, the parties disagree on the appropriate legal stand ard for asses sing whe ther equitab le subrogation should apply. In order to clarify the Arizona standard, we first review the approaches taken by other jurisdictions. Majority Approach ¶8 The four primary elements of equitable subrogatio n are as follow s: (1) the party claiming subrogation has paid the debt; (2) the party was not a volunteer; (3) the party was not primarily liable for the debt; and (4) n o injustice w ill be done to the other party by allowing subrogation. See Kuznik v. Bees Ferry Assocs., 538 S.E .2d 15 (S .C. Ct. A pp. 2000 ); accord St. Paul Fire & Marine Ins. Co. v. Murray Guard, Inc., 37 S.W.3 d 180 (A rk. 2001); County v. Jensen, 83 P.3d 405 (Utah Ct. Ap p. 2003); cf. Mosher. A majo rity of jurisdictions apply the doctrine of e quitable subrogation when the subsequent mortgagee had no actual knowledge 6 of an existing lien, reasoning that the subsequent mortgagee, having paid the preexisting obligation, reasonably had expected to step into the shoes of the previous creditor. Houston v. Bank of Am. Fed. Sav. Bank, 78 P.3d 71 (Nev. 2003) (characterizin g, though declining to adopt, majority approach viewing equitable subrogation as defeated only by actual, but not constructive, knowledge of existing lien ; adopting in stead more liberal appro ach); Osterman v. Baber, 714 N.E.2d 735 (Ind. Ct. App. 1999) (same); see, e.g., Han v. United States, 944 F.2d 526 (9th Cir. 19 91); Smith v. State Sav. & Loan Ass n, 223 Cal. Rptr. 298 (Cal. Ct. App. 1985). 3 Minority Approach A minority of states, however, consider, in addition to the primary eleme nts ¶9 considered by the majority, such things as whether the subsequent mortgagee had constructive notice of intervening liens, the lender s sophistication, and the lender s negligence in failing to discover an existing encu mbrance. See, e.g., Bankers Trust C o. v. United States, 25 P.3d 877 (Kan. Ct. App. 2001) (denying equitable subrogation to negligent sophisticated lender); Carl H. Peterson Co. v. Zero Estates, 261 N.W.2d 346 (Minn. 1977) (equitable subrogation denied because o f sophistication of party seekin g subroga tion); see also Landmark Bank v. Ciaravino, 752 S.W .2d 923 (M o. Ct. Ap p. 1988) (equitable su brogation a llowed on ly in extreme cases bordering on fraud); Richards v. Sec. Pac. Nat l Bank, 849 P.2 d 606 (U tah Ct. 3 Indeed, an increasing trend is to allow subrogation notwithstanding actual knowledge of intervening liens, if the parties had intended that subrogation occur. Osterman, 714 N.E.2d at 739. 7 App. 1993) (constructive notice of mechanics lien defeats claim of e quitable subrogation); Kim v. Lee, 31 P.3d 665 (Wash. 2001 ) (constructive notice bars equitable su brogation). Restatement Approach ¶10 The Restatement sets forth an even more liberal ru le concern ing equitab le subrogation than that of the majority of jurisdictions. Section 7.6 of the Restatement states: (a) One w ho fully performs an obligation of an other, secured by a mortgage, becomes by subrogation the owner of the obligation and the mortgage to the extent necessary to prevent unjust enrichment. Even though the performance w ould otherwise discharge the obligation and the mortgage, they are preserved and the mortgage retains its priority in the hands of the subrogee. (b) [S]ubrogation is appropriate to prevent u njust enrich ment if the person seeking subrogation performs the obligation: .... (4) upon a request . . . to do so, if the person performing was promised repayment and reason ably expecte d to receive a security interest in the real estate with the priority of the mortgage being discharged, and if subro gation will n ot materially prejudice the holders of intervening interests in the real estate. Thus, under the Restateme nt, a subsequent mortgagee s negligence in failing to discover an existing lien does not preclude application of the doctrine so long as the intervening lienholders are not prejudiced. And, notice is not a consideration. Rather, the question is whether a subsequent mortgagee reasonably expected a security interest w ith the same p riority as that of the mortgage being discharged. See Restatement § 7.6(b)(4) and cmt. e; see also Houston. 8 ¶11 The rationale behind the Restatement s approach is that the intervening lienholder suffers no prejudice because its lien maintains the same position it occupied before the subsequent lender satisfied the pre-existing obligation. Restatement § 7.6 cmt. a. ( The holders of intervening interests can hardly complain about this result, for they are no worse off than before the senior obligation was discharged. If the re were no subrogation, such junior interests would be promoted in priority, giving them an unwarranted an d unjust windfall. ); see also Pappas (focus of Restatement is on whether intervening lienholders prejudiced). Arizona Approach ¶12 As this court stated in Herberman v. Bergstrom, 168 Ariz. 587, 590, 816 P.2d 244, 247 (App. 1991), [f]o r equitab le subro gation to apply, there must be an agreement, either express or implied, tha t the subseq uent lender w ill be substituted for the holder of the prior encumbrance. See also P eterman -Donne lly. In addition, the subsequent mortgagee must not be a volunteer. Id. Becau se subrogation is a creature of equity, its application may be defeated by intervening rights wh ich wou ld be prejudiced by the substitution. Id. at 326, 408 P.2d at 846. As an equitable construct, [i]t rests upon the principle that substantial justice should be attained, regardless of form. Mosher, 45 Ariz. at 468, 46 P.2d at 115. ¶13 Arizona s approach to equitable subrogation appears consistent with the Restateme nt: the doctrine will apply w hen there is a n express o r implied agre ement to subrogate, which is concordant with a party s having a reasonable expectation of receiving a security interest, and when an intervening lien claimant suffers no prejudice . See PetermanDonnelly; see also Wetherill v. Basham, 197 Ariz. 198, ¶ 13, 3 P.3d 1118, 1123 (A pp. 2000), 9 quoting Ramirez v. Health Partners of So. Ariz., 193 Ariz. 325, ¶ 26, 972 P.2d 658, 665 (App. 1998) (A rizona cou rts usually follow Restateme nt absent controlling authority, provided its application is logical, furthers the interests of justice, is consistent with Arizona law and policy, and has been g enerally acknowledg ed elsewhere. ). ¶14 Although expressly declining to set forth a general rule for the future applicability of equitable subrogation, our supreme court in Mosher nonetheless stated, when one, being himself a creditor, pays another creditor, whose claim is prefera ble to his, it is held that the person so paying is subrogated to the rights of the other creditor. 45 Ariz. at 469, 46 P.2d at 116. Th e court determined that whether the doctrine applies depends upon the particular facts and circumstances of each case as it arises, id. at 468, 46 P.2d at 115, but equitable subrogation will not be applied when the subsequent creditor is a mere volunteer. Id. ¶15 Peterma n-Donn elly, this court s most recent interpretation of Mosher, includes the following observation: Although the Mosher case indicates that an a d hoc app roach is required, the following statement . . . approxim ates a ge nerality: [A] third person , having agreed to ad vance mo ney to discharge an encumbrance on proper ty of another, where he [or she] is not a volunteer, and where payment is made under an agreement that he [or she] will be substituted in place of the holder of the encumbranc e, is entitled to subrogation, whether such agreement is express or whether such agreement is implied. Peterman-D onnelly, 2 Ariz. App. at 325, 408 P.2d at 845 (citing what is now 83 C.J.S. Subrogation § 50, p. 583-4). Although the parties dispute the import of this language, which 10 Lamb characterize s as mere dic ta, we find it persuasive when viewed in combination with the remainder of the court s analysis. Moreover, we do not find the two cases incompatible.4 In considering whether to apply subrogation, the court in Peterman-Donnelly focused p rimarily on the parties express or implied understanding and intent to subrogate and on whether any intervening rights would be prejudiced by subrogation. N either Mosher nor PetermanDonne lly requires that subrogation be denied where a subsequent creditor has actual or constructive notice of intervening liens; nor does either contain any language suggesting subrogation is inappropriate when a sophisticated lender is involved . Furthermore, Mosher s dictate, were we to apply it, that courts must consider the facts and circumstances of each individual case,5 seems mere ly to state the obv ious, that, in evaluating an equitable subrogation claim, a court mus t necessarily consider the factual and procedural framework in which the case developed. Lamb s protestations notwithstanding, nothing in Peterman-Donn elly contradicts the general language in Mosher. Having identified the appropriate parameters for applying equitable subrogation, ¶16 we now examine whether the trial court failed to properly apply it here. We find that it did. First, as Chase maintains and Lamb does not dispute, there existed at least an implied 4 Interestin gly, the trial court in its decision cited Mosher for the proposition th at the applicability of equitable subrogation depends upon the particular facts and circumstances of each individual case, bu t made no mention o f Peterma n-Donn elly. 5 We note that, immediately after refusing to promulgate a general rule, the Mosher court remarked that the modern tendency is to extend [equitable subrogation s] use rather than to restrict it and that it now has a very liberal application, its principle being modified to meet the circumstances of ca ses as they arise. 45 Ariz. at 468 , 46 P.2d at 115. 11 agreement to subrogate, reflected in the form of the loan documents and escrow closing instructions. For exam ple, the closing instructions provide that [the] title insurance policy . . . must show [Chase s] mortgage to be a valid first lien against the property. In addition, one of the conditions in the closing instructions specifically stated that the loan was to payoff the following: comm fed-$231100. It is clear and undisputed that Chase was not acting as a volunteer in paying off the CFB loan, and nothing in the record suggests its motivation was anything oth er than com mercial. ¶17 Second, we agree with Chase that the trial court erred in finding that the mechanics lienholders would be prej udiced by su brogation. In so finding , the court sim ply stated, without elaboration, that equitable subrogation would defeat the rights of other creditors who w ould be prejud iced by its application and that applying the doctrine would be inequitable. ¶18 We fail to comprehend the nature of the perce ived preju dice or ineq uity, as it appears the lienholders would re main in the same position they occupied before subrogation if that doctrine were applied. To the contrary, without subrogation, the lienholders w ould receive a windfall if elevated to a higher priority status. See Restatement § 7.6 cmt. a. The record establishes that when the lienholders agreed to perform work on the property they understood that CFB, not they, had a superior position. They therefore accepted the risk that the Torrejons would not pay them and would not pay the first lienholder, thereby defeating their liens. See E. Boston Sav. Bank v. Ogan, 701 N.E.2d 331 (Mass. 1998). Furthermore, although the lienholders e mphasize C hase s allege d negligen ce, they offer n o concrete 12 example of how subrogation would prejudice their interests other than characterizing themselves as truly innocent intervening lienholders who, if subrogation is denied, will be paid for the wo rk they have already performed and nothing else. Lamb s contentions rest solely on theoretical policy arguments and fail to demonstrate how applying the criteria stated in Mosher and Peterma n-Donn elly supports the trial court s gran t of summary judgmen t in its favor. ¶19 In denying equitable subrog ation, the trial court cited the difference in terms between the CFB and Chase loans as an important factor in its decision, suggesting that, from the court s perspective, the lien claimants would have been prejudiced by the implementation of the Chase loan terms, w hich differed from the terms of the o riginal CFB financing. Howeve r, it is well settled in A rizona that, w hen equita ble subrogation is ap plied, its application is limited to the extent of the prior lien only. See Mosher; Restateme nt § 7.6 cm t. e. Peterma n-Donn elly does not suggest otherwise. The Mosher court recog nized the limits of subrogation, stating, the doctrine . . . cannot give any greater rights to the subrogee than a re held by the person to whose rights he is subrogated. According to the Restatement, [t]he payor is subrogate d only to the ex tent that the funds disbursed are ac tually applied toward payment of the prior lien. There is no right of subrogation with respect to any excess funds. Restatement § 7.6 cmt. e. The Restatement also recognizes that when a lender, such as Chase, demands a higher inte rest rate than that under the prior loan, the intervening lienholders may be jeopardized. In this situation, [s]ubrogation should be granted only to the extent of the debt balance that would have existed if the interest rate had been unchanged. Id. While 13 emphasizing that the terms of the two loans differed, Lamb has failed to explain precisely how it is prejudiced by that difference. Indeed, Chase readily concedes that its lien can only be subrogated to the extent of the [CF B lien]. Thus, if Chase is only subrogated to the extent of the original loan, the lien claima nts can hard ly claim they will be prejudiced. We see no reason to deny equitable subroga tion on this basis. ¶20 Finally, we briefly address the trial court s statement that Chase had constructive notice of the potential for the filing of a mechanic s lien[] again st the property when it made the loan. (Emphasis added.) Significantly, when Chase recorded its deed, no mechanics liens had yet been recorded. Thus, in addition to imposing an improper constructive-notice requirement, the trial court also impliedly charged Chase with notice of mechanics liens not then in existence, based purely on the future possibility of such liens. Cf. Richards (commencemen t of visible work imparts constructive notice of lien). Regardless, the court s findin g is irrelevant, given our determination that constructive notice is not an element of equitable subrogation under A rizona law . This con clusion is also consistent w ith those of the majority of jurisdictions that have addressed the issue. See, e.g., Han; Smith; Osterman; Dodge City of Spartanburg, Inc. v. Jones, 454 S.E.2d 9 18 (S.C. Ct. A pp. 1995). Disposition ¶21 We reverse the grant of summary judgment in favor of Lamb and remand the case to the trial court for further proceedings consistent with this opinion. Both parties have requested attorney fees on appeal, and Chase also has requested attorney fees incurred at the trial level. In view of Chase s failure to provide any substantive basis for an award of fees, we 14 decline to grant its requests. See In re Wilcox Revocable Trust, 192 Ariz. 337, 965 P.2d 71 (App. 1998 ). ¶22 Reversed and remanded for further pro ceedings. PHILIP G. ESPINOSA, Acting Presiding Judge CONCURRING: PETER J. ECKER STROM, Judge JOSEPH W. HO WARD, Judge 15

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