Washington courts have applied the doctrine of equitable subrogation in many contexts. The doctrine is typically applied where one party has answered for the debt of another, usually by one creditor paying another creditor. The doctrine effectively operates as an equitable assignment to the party who has paid the debt, entitling that party to step into the shoes of the parties’ interest they have paid (and maintain the priority of the corresponding lien interest) in order to prevent unjust enrichment of the debtor or another creditor. A traditional requirement of this rule is that the party seeking equitable subrogation must have acted under some duty or compulsion, and not acted as a volunteer or intermeddler.[i] The requirement that the party seeking equitable subrogation be acting to protect its interest has often been referred to as the “volunteer rule” or “volunteer exception” to application of the doctrine.
Recently, the Washington Supreme Court revisited the doctrine of equitable subrogation in the case Columbia Community Bank v. Newman Park, LLC. In 2004, Newman Park LLC (“Newman Park”) purchased a Thurston County property. To pay for the property, Newman Park obtained a loan for around $400,000 from Hometown National Bank which was secured by a deed of trust on the property. Newman Park consisted of 12 members, including Landmark Development Ventures (“Landmark”), which held a 39% interest in Newman Park.
In 2008, Landmark went to a different bank, Columbia Community Bank (“CCB”), and took out a $1.5 million loan without the knowledge or permission of the other owners of Newman Park. CCB required that Landmark use the proceeds from the new loan to pay off the existing loan to assure that CCB would have a first priority lien position on the property. To CCB’s demise, Landmark had no authority to refinance the property, as Landmark’s operating agreement required that 80% of the membership approve any such transaction. CCB was unaware that Landmark lacked the authority to enter into the transaction. After a default on the loan, CCB took action to foreclose and Newman Park’s investors objected that they had not consented to CCB’s security interest on the property, and argued that CCB was a “volunteer” and thus could not benefit from the doctrine of equitable subrogation.
After discussing Washington’s historical treatment of the doctrine of equitable subrogation, the Supreme Court rejected the traditional volunteer rule, and noted that the doctrine can be applied when a party has been induced to discharge another obligation by misrepresentation, mistake, duress, undue influence, deceit, or some other similar imposition provided that there was not any prejudice to an innocent person. The Court affirmed the decision to equitably subrogate CCB’s deed of trust to the extent of the original lienholder’s position because applying equitable subrogation would not prejudice Newman Park (it was in the exact same position as it would have been had CCB never paid off the loan).
While the doctrine of equitable subrogation is most often applied in the mortgage context, there are instances where the principles of the doctrine can potentially affect priority of construction liens, most often where a neglectful second lender is unaware of the intervening interest of a contractor. This was discussed in the January 31, 2013, blog entry found here.
Also of note in the opinion was the Supreme Court’s strong statement regarding the broad equitable powers possessed by Washington courts:
The goal of equity is to do substantial justice. Equity exists to protect the interest of deserving parties from the “harshness of strict legal rules.” Washington courts embrace a long and robust tradition of applying the doctrine of equity.
While at first glance this statement seems to give a court the power to do whatever it would like based upon the facts of the case, there are limits on a court’s equitable power. A typical example of this is in the construction lien context where courts have repeatedly held that equity cannot remedy a party’s failure to comply with the perfection requirements of the lien statute.[ii] In other words, contractors better be sure to comply with the requirements of the construction lien statutes in Washington, because in the context of construction liens, courts typically lack the equitable authority to relieve lien claimants from the “harshness of strict legal rules” if a contractor has blown its lien rights.
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[i] See BNC Mortgage, Inc. v. Tax Pros, Inc., 111 Wn. App. 238, 254, 46 P.3d 812 (2002).
[ii] See e.g., Van Wolvelaere v. Weathervane Window Co., 143 Wn. App. 400, 409, 177 P.3d 750, 754 (2008) (noting, “[t]he Mechanics’ and Materialmen’s Liens statute must be strictly construed, and equitable considerations cannot ameliorate its effects.”)