A person can be substituted in place of another so as to have all rights and obligations pertaining to a lawful claim, demand, or right against a third party. This right is called subrogation and is an equitable doctrine. A person can satisfy his/her loss that is created by the wrongful act or omission of another person by stepping into the shoes of another and recovering on the claim from the wrongdoer. Interstate Fire & Casualty Ins. Co. v. Cleveland Wrecking Co., 182 Cal. App. 4th 23 (Cal. App. 1st Dist. 2010).
The primary purpose of subrogation is to obtain reimbursement to the person who advanced payment (“subrogee”) for the payments made by that person with respect to a legal claim. Rosenbaum v. Goodman, 78 Va. 121 (Va. 1883). Note that the subrogee must have given some consideration to occupy that role and cannot have more rights than the person for whom the subrogee is being substituted. A person cannot claim rights by subrogation from another which exceed the rights that said person possessed. Home Ins. Co. v. Smith, 235 Mo. App. 552 (Mo. Ct. App. 1940). Once achieved, the subrogee becomes the party who advances the claim and has all rights to prosecute or settle said claim, subject to all the defenses that the opposing party could have advanced against the original claimant.
The Basic Law:
There are three types of subrogations:
- Legal subrogation: a legal subrogation which arises by operation of law. It is an equitable subrogation that can take effect with or without a contract. In re Eastern Marine, Inc., 104 B.R. 421 (Bankr. N.D. Fla. 1989). Note that normally, legal subrogation cannot be used to displace a contract agreed upon by the parties. A legal subrogation can be modified or terminated by a contractual agreement.
- Conventional subrogation: a conventional subrogation is a right flowing from a contract. National Union Fire Ins. Co. v. Riggs Nat’l Bank, 646 A.2d 966 (D.C. 1994). It normally arises when one individual satisfies the debt of another as a result of a contractual agreement which provides that any claims or liens that exist as security for the debt be kept alive for the benefit of the party who pays the debt. It is necessary that a conventional subrogation agreement should be supported by consideration. However, it does not have to be in writing and can be either express or implied. Usually, insurance payments vest to the insurance company the rights of the insured once payment from the insurance company is made and this is the subrogation most commonly known.
- Statutory subrogation: a statutory subrogation arises by an act of legislature. In re Stratford Lamps, Inc., 120 B.R. 31 (Bankr. W.D. Pa. 1990). The act usually vests a right of subrogation with a party or category of parties. It is governed by the terms of the statute under which it is claimed as a matter of statutory construction.
Examples of Subrogation and Limitations on Subrogation:
Preexisting Debt: The right of subrogation is not available when a person pays a debt that s/he is already obligated to pay based on an obligation already owed. The right of subrogation is not available to a person who is simply paying his/her own debt. And subrogation is not applicable to “volunteers” who, without any moral or legal duty, pay the debt of another. When a person pays the debt of another without any assignment or agreement of subrogation, s/he can be considered such a “volunteer”. Hulen v. Hamilton, 2008 Tex. App. LEXIS 1672 (Tex. App. Fort Worth Feb. 28, 2008). When a person pays the debts of another by mistake, s/he is in the same position as a volunteer. According to equitable subrogation, the responsibility of a mistake can determine the results of the mistake. Martin v. Hickenlooper, 90 Utah 150 (Utah 1936).
Guaranty and Insurance: Further, when dealing with insurance or guaranties, generally, a right to subrogation does not accrue in favor of a surety until the surety has performed its own contractual obligation. See more on this topic discussed below.
Real Estate Payments: Regarding real estate, a person who has an interest in a property can pay the taxes and the assessment that are due from another on the land. In doing so, the person is subrogated to the lien of the state or of the public taxing bodies. Willmon v. Koyer, 168 Cal. 369 (Cal. 1914). Generally, such rights of subrogation are statutorily granted. But note to avoid being a volunteer, when there is no written agreement for subrogation, no person can pay the taxes or the assessment on a property in which that person has no interest. Pacific Tel. & Tel. Co. v. Pacific Gas & Electric Co., 170 Cal. App. 2d 387 (Cal. App. 1st Dist. 1959). If there is no prior agreement, subrogation can be denied even if the party paid the taxes at the request of the owner of the property. Employees’ Bldg. & Loan Ass’n v. Crafton, 63 Okla. 215 (Okla. 1917).
A person who pays a mortgage when the original debtor fails to pay can get all the rights under the doctrine of subrogation. However, many courts hold that to obtain subrogation rights, the entire mortgage should be paid off by the person. Merchants’ Ins. Co. v. Herber, 68 Minn. 420 (Minn. 1897). The person must also have an interest over the property mortgaged. A person cannot invoke the rule of subrogation favorably without an agreement of subrogation, unless fraud, mistake, or some other consideration is shown. Stroh v. O’Hearn, 176 Mich. 164 (Mich. 1913). However, when a person has an interest in the property, the person can hold the subrogation rights of a creditor when the person has lent money for the property.
Equitable Subrogation and Its Usual Requirements:
Subrogation does not flow from any fixed rule of law. The principle to be derived from the doctrine of subrogation is that it is a product of equity or “fairness.” Subrogation results from the natural justice of placing the burden where it ought to rest. Like other equitable doctrines, subrogation depends upon the facts and circumstances of each particular case. Moreover, it is a device adopted or invented by equity to compel the ultimate discharge of a debt or obligation upon the person who in good conscience ought to pay the debt. Home Owners’ Loan Corp. v. Parker, 181 Okla. 234, 235 (Okla. 1937).
A person claiming to be equitably subrogated to the rights of a secured creditor must satisfy certain prerequisites or conditions. The conditions are:
- Payment must be made by the subrogee to protect his own interest;
- The subrogee must not have acted as a volunteer;
- The debt paid must be one for which the subrogee was not primarily liable;
- The entire debt must have been paid; and
- Subrogation must not work any injustice to the rights of others.
Morgan Creek Residential v. Kemp, 153 Cal. App. 4th 675, 690 (Cal. App. 3d Dist. 2007).
The purpose of equitable subrogation is to place the burden for a loss on the party ultimately liable or responsible for debt. The burden must be on the person who should have discharged the debt. Moreover, subrogation relieves entirely the insurer or surety who indemnified the loss and who is not primarily liable for the debt. Morgan Creek Residential v. Kemp, 153 Cal. App. 4th 675, 695 (Cal. App. 3d Dist. 2007).
Subrogation is allowed only in favor of parties who pay the debt of another. There can be no right of subrogation when one pays a debt which s/he is already obligated to pay. Bank of Marlinton v. McLaughlin, 123 W. Va. 608 (W. Va. 1941).
A volunteer, stranger, or intermeddler is one who thrusts himself or herself into a situation on his own initiative. The doctrine of subrogation is not applied for the mere stranger or volunteer who has paid the debt of another. The volunteer making payment has no right or interest of his/her own to protect. A volunteer cannot invoke the aid of subrogation, for such a person cannot establish equity. BMW Fin. Servs., NA, LLC v. Bill Heard Enters. (In re Bill Heard Enters.), 423 B.R. 771, 783 (Bankr. N.D. Ala. 2010). A volunteer makes payment upon request or as a surety, or under some compulsion made necessary by the adequate protection of his or her own right. Payment by a volunteer operates as an absolute discharge of the debt. Additionally, a person discharging an encumbrance upon property in which s/he has no interest in having relieved is not subrogated to the rights of the holder of the encumbrance. Moreover, loaning of money to discharge a lien does not subrogate the lender to the rights of the lien holder. BMW Fin. Servs., NA, LLC v. Bill Heard Enters. (In re Bill Heard Enters.), 423 B.R. 771, 783 (Bankr. N.D. Ala. 2010)
A subrogee stands in the shoes of a subrogor only to the extent subrogee has made payments. A surety liable only for part of the debt does not become subrogated to collateral. Such a surety cannot seek remedies available to the creditor until s/he pays the whole debt. It is not necessary that the debt itself is satisfied. Satisfaction can be through the other modes also. National Surety Corp. v. Cherokee County Bank, 57 F. Supp. 370, 372 (D. Ala. 1944).
Subrogation and Sureties and Guaranties:
The reader should review our article on guaranties. In finance, a surety or guarantee is a promise by one party to assume responsibility for the debt or obligation of a borrower if the borrower defaults. The person or company that gives such promise is known as a surety or guarantor. In the case of a principal’s failure to make payment, the surety is asked to pay the debt. On making such a payment, the law will usually give the surety a right of subrogation. By subrogation, a surety is allowed to step into the shoes of the principal and use the surety’s contractual rights to recover the cost of making payment. The surety is entitled to recover the cost even in the absence of an express agreement to that effect between the surety and the principal. When a guarantor or a surety makes good the default of his/her principal, by discharging the obligation of the principal, the surety is generally subrogated to the rights of a creditor or obligee.
The right of a surety to subrogation exists independently of statute. However, some statutes define the right. They usually only declare the existing rules in equity. King v. Hartford Acci. & Indem. Co., 133 Cal. App. 711 (Cal. App. 1933). A surety is entitled to the benefit of every security for the performance of the principal obligation held by the creditor at the time of entering into the contract of suretyship. In the case of a suretyship, the right of subrogation arises when a surety completes his/her contractual obligation. The right is not dependent on an assignment, lien, or contract. A subrogation right is not a security right and hence does not require conformity with the filing requirements under the Uniform Commercial Code. State Bank & Trust Co. v. Insurance Co., 132 F.3d 203, 206 (5th Cir. Tex. 1997).
A surety’s right of subrogation does not exist beyond the extent necessary to reimburse itself for expenditures made in fulfilling its obligations on a surety bond. In construction bonds often utilized on construction projects and which can involve mechanics liens, the subrogation rights of the surety on a contractor’s performance bonds begin on the date of the execution of the bond. To maintain a claim for equitable subrogation, a surety must take over contract of performance. Additionally, a surety can finance the completion of the defaulted contract under the performance bond.
The right of a surety discharging the obligation of his/her principal to be subrogated may depend on his/her legal status as a surety. A compensated surety is discharged without the surety’s consent, when there has been a material modification in the creditor-debtor relationship. The modification must substantially increase a surety’s risk. However, no distinction in respect to subrogation can ordinarily be made between compensated and gratuitous sureties. Even when the suretyship is one for compensation, it will not deprive the surety’s right of subrogation.
The doctrine of subrogation goes to the extent of giving to the surety the benefit of the rights and remedies of the creditor against all persons who were liable for the debt. This is especially held to be true of the sureties of a fiduciary who are compelled to answer for his breach of trust against the fiduciary and those participating in the wrongful act. American Bonding Co. v. National Mechanics’ Bank, 97 Md. 598, 606 (Md. 1903) In Hall v. Windsor Sav. Bank, 97 Vt. 125, 134 (Vt. 1923), the court observed that, “whenever the surety of a fiduciary is compelled to answer for the latter’s breach of trust, he succeeds to the rights of both the fiduciary and the cestui”.
Subrogation and Mortgages:
A person, who pays a mortgage when the original debtor fails to pay, can obtain all the rights under the doctrine of subrogation. However, the entire mortgage should be paid off by the person. Merchants’ Ins. Co. v. Herber, 68 Minn. 420 (Minn. 1897). The person must also have some type of an interest over the property mortgaged. The person paying the debt will be substituted in the place of the original creditor. The person providing the sums can enforce the security over the original debtor for reimbursement. Usually, the person paying the sums is a person paying a mortgage to protect his/her own interest in the property or because s/he is secondarily liable for the debt or for the discharge of the lien.
Note that if the borrower used the proceeds of the loan to discharge a prior unrelated encumbrance, it is not a sufficient reason to entitle the new lender to subrogation. There should be ample proof that the new loan from the subrogor was made for the right purpose. Gower v. State Tax Com., 207 Ore. 288 (Or. 1956)
When a subsequent mortgagee substitutes a prior mortgage by a subsequent mortgage, courts apply equitable subrogation only after determining the following factors:
- the subrogee made payment to protect his/her own interest,
- the subrogee did not act as volunteer,
- the subrogee was not primarily liable for the debt paid,
- the subrogee paid off the entire encumbrance, and
- subrogation would not work any injustice to the rights of a junior mortgage holder.
However, courts can grant rights under the doctrine of subrogation even where one or more of factors is absent. Hicks v. Londre, 125 P.3d 452 (Colo. 2005). A court determining whether to apply equitable subrogation to a mortgage must examine the actions of the subrogee. The degree of knowledge attributable to a subrogee concerning the existence of the intervening mortgage may nullify equitable subrogation. Wells Fargo Bank, N.A. v. Nat’l Lumber Co., 76 Mass. App. Ct. 1 (Mass. App. Ct. 2009)
When a third party pays off an encumbrance on a mortgaged property based on a contract, the right to subrogation can be granted. The agreement should provide that a new mortgage can be executed by the person paying the mortgage. A person cannot invoke the rule of subrogation successfully without a contract of subrogation, unless fraud, mistake or some other consideration is shown. Stroh v. O’Hearn, 176 Mich. 164 (Mich. 1913). However, when a person has interest in the property, the person can obtain the subrogation rights of a creditor when the person has lent money for the property.
In certain cases, when the security taken for a loan turns out to be invalid, the party advancing the money will be subrogated to the rights of the holder of the lien. Therefore, subrogation can also be allowed when a security fails due to lack of authority or capacity.
When one person in good faith lends money to another for security of a mortgage to discharge a property titled to the borrower, the person lending the money can have subrogation rights that the mortgagor had against the parties claiming title to the property. When a person holding a junior mortgage advances money to secure a prior mortgage, that person is entitled to the subrogation rights of a senior encumbrance. Texas Commerce Bank Nat’l Asso. v. Liberty Bank, 540 S.W.2d 554 (Tex. Civ. App. Houston 14th Dist. 1976). However, the entire debt must be cleared by the junior lien holder. (This is necessary because when there is a threat of foreclosure, a senior lien can eliminate a junior lien and therefore a junior lien holder can reinstate the loan by making a payment sufficient to cure the default or to pay off the senior lien and become subrogated to the rights of the senior lien holder.)
Purchasers who pay liens on a property can also be granted subrogation rights. An assignee of a mortgage cannot obtain subrogation rights for amounts advanced to pay off a second mortgage. This is because there is no relation between principal and surety, or guarantor, or other relation between the parties to give rise to such a right. However, subrogation does not apply to a purchaser who buys a property without prior knowledge about a lien. Taxel v. Chase Manhattan Bank (In re Deuel), 361 B.R. 509 (B.A.P. 9th Cir. 2006).
Subrogation is an invaluable tool for those seeking to protect their economic interests by assuming or guarantying other’s obligations. It is part of almost every insurance contract, including health insurance that is provided for accidents. To those considering guarantying the debt of another, obtaining subrogation rights is a vital aspect of the economic protection you should impose in your contractual subrogation documents.
Above all, it is vital to have a good agreement for subrogation if at all possible, including clauses as to payment of costs and attorneys fees to the prevailing party and possibly arbitration to enforce the subrogation rights if necessary. Above all remember that if you are enforcing subrogation rights, your claim is no better than the rights you have assumed. Due diligence is thus required to determine just how much real security you will achieve.