Posting for

Monday, March 12, 2001

by: Bert Rush

brush@firstam.com

VENDEES' LIENS/MORTGAGE LENDERS/RECORDING ACTS/CONSTRUCTIVE NOTICE/OPTIONAL ADVANCES

The Supreme Court of New Jersey has held that a purchaser/vendee of land, under an unrecorded contract which also provides that the seller/vendor will construct a residence on the land before delivering a deed, is entitled to a vendee's lien against the land for payments made to the vendor before closing; and this vendee's lien is entitled to priority over a subsequent construction mortgage given to a lender with actual notice of the unrecorded contract, but only to the extent that vendee payments were obligatory.

However, since this is a case of first impression, and the law was previously unclear, the Court makes its holding "prospective"--in this case allowing the vendee priority for all payments made.

The case is Cox v. RKA Corporation, 753 A.2d 1112 (2000). Here are the details.

Harry and Betty Ann Cox contracted with RKA Corporation to purchase real property in Pennsuken, NJ, on which RKA would construct a new home before delivering the deed. The purchase price was $106,880, payable with an initial installment of $12,000 and the balance due "at settlement." This contract was not recorded.

Weeks later, and unbeknownst to the Coxes, RKA sought a construction loan from Roebling Savings and Loan Association in the amount of $80,250. In applying for the loan, RKA showed the Cox contract to Roebling, as proof the property was "pre-sold."

On October 21, 1994, RKA closed the construction loan, giving Roebling a mortgage against the property. At the same time, the principal of RKA, one Richard Niel, signed an affidavit of title certifying that "no other persons have legal rights in this property." Roebling did not attempt to contact the Coxes or make them aware of its mortgage.

Roebling made an initial advance to RKA of $43,335. Later, on December 12, 1994, Roebling made a second advance of $30,896. Two days later, on December 14, 1994, Roebling recorded its mortgage.

Meanwhile, construction lagged. RKA asked the Coxes for more money--which technically they weren't required to pay until closing on their new home. Nevertheless, between January 3 and August 3, 1995, the Coxes paid RKA a total of $71,225 in additional advances.

Apparently construction halted before completion, for on November 28, 1995 the Coxes filed suit against RKA for specific performance. RKA defaulted on its loan from Roebling, and Roebling commenced foreclosure. The Coxes amended their complaint to add causes of action for breach of contract, fraud, etc. against RKA and its principal, Richard Niel, as well as causes of action against Roebling, seeking to avoid the Roebling mortgage or, alternatively, to have the court declare a lien against the property in favor of the Coxes--and prior to the Roebling mortgage--to secure repayment of their advances of $12,000 (the obligatory advances) plus $71,225 (the optional advances).

The trial court entered default judgments against RKA and Niel, and ruled that the Coxes would have an equitable lien against the property to recover all advances paid to RKA, with priority for this equitable lien over the Roebling mortgage. The trial court said the Cox lien was entitled to priority because Roebling was aware of the Cox contract when it made its loan.

Roebling appealed, and the court of appeals affirmed. The appeals court particularly noted Niel's affidavit ("no other persons have legal rights in the property"), which the court said was a lie under oath that should have caused Roebling to contact the Coxes. Had it done so, the later advances totaling $71,225 might not have been made. This factor, said the court, tipped the scales of equity in favor of the Coxes.

Roebling appealed again, to the Supreme Court, and the Supreme Court affirmed--mainly.

The Supreme Court first explained that its task was to reconcile the equitable notion of a vendee's lien with state recording statutes.

The Court began its analysis with a discussion of the history and rationale for the vendee's lien, under common law and New Jersey case law (as far back as 1830).

The Court explained that, under the doctrine of equitable conversion, a vendee under a contract to purchase land becomes the equitable owner of the land at the time the contract is entered into. This is because of the recognized uniqueness of land and inadequacy of money damages to compensate the vendee in the event the vendor fails to deliver a deed (i.e., the legal rationale for the cause of action for specific performance). So, upon execution of a contract the vendee becomes the equitable owner of the land and the vendor holds bare legal title, as a trustee for the vendee.

Consistent with this, any payment by a vendee (such as a down payment) gives rise to a lien against the land--the so-called "vendee's lien"--to secure repayment to the vendee if the conveyance is not be completed.

Against this "common-law backdrop," the Court said, "the Legislature has enacted New Jersey's recording statutes." In New Jersey, as in most other states, the recording acts create a "race-notice" jurisdiction--in which it is said that the first to record without notice of competing interests is entitled to priority. And, once an interest is recorded, constructive notice of the interest is imparted to 'the world.' The Court stressed the importance of the recording statutes to the "integrity of the recording scheme."

In this case, the Court said it was clear that the Coxes should have a vendee's lien. "What is not so clear," said the Court, "is how to determine the priority or value of plaintiffs' lien vis-à-vis Roebling's recorded mortgage." Citing an article at 82 A.L.R.3d 1040 (1978), the Court said other jurisdictions are not uniform in their approach to these issues, and there was no New Jersey case reasonably "on point."

But after reviewing two cases (from Missouri and Maryland), the Court concluded that the Coxes should have a lien prior to the Roebling mortgage to the extent of their $12,000 obligatory advance to RKA, only, and junior to the Roebling mortgage to the extent of their $71,225 in optional advances. In so holding, the Court noted that Roebling was aware of the Cox contract when it made its loan, but after recording its mortgage it should be entitled to the protections of the recording statutes. In other words, once the Roebling mortgage was recorded, the Coxes were chargeable with constructive notice of it --and should be subject to it when making their subsequent optional advances.

Having said all this, and mindful of a strong dissent to the majority opinion, the Court said its holding in this case should be enforced "prospectively," only. In light of prior uncertainty of the law, it would be inequitable for the Coxes to "be required to bear the consequences of this decision."

With that, the Court affirmed the court of appeals decision awarding the Coxes a vendee's lien with priority for all of their advances to RKA, saying, "(i)n all subsequent matters, whose operative facts arise after the date of this opinion, we will apply a rule of law consistent with our holding here."

One Justice (Stein) concurred with the result, but dissented as to the Court's holding--criticizing the majority for elevating the recording statutes in importance above the law of equity. In doing so, Justice Stein said the majority fashions a rule that is unique to New Jersey, and unduly burdensome for contract vendees.

This dissent is recommended reading. In it, Justice Stein covers the subjects of equitable conversion, vendee's liens, and subordination agreements, suggesting that previous cases in the majority of states have not recognized a distinction between obligatory and optional advances because the distinction should have no bearing on enforcement of a vendee's lien.

Instead, the Justice looks for an appropriate analogy to the situation where a lender with a recorded mortgage, under which future advances are optional, is asked to make an optional advance. Under the laws of most states, a first mortgagee making an optional advance is entitled to priority for the advance unless it has actual notice of an intervening lien or interest. And, lenders are not held to constructive notice of recorded junior interests in this situation.

For example, a first mortgagee records its mortgage in 1995. The mortgage secures repayment of funds advanced at the time it was executed and delivered (in a maximum stated amount), plus any future advances that might be made at the lender's discretion. In 1997, the borrower requests an additional advance of $10,000. If the first mortgagee has no actual notice of a junior lien or mortgage against the security property, it may make the advance and be entitled to include the amount of the optional advance in the balance secured by the first mortgage. The first mortgagee is not required to search the land records before making the optional advance, and is not held to constructive of what such a search would have disclosed.

As said above, this is the law in most states--and was also the law in New Jersey until 1982. In 1982, however, the Chancery Division handed down a decision in Lincoln Federal Savings and Loan Association v. Platt Homes, Inc., 449 A.2d 553, that departed from prior case law in holding that (according to the dissent) "the recording statutes required that constructive notice 'be on a par with actual notice' when determining the effect of constructive notice of intervening liens of (on?) optional advances."

This, the dissent implies, may be the source of the majority's inclination to give lenders greater protection under the recording statutes vis-a-vis the vendee's lien. In any case, the dissent is critical of the majority holding as an unnecessary departure from the well established majority rule (that makes no obligatory vs. optional distinction).

Instead, Justice Stein says that a lender wishing to establish priority over a vendee's lien should obtain a subordination agreement from the vendee, before making its loan.

Otherwise, the dissent argues, vendees are saddled with an unreasonable burden--having to search the land records "from day to day"--before making optional advances.

Comment: This very interesting decision contains a spirited debate between the majority (five justices) and the lone dissenter. In fact, a goodly portion of the majority opinion is devoted to a pre-emptive rebuttal of points raised in the dissent. Fun reading.

These issues are not unheard of in our claims experience. In the case of BancFlorida v. Hayward, 689 So.2d 1052 (Fla.Sup.Ct. 1997), First American successfully defended its insured construction lender against competing vendees' lien claims--but only to the extent the insured lender's loan proceeds had been used to acquire the land. As to additional loan proceeds, used for construction, our lender was denied priority.

Title underwriters should be mindful of the potential for vendees' liens in connection with construction loans for "pre-sold" property. Arguably, this may not be a matter automatically excluded from coverage as "created, suffered, assumed or agreed to" by the lender, or as "post-policy."

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Following Monday's posting, Frank Melchior (Iselin, NJ) writes:

Attached is a copy of an article I wrote for The Advocate, the NJLTA magazine (Vol XII, #3, Sept. 2000), re the above case. (URL below.)