“I Want My (Former) Property Back!”: Lien Priority, Merger, Subrogation and the Victory of Full Faith and Credit and Equitable Principles
There is nothing quite like an old-fashioned legal battle over a parcel of valuable land. Add to it the sorting-out of lien priorities, sprinkle in the edicts of a bankruptcy court order, and you have the makings of a case that fosters real forensic creativity in the parties’ claims. On appeal from the Circuit Court of Fairfax County (“trial court”), in Thoburn Ltd. Partnership v. Brisa Fund LLLP, 2019 LEXIS 27 (Va. Sup. Ct., October 24, 2019), the Virginia Supreme Court adjudicated just such a case in a unanimous unpublished opinion.
Thoburn Limited Partnership (“TLP”) initially owned the Vienna, Virginia property and thrice borrowed against it. In 1989, TLP’s general partner, John Thoburn (“Thoburn”), borrowed $320,000 and secured it with a deed of trust (“DOT 1”). Wilmington Savings Fund Society (“Wilmington”) held DOT 1 at all relevant times. In 2009, TLP borrowed $185,000, securing it with “DOT 2,” held by Brisa Fund, LLLP (“Brisa”). In 2011, Thoburn borrowed an additional $180,000 and secured it with “DOT 3,” also held by Brisa.
By early 2012, TLP and Thoburn defaulted on the loans and TLP filed for bankruptcy. During those proceedings, TLP settled easement-related issues with Oakcrest School (“Oakcrest”), an adjoining landowner. The settlement agreement allowed Oakcrest to purchase from TLP several rights-of-way (ROWs) on the subject property.
The bankruptcy court approved the settlement in an Approval Order, which order (1) allowed the ROWs to be transferred free of liens, and (2) “provided that the proceeds from the settlement would be substituted for the ROW property as collateral for the lienholders.” The Approval Order further provided that the proceeds would be escrowed and could not be “spent or otherwise distributed absent” the parties’ agreement or an order from “a court of competent jurisdiction.”
The Approval Order incorporated the escrow agreement and directed that the liens upon the property “shall attach to the net proceeds of the sale of the ROWs in the order of their priority, with the same validity, force and effect as they now have[.]” After the proceeds of Oakcrest’s ROWs purchase entered escrow, the bankruptcy court dismissed TLP’s petition.
In 2016, DOT 3’s substitute trustee foreclosed on the property. Brisa contracted to purchase it for $50,000, subject to “liens, encumbrances, and rights, actual or inchoate,” of superior priority to DOT 3. Prior to closing, Brisa assigned its purchase contact rights to Hunter Mill Vista, LLC (“Hunter Mill”), “a corporation created by Brisa.” Hunter Mill then closed on and took title to the property.
A year later, Brisa, Hunter Mill, the escrow agent and DOT 3’s substitute trustee (“Creditors”) filed a declaratory judgment action. The Creditors requested that the trial court judicially direct the escrow agent “to distribute the proceeds from the ROWs to the lienholders according to their priority and a declaration that TLP had no entitlement to those proceeds.”
TLP filed a counterclaim for declaratory relief (1) claiming “merger and/or extinguishment of DOT 2 upon Brisa’s” contract to purchase the property at the foreclosure sale; and (2) that TLP should be “subrogated to Wilmington’s rights under DOT 1 if the proceeds held in escrow fully satisfied the amount due on DOT 1, or (3) that TLP “would be equitably subrogated to Wilmington’s rights under DOT 1 if TLP paid ‘the difference between the indebtedness and the amount satisfied by the funds held in escrow.’” Finally, TLP requested (4) that the trial court order Wilmington to foreclose on the property before entering any order “requiring distribution of the funds held in escrow to the lienholders.”
The trial court ruled for Creditors and granted them declaratory relief. It ruled against TLP’s counterclaims and dismissed them. TLP appealed and the Supreme Court granted an appeal on the assigned errors arising from TLP’s counterclaims. The Court affirmed the trial court.
TLP first asserted that the trial court “erred in setting a specific amount due and owing” under DOT 1, asserting that “there was no affirmative request for the relief” and that “the relief was not necessary” to the trial court’s ruling. To resolve this claim, the Court first noted that TLP’s counterclaim sought subrogation “to Wilmington’s rights” through a trial court declaration that “the amount in escrow fully satisfied the amount of the indebtedness secured by DOT 1 and if it did not, that TLP could pay ‘the remainder of Wilmington’s indebtedness, the difference between the indebtedness and the amount satisfied by the funds held in escrow,’ and thereupon be subrogated to Wilmington’s rights.”
The Court then reasoned that the “indebtedness” to which TLP’s counterclaim referred was “the amount TLP owes Wilmington on the debt secured by DOT 1. Thus, the relief requested by TLP required the circuit court to determine the amount owed on the lien created by DOT 1…TLP cannot seek such relief…in its counterclaim and then argue on appeal that the circuit court did not have authority to determine the amount of debt secured by DOT 1.” The Court reiterated the Virginia law rule that a party “cannot ‘approbate and reprobate’ – it cannot occupy inconsistent positions within the same litigation.”
TLP further asserted that the trial court erroneously failed to require “‘the secured parties to look to the land first for satisfaction of their liens prior to…ordering distribution of the funds held in escrow.” The Court rejected this claim, recalling that the bankruptcy court’s Approval Order directed that the secured liens “shall attach to the net proceeds” of the ROWs sale “in the order of their priority[.]” As a result, both “the Full Faith and Credit Clause of the United States Constitution and Code §8.01-389(B) ‘require Virginia courts to give full faith and credit to the judicial proceedings of…federal courts.’” The Creditors therefore were not required to foreclose on the property “prior to asserting a claim to the escrowed proceeds held as security for their loans to TLP.”
Turning to TLP’s merger and extinguishment counterclaims, the Court drew upon a number of equitable principles to guide its analysis. TLP claimed that the trial court “erred as a matter of law in ruling that merger required the showing of intent on behalf of the merging party,” and that the trial court “abused its discretion in refusing to equitably merge and extinguish DOT 2 because of Brisa’s purchase” of the property at the foreclosure sale.
The Court stated that the “merger doctrine deals with extinguishing a previous contract by an instrument of higher dignity, the deed…‘When one acquires absolute title to property which secures his debt, in the absence of evidence showing a contrary intention it is presumed that he intended to merge his secured interest into the legal title acquired…If the intention not to merge has been expressed, however, it controls…Whether a party has expressed intention to merge is an issue of fact.”
The Court noted that Brisa’s sales contract “stated that title to the [p]roperty would be transferred subject to ‘liens, encumbrances, and rights, actual or inchoate, having priority over’” DOT 3. And additionally, “Brisa transferred its sales contract to Hunter Mill,” a separate corporate entity, and Hunter Mill took title to the property. The Court found that these facts “clearly supported” the trial court’s “conclusion regarding Brisa’s intent” against any merger.
Further, the Court noted that a “court of equity will refuse to merge a debt and a property acquisition ‘if that is required by the outstanding claim of a third party or is necessary in view of the proprietor’s own situation.” Here, “[a]pplication of the merger doctrine would have left Brisa without possible recourse to recover…its security interest in the sales proceeds.” Thus, the trial court properly rejected TLP’s merger claims.
To resolve TLP’s subrogation claim to Wilmington’s rights, the Court again relied upon long-established equitable principles. It began with the operative definition: “‘Subrogation is the substitution of another person in the place of the creditor to whose rights he succeeds in relation to the debt’ and is a ‘creature of equity.’” The Court then noted that subrogation to another’s rights cannot occur “‘until the whole debt is paid’ by the party seeking subrogation.” And further, subrogation generally is not appropriate “where intervening equities are prejudiced.”
The Court then reasoned that “it is undisputed that the amount of escrow funds is not sufficient to satisfy the debt secured by DOT 1. Further, TLP has not satisfied the debt secured by DOT 1. Thus, subrogation cannot occur.”
In addition, as to intervening equities, the Court held that subrogating TLP to Wilmington’s rights “would permit the debtor to interfere with the rights of its secured creditor; TLP could foreclose on the [p]roperty and potentially eliminate Brisa’s secured interest under DOT 2.” The trial court therefore “did not err as a matter of law in denying TLP’s subrogation claim.”
I give TLP’s counsel credit for coming forth with creative, indeed, complex equity-based claims to gain a financial interest the escrowed ROWs proceeds, and potentially regain title to the property. Their strategy simply did not work out.
Also, I credit Brisa and its counsel, who foresaw TLP’s efforts and, upon the foreclosure of DOT 3, wisely created Hunter Mill and assigned the purchase contract to that corporate entity. When Hunter Mill took title to the property it made merger equitably impossible. Brisa, the holder of DOT 2 and DOT 3, did not acquire legal title to the property in which it held secured interests.
As for Wilmington, it remains atop the lien priority pyramid with DOT 1 intact. Moreover, it collected the totality of the escrowed ROWs sales proceeds. Brisa received nothing on the debt secured by DOT 2, but that lien remains intact. Because DOT 3’s foreclosure left a deficiency owed on the secured debt, Brisa certainly may pursue that amount’s collection. Considering the property’s location in populace Vienna, it may yet come to pass that all lienholders get paid in full or nearly so.
As for me, reading the Court’s opinion provided an excellent refresher on equitable principles concerning merger, extinguishment and subrogation, on the full faith and credit doctrine, on the prohibition against “approbation and reprobation,” and even on Virginia pleading requirements. In my line of work, such a diverse and comprehensive refresher can come in handy.
I commend the reading of the Thoburn decision to you. It provides a good “lawyer’s education.”
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