SUPREME COURT OF ARIZONA
En Banc
In re: Petition of Price )
Waterhouse Limited as Judicial )
Trustee and Receiver of, inter ) Supreme Court
alia, Eron Mortgage Corporation, ) No. CV-01-0074-CQ
Eron Financial Services, Ltd., )
and as Judicial Trustee of 494597 )
BC Ltd.; 519722 BC Ltd.; 530884 )
BC Ltd.; 534172 BC Ltd.; 494043 )
BC Ltd.; Maxim Resources, Ltd.; )
533373 BC Ltd.; 545054 BC Ltd.; ) United States
533175 BC Ltd.; 729720 Alberta ) Bankruptcy Court
Ltd.; and 532285 BC Ltd., each a ) Southern District of
company incorporated under the ) California
laws of the Province of Canada, ) Case No. 97-16013-PB
in a foreign proceeding by ) (In a Case Ancillary
appointment of the Supreme Court ) to a Foreign Proceeding
of British Columbia, ) Under 11 U.S.C. §304)
)
Debtor. ) Adversary No. 99-90066B
___________________________________)
)
PricewaterhouseCoopers, Inc. as )
Foreign Representative herein, and )
Judicial Trustee of, inter alia, )
Eron Mortgage Corporation and )
494597 B.C. Ltd. by Appointment )
of the Supreme Court of British )
Columbia, )
Plaintiff, )
)
v. )
) O P I N I O N
Decca Design Build, Inc., an )
Arizona corporation, )
Defendant. )
___________________________________)
CERTIFIED QUESTION ANSWERED
_________________________________________________________________
PERKINS COIE LLP Santa Monica
by Steven G. F. Polard
and
SQUIRE, SANDERS & DEMPSEY LLP Phoenix
by Donald A. Wall
Debora L. Verdier
Attorneys for PriceWaterhouseCoopers, Inc. as
Judicial Trustee and Foreign Representative
of Eron Mortgage Corporation, Eron Arrowhead
Ltd., and 494597 BC Ltd., et al.
ALHADEFF & SOLAR LLP San Diego
by Robert K. Edmunds
S. Douglas Kerner
and
SACKS TIERNEY Scottsdale
by Sharon Shively
Isabel M. Humphrey
James W. Armstrong
Attorneys for Decca Design Build, Inc.
_________________________________________________________________
J O N E S, Chief Justice
This case involves a certified question from a bankruptcy
court in California. We address first the jurisdictional issue.
The Arizona Constitution confers jurisdiction on the state supreme
court as “provided by law.” Article VI, § 5(6). By statute, this
court has jurisdiction over questions certified to it by other
courts, including the Supreme Court of the United States, a court
of appeals of the United States, a United States district court, or
a tribal court. Arizona Revised Statutes § 12-1861 (1994)
(A.R.S.). Section 12-1861 is based on the 1967 version of the
Uniform Certification of Questions of Law Act. That act was
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modified in 1995 specifically to include bankruptcy courts.1 While
Arizona has not directly amended its version of that law to include
any federal court, the intent of the statute as it currently
exists, coupled with our own supreme court rule allowing
certification of questions from federal and tribal courts,
sufficiently provides this court with the discretionary authority
to answer the bankruptcy court’s certified question. Ariz. S. Ct.
R. 27(a)(1); see also 28 U.S.C.A. § 151 (1993) (bankruptcy judges
constitute “a unit of the district court.”).
The Honorable Peter Bowie of the United States Bankruptcy
Court for the Southern District of California has certified the
following question to this court upon stipulation of the parties:
Where real property is subject to a first priority deed
of trust, a second priority mechanic’s lien, and a third
priority deed of trust, where the holder of the first
priority deed of trust and the holder of the third
priority deed of trust enter into a written subordination
agreement pursuant to which the holder of the first
priority deed of trust agrees that the third priority
deed of trust shall constitute a lien or charge upon said
land which is unconditionally prior to and superior to
the lien or charge of the first priority deed of trust,
and where the holder of the second priority mechanic’s
lien is not a party to the subordination agreement, what
effect, if any, does the subordination agreement have on
1
Unif. Certif. Questions of Law Act § 3, 12 U.L.A. 73 (1996).
“The [Supreme Court] of this State may answer a question of law
certified to it by a court of the United States . . . .” The
comment notes that “[t]his section has been revised to replace the
previous list of federal courts with the term ‘a court of the
United States.’ This is intended to permit a court in a State
adopting the section to answer questions certified by any United
States court including bankruptcy courts.”
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the relative priorities of the liens of the three parties
based on the facts set forth below?
The bankruptcy court then attached a statement of facts. We will
summarize those facts as follows.
Fairway Condominium Development, Inc. (Fairway), a real estate
development company, obtained a loan from a Canadian company known
as 494597 B.C. Ltd. (the Canadian company) for $7.5 million to
develop real property. This $7.5 million loan became the first
lien on the subject property. The Canadian company later went into
bankruptcy in British Columbia, Canada. An ancillary bankruptcy
proceeding is underway in California commenced by Pricewaterhouse
as the Canadian company’s trustee.
Decca Design Build, Inc. (Decca) had a second position
mechanic’s lien on the same property. This mechanic’s lien was for
$350,000. An additional $3 million in funding was sought by
Fairway for the development of the property. First Mortgage Bank
(First Mortgage) supplied that additional funding, taking back the
third priority deed of trust, and the property was then subject to
three liens. The Canadian company and Fairway entered into a
subordination agreement with First Mortgage at the time Fairway
sought the additional $3 million funding. That subordination
agreement specified that the $7.5 million loan would be
subordinated to the $3 million lien of First Mortgage. First
Mortgage’s $3 million lien would then become the first priority
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lien on the property. The foreclosure sale of the property yielded
$5 million.
The Agreement
The subordination agreement was between the Canadian company
that funded the first $7.5 million loan and Fairway, the borrower,
and First Mortgage. First Mortgage agreed to fund the second $3
million loan to the development company in exchange for the
priority of its lien before the Canadian company’s lien. The
agreement did not involve or consider Decca’s intervening second
priority mechanic’s lien.
The language of the agreement reads:
This subordination agreement results in your security
interest in the property becoming subject to and of lower
priority than the lien of some other or later security
instrument . . . it is a condition precedent to obtaining
said [$3 million] loan that said deed of trust last above
mentioned shall unconditionally be and remain at all
times a lien or charge upon the land . . . prior and
superior to the lien or charge of the deed of trust first
above mentioned . . . .
Appendix re Order re Stipulation re Request to Certify State Law
Question to the Arizona Supreme Court, Exhibit C, p. 1 (Appendix,
Ex. C). The Canadian company “intentionally and unconditionally
waives, relinquishes and subordinates the lien . . . first above
mentioned in favor of the lien . . . in favor of [First Mortgage].”
Appendix, Ex. C, p. 3. “[T]his Agreement shall be the whole and
only agreement with regard to the subordination of the lien...and
shall supersede and cancel, but only insofar as would affect the
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priority between the deeds of trust hereinbefore specifically
described, any prior agreements as to such subordination . . . .”
Appendix, Ex. C., p. 2.
Analysis
The issue, requiring that we determine the effect of a
subordination agreement between first and third lienholders,
presents a case of first impression in Arizona. We are aware that
courts from other jurisdictions have approached the same issue in
two different ways. One approach follows the partial subordination
analysis of the Supreme Court of Texas in ITT Diversified Credit
Corp. v. First City Capital Corp., 737 S.W.2d 803 (Tex. 1987). The
other follows the complete subordination analysis of the Supreme
Court of Alabama in Amsouth Bank v. J & D Financial Corp., 679 So.
2d 695 (Ala. 1996). For the reasons stated below, we adopt the
partial subordination analysis.
Partial subordination means that this alteration of the
priority of liens between the first and third lienholders has no
effect on the second priority lienholder. The shift in priority
relates only to the amount of the original third priority lien. If
the third priority lien is larger than the original first priority
lien, then the original first priority lien moves completely to the
third position. The original third priority lien moves into first
position but only to the amount of the original first priority
lien. If the third priority lien is smaller than the original
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first priority lien, then the difference between the two amounts,
up to the total of the original first priority lien, is still in a
priority position relative to the second priority lienholder. The
holder of the second priority lien is neither advantaged nor
disadvantaged by the agreement. The second priority lienholder is
not a party to the agreement and should not be affected by it. His
status remains the same to the extent of any remaining assets
available once the amount of the first priority lien has been
satisfied. The consequence of a subordination agreement is that
the amount of the first lien simply goes toward satisfying in whole
or in part two liens as opposed to one.
Without any subordination agreement, the following would be
the distribution of assets:
Canadian company--$7.5 million
Decca--$350,000
First Mortgage--$3 million
With the subordination agreement, the following is the distribution
of assets:
First Mortgage--$3 million
Canadian company--$4.5 million
Decca--$350,000
Canadian company--$3 million
The sum total of liens ahead of Decca remains at $7.5 million both
before and after the subordination agreement.
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The foreclosure sale of the subject property yielded only $5
million. The first $3 million of that amount goes to First
Mortgage under the subordination agreement. The remaining $2
million goes towards satisfying the $4.5 million lien still owing
to the Canadian company. No additional funds are available to
satisfy Decca’s lien.
This is a fair result under the circumstances as $7.5 million
in liens were in priority ahead of Decca’s second priority lien
prior to the subordination agreement, and the same $7.5 million in
liens is still ahead of Decca after subordination, but it will be
distributed in respective amounts to First Mortgage and to the
Canadian company. Decca’s position has not been altered or
modified in any way by the agreement to which it was not a party.
Decca has not received a windfall nor has it suffered negative
consequences. The agreement between the Canadian company and First
Mortgage has no effect whatever upon Decca’s lien.
Other courts follow this line of reasoning. Grise v. White,
247 N.E.2d 385 (Mass. 1969); ITT, id. at 804; In the Matter of
Cliff’s Ridge Skiing Corp., 123 B.R. 753 (Bankr. W.D. Mich. 1991);
Duraflex Sales & Service Corp. v. W.H.E. Mechanical Contractors,
110 F.3d 927 (2d Cir. 1997); Mid-Ohio Chemical Co., Inc. v. Petry,
140 F. Supp. 2d 828 (S.D. Ohio 2000); Bratcher v. Buckner, 109 Cal.
Rptr. 2d 534, 541 (Cal. Dist. Ct. App. 2001); see also Gilmore,
Security Interests in Personal Property § 39.1 at 1021 (1965).
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Decca advances the theory that complete, not partial,
subordination occurred here. Under such a reading of the
agreement, the original first priority lienholder would have waived
all priority to the third party lienholder unless some reservation
of first priority status occurred in the language of the agreement.
Decca argues that no such reservation language exists in this
agreement. It would have the result appear as follows after the
subordination agreement:
First Mortgage--$3 million
Decca--$350,000
Canadian company--$7.5 million
Decca reasons that where other liens on the same property exist,
parties to subordination agreements are presumed to know about and
consider them.
Some courts have followed this logic. Shaddix, et al. v.
National Surety Co., 128 So. 220 (Ala. 1930); J.C. McConnell, et
al. v. Mortgage Inv. Co., 292 S.W.2d 636 (Tex. Civ. App. 1955);
Ladner v. Hogue Lumber & Supply Co., Inc., 91 So. 2d 545 (Miss.
1956); Old Stone Mortgage and Realty Trust v. New Georgia Plumbing,
Inc., 236 S.E.2d 592 (Ga. 1977); Amsouth, id. at 695; In re Exec
Tech Partners v. Resolution Trust Corp., 107 F.3d 677 (8th Cir.
1997).
We reject the latter reasoning because it affects the rights
of others not in privity. Decca was not intended to be a
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beneficiary of this agreement and is not entitled to a windfall.
Because Decca’s position is unaffected, a result that appears fully
equitable, we embrace the partial subordination analysis.
Conclusion
We find that a partial subordination occurred from the
subordination agreement in this matter. Decca’s status as second
priority lienholder remains undisturbed by the subordination
agreement between the other parties.
________________________________________
Charles E. Jones
Chief Justice
CONCURRING:
____________________________________
Ruth V. McGregor, Vice Chief Justice
____________________________________
Stanley G. Feldman, Justice
____________________________________
Thomas A. Zlaket, Justice
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