Supreme Court Reverses Arizona Court of Appeals’ Ruling in Weitz

By Thomas A. Stoops

In the April 2014 Legal Advisor article we noted that the Arizona Court of Appeals in the case of The Weitz Company, L.L.C. v. Nicholas Heth, 674 Ariz. Adv. Rep. 29, had made a significant ruling on the application of equitable subrogation.  The Arizona Court of Appeals determined that based on its statutory interpretation the doctrine of equitable subrogation did not apply to elevate claims in priority over mechanics’ liens. As noted in our article this was a major departure from previous Arizona Court of Appeals rulings, and as predicted the ruling provoked an extreme reaction particularly from title company representatives who had long used equitable subrogation as a talisman to defeat mechanics’ and materialmens’ liens.

The Arizona Supreme Court granted review, the matter was argued on June 10, 2014, and the Opinion was published August 26, 2014. The decision reverses the Arizona Court of Appeals decision. Justice Timmer, joined by Vice Chief Justice Pelander, Justice Berch, Justice Brutinel, and Judge Kelly, wrote the opinion of the Court. The issue before the Court was stated this way:

Arizona Revised Statutes § 33-992(A) gives mechanics’ liens priority over liens recorded after construction begins on real property. We are asked to decide whether that statute precludes assignment by equitable subrogation of a lien that attached before construction began on the project at issue. We hold that it does not. Additionally, although a third party generally must discharge the entire lien obligation to qualify for equitable subrogation, when a single mortgage burdens multiple parcels, a third party may be entitled to equitable subrogation when that party has paid a pro rata amount of the obligation and obtained a full release of the parcel at issue from the mortgage.

The Court went on to recite the background of the case.  First National Bank of Arizona loaned approximately $62 million to The Summit at Copper Square, LLC (“Summit”) to construct a high-rise commercial and condominium project in Phoenix. First National agreed to release condominium units from both their deeds of trust upon payment of specified release prices as third parties purchased the completed units.  The first deed of trust was recorded in April 2005, and the second deed of trust in favor of First National Bank of Arizona was recorded in February 2007.

The plaintiff, The Weitz Company, LLC, was the general contractor and began construction in November 2005. Summit failed to pay Weitz approximately $4 million dollars.  Beginning in September 2007, Summit sold 91 completed condominium units to purchasers who paid a portion of the debt to First National and who received releases from First National’s liens. In May 2008, Weitz recorded a mechanics’ lien against the project. The owners and lenders asserted that because they had paid a portion of the construction loan allocated to their units they were equitably subrogated to First National Bank of Arizona’s April 2005 deed of trust, therefore; had priority over Weitz’s mechanics’ lien.

Weitz argued at the trial court level two issues: First, that by its nature A.R.S. § 33-992(A) precludes equitable subrogation because it elevates mechanics’ liens above all subsequently recorded liens, and as an alternative argument, that the owners and lenders were not eligible to invoke the doctrine because they did not fully discharge the debt to First National Bank of Arizona.
The court of appeals agreed that Weitz’ lien had priority because it held that A.R.S. § 33-992(A) precludes the application of the equitable subrogation to give the owners and lenders lien priority over the Weitz’ lien. The Arizona Supreme Court interestingly noted that this was its first opportunity to address the interplay between equitable subrogation and the priority granted to mechanics’ liens by A.R.S. § 33-992(A), quoting the statute in relevant part:

The liens provided for in this article . . . are preferred to all liens, mortgages or other encumbrances upon the property attaching subsequent to the time the labor was commenced or the materials were commenced to be furnished except any mortgage or deed of trust that is given as security for a loan made by a construction lender . . . if the mortgage or deed of trust is recorded within ten days after labor was commenced or the materials were commenced to be furnished.

The Arizona Supreme Court observed that until the court of appeals decision in the Weitz case, the court of appeals had consistently acknowledged the viability of equitable subrogation as it applied to mechanics’ liens.

The Court went on to list several reasons that it disagreed with the holding of the court of appeals.

First, it stated: “When equitable subrogation  occurs, the  superior lien and attendant obligation are not discharged, but are instead assigned by operation of law to the one who paid the obligation.” The Court reasoned that because the senior lien was not discharged but rather the obligation transferred to the person paying the obligation, the issue of a new lien with priority over the mechanics’ lien does not arise. “The subrogee is in the same position as if the superior lienholder had expressly assigned the superior lien to the subrogee.”

The second reason articulated by the Arizona Supreme Court was that the mechanics’ lien statute is to protect the rights of laborers and materialmen who enhance the value of property.  The Arizona Supreme Court said, “Equitable subrogation does not prejudice those rights. When a lien that is superior to a mechanics’ lien is assigned to another through equitable subrogation, the mechanics’ lien remains in the same position it occupied before subrogation.”

The third reason stated is that, “Permitting equitable subrogation of a lien that is superior to a mechanics’ lien is consistent with the legislature’s treatment of junior lienholders’ interests in foreclosure actions.” Citing A.R.S. §33-723, it provides that a junior lienholder “shall be entitled to an assignment of all the [superior lienholder’s] interest” by paying that person or entity the amount secured by the superior mortgages or deeds of trust together with interest and costs. The Court noted that the statute makes no exceptions for an intervening mechanics’ lien.

Weitz alternatively argued, and the trial court agreed, that owners and lenders are not entitled to equitable subrogation because they did not fully discharge the obligation to First National, and Arizona does not permit partial equitable subrogation. The Supreme Court agreed that equitable subrogation is generally permitted only when a person fully discharges a debt secured by a mortgage, however, the Court relied on an exception to that rule, “permitting equitable subrogation when a party discharges only part of an obligation secured by a single mortgage on multiple properties but obtains a release of the lien on the property at issue.” Citing to the Restatement’s expansive view of equitable subrogation and citing to Sourcecorp, 229 Ariz. at 273 ¶ 10, 274 P.3d at 1207.

The Court stated: “We conclude that equitable subrogation of a mortgage is prohibited when it would divide security between the original obligee and a payor who discharges part of the obligation. However, when the obligation is secured by a single mortgage on multiple properties and the obligee releases the property at issue from the mortgage lien in return for discharge of the entire obligation allocated to that property, equitable subrogation is permitted.”

The ruling by the Supreme Court is extremely significant particularly for title companies. In fact, you can probably hear a collective sigh of relief from all the counsel for all title companies in the State of Arizona, since title companies have for many years relied very heavily on the concept of equitable subrogation to defeat the liens of mechanics and materialmen. Whether or not this is good policy, it is now the settled law in the State of Arizona.