Article

Subrogation; Subordination Agreement; Foreclosure; Mortgage

Note: As part of a complex real estate financing arrangement, Empire of America Federal Savings Bank issued an LC to assure repayment to Type "A" class bond holders. Type "B" class bondholders were secured only by a mortgage which was maintained by a trustee. When the applicant/mortgagor defaulted on its obligation to buy back the Type "A" bonds, a drawing was made on the LC and the issuer honored and then claimed reimbursement from the applicant. When the applicant defaulted on its reimbursement obligations, the issuer brought an action to foreclose on the property. Meanwhile, the trustee had also brought an action for foreclosure when the applicant/ mortgagor defaulted on its obligation to buy back the Type "B" bonds.

The trustee sought summary judgment on the ground that its mortgage had priority over that of the issuer's due to a subordination agreement. Agreeing, the Supreme Court of New York, Erie County, Kane, J., granted summary judgment. On appeal, the Supreme Court of New York, Appellate Division, Fourth Department, unanimously reversed and remanded, ordering that the motion be denied.

The appellate court noted that the reimbursement agreement provided that "in the event [Issuer] makes payment to [Trustee] pursuant to the Letter of Credit for which it does not receive reimbursement by or on behalf of [Applicant/ Mortgagor] ... [Issuer] shall thereupon automatically become subrogated to the second lien position on the collateral secured by the Indenture." The trustee argued that a contemporaneous subordination agreement between the issuer and the trustee gave the trustee priority. Reading the agreements as part of the entire transaction, the appellate court ruled that the subordination agreement only gave the trustee priority in the event that there was no drawing on the LC.

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