Many Defective Mortgages Are Salvageable

A mortgage may be legally defective for a variety of reasons: The property description may be flawed; it may lack an essential affidavit; or it may be missing a signature.

Such seemingly minor defects can cause problems when a bank seeks to foreclose and faces adverse claims from judgment creditors, competing mortgagees and tax authorities who insist that their liens should take priority over the bank’s legally defective instrument. A bankruptcy trustee may also move for the mortgage to be declared invalid, allowing the estate to avoid the lien entirely.

In some cases, courts turn to equitable doctrines that can salvage the situation for the holder of the defective lien. Under the doctrine of “equitable subrogation,” courts at times impose an equitable lien in cases where the proceeds of a loan were used to pay off a pre-existing lien. Lenders may still suffer a loss, however, because the lien amount is often limited to the amount paid to satisfy the prior lien.

Another argument to defeat a claim of priority over a defective mortgage is constructive notice. The Arizona Court of Appeals recently held that two deeds of trust recorded without property descriptions took priority over a competing mortgage because the facts showed that the holder of the competing mortgage had constructive notice of the defective liens. The court looked to the contract that showed that the holder of the competing mortgage knew it was in “third lien” position.

Recent cases demonstrate numerous ways that a defective mortgage can regain at least some of its priority position.