Bookmark and Share
Share
Home » Guides » Mortgage Subordination

Mortgage Subordination

When a mortgage precedes an easement on a property, there is no guaranty of perpetual enforceability of the easement unless the Mortgage Holder signs a document (sometimes called a "mortgage subordination") that allows the easement to survive a foreclosure of the mortgage. While not easy or quick to obtain, careful preparation that addresses the concerns of the mortgage holder can expedite the process.

First in Time, First in Right

Competing Interests

Land ownership is sometimes described as a bundle of sticks due to the number of interests that, bundled together, equate to fee simple ownership. These interests can be separated and vested in different people or entities all at the same time. The right to use a portion of the property to transport power, called a utility easement, may be held by one entity. The power to constrain the use and development of the property, called a conservation easement, may be held by a conservation organization. The right to take ownership of a property for failure to pay a debt obligation (a mortgage) may be held by a third entity. The right to exclusively possess a portion of the property (a lease) may be held by a fourth entity and so on. Because disputes can arise when these interests compete or collide with one another, courts have developed over a long period of time rules to sort out which interests will prevail. The basic rule is first in time, first in right.

A Rule Not to be Ignored

If a conservation easement is recorded on a property that is subject to a previously existing mortgage, the rights of the holder of the mortgage come before the rights of the conservation easement holder. That is, unless the holder of the mortgage (the “Mortgage Holder”) agrees to change the first in time, first in right rule.

The consequences of not securing such agreement can be severe:

  • If the owner fails to make mortgage payments, the Mortgage Holder has the power to order the county sheriff to sell the property at a public sale to recoup the debt owing to it. If the Mortgage Holder has not agreed to allow the conservation easement to survive such action, the sale will be ordered free and clear of the conservation easement.
  • If the owner used the donation of the conservation easement as a charitable deduction for federal tax purposes, the Internal Revenue Service could successfully disallow the deduction and subject the owner to interest and penalties. (Treasury Regulations Section 1.170A-14(g) states that: “[N]o deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.”)

To guard against such outcomes, an owner could pay off the mortgage prior to entering into the conservation easement or refinance in conjunction with the easement. However, if this is not financially feasible, the owner will have to secure agreement from the Mortgage Holder to place some of its rights in a subordinate position to those of the prospective holder of the conservation easement.

Incentive to Subordinate

The Mortgage Holder can voluntarily agree to step into a subordinate position by signing and recording a document called a subordination agreement. Why would it do so? Often it is because the Mortgage Holder sees an economic advantage in accommodating the other interest. In the case of a proposed second mortgage, the new mortgage may fund improvements increasing the value of the property. (For example, a power line or sanitary sewer facilities to be installed will increase the value of this and other real property in the community.) Sometimes the Mortgage Holder agrees to subordinate to avoid the loan being paid off or refinanced. The loan secured by the mortgage may bear a higher interest rate than the Mortgage Holder could obtain currently and is being paid down regularly without a problem. Thus, the Mortgage Holder has an incentive to keep this asset on its books.

Hurdles in Obtaining a Mortgage Subordination

Identifying the Mortgage Holder

The first hurdle to overcome in obtaining mortgage subordination is to find a person who has the capacity to review and approve the request. That may be an easy task if the mortgage is held by a bank or other lender with whom the owners have an ongoing relationship. Direct the request for subordination to a senior level officer or some other person that regularly services the owners as a customer.

In all other cases, and especially when the assignee of the mortgage identified on the public record is MERS (Mortgage Electronic Registration Systems, Inc.), direct the request to the mortgage servicing company that collects monthly payments from the owners. Try to find out which department handles requests for subordination and direct the communication to the head of that department.

The initial communication should come from the owners. Most, if not all, mortgage servicing companies have a policy of not communicating with anyone else about a loan but for the borrowers. If agreeable to the owners, the initial communication should authorize one or more representatives of the future holder of the conservation easement (the “CE Holder”) to discuss the subordination arrangements with the Mortgage Holder. The representatives of the CE Holder authorized to contact the Mortgage Holder will need both the loan number and social security numbers of the borrowers.

Initial Communication

The goal of the initial communication is to get past rejection out of hand -- it’s always easier to just say no. The following are samples of the kinds of arguments that might be advanced in the initial letter to, or other communication with, the Mortgage Holder requesting subordination.

  1. This loan is a valuable asset, which the Mortgage Holder will not want to have paid off or refinanced. The loan bears an advantageous interest rate compared to current market. The customers have an excellent record of regular payment.
  2. The Mortgage Holder’s security for the loan will not be materially impaired by the conservation easement. The loan to value ratio (the ratio, expressed as a percentage, between the outstanding principal balance of the loan and the value of the property as diminished by the conservation easement) is equal to or less than the loan to value ratio at the time the loan was made.
  3. Alternative to 2: The Mortgage Holder’s security after taking into account the diminution in value resulting from the conservation easement is ___%, which maintains conformity with the maximum 80% loan to value ratio required by industry standards.
  4. The conservation easement will not materially impair marketability of the property. There is a robust market for lands protected by conservation easement in the vicinity.
  5. The CE Holder will, if the Mortgage Holder has no objection, publicly acknowledge the Mortgage Holder’s cooperative role in advancing the protection of natural and scenic resources in the community.

Supporting Information

If the mortgage was originated as a residential mortgage loan and is held by a mortgage servicing company, it is likely to have been sold to FNMA (Fannie Mae) and securitized into an investment conduit. In that case, FNMA Form 236 must be submitted with the accompanying information required by the form. If the mortgage has not been acquired by FNMA, the form is not necessary and submission might confuse the Mortgage Holder. Nevertheless, owners and CE Holder are advised to review FNMA 236 as a guide to what information the Mortgage Holder is likely to want to review in order to make its decision to approve subordination. Form 236 is entitled “Application for Release of Security”, which sounds inappropriate because subordination, not release, is being requested. Nevertheless, for reasons known only to FNMA, it is the form to be used for requests for subordination.

FNMA 236, available at https://www.efanniemae.com/sf/formsdocs/forms/236.jsp, includes the following items:

Type of Release Required. Check the box marked “Subordination of Mortgage to Easement”.

Purpose of Proposed Release. Insert “No change is proposed in existing use. Purpose of conservation easement is to protect natural and scenic resources”.

Legal Description of Property to be Released, Divided, or Substituted. Insert “Conservation Easement on entire Property” or “Conservation Easement on portion of property containing ___ acres more or less described in attached Exhibit “__”.

Future Use of Remainder of Security Property. Insert short description such as “property can continue to be used for ....” Focus on the uses that continue to be permitted rather than what has been prohibited. Use an attachment to expand on permitted uses.

Restrictions on Security Property as a Result of New Easement. Example: “Except for ___ acres designated Highest Protection Area, the remainder of the property (___ acres) can continue to be used for agriculture, forestry and other open space uses. One or more areas totaling ___ acres are available for residential use. Existing uses and improvements are not impaired.”

Cash Consideration to be Received through Transaction. If this is a bargain-sale transaction, the purchase price needs to be disclosed. Consider deducting under subsection (c) of this heading, other transactional costs such as survey, appraisal, funds contributed to the CE Holder to defray costs and expenses incurred in connection with the conservation easement.

Describe Any Other Consideration Received by the Borrower(s). Probably none. Federal income tax deductions for charitable contributions are not considered consideration.

Agreement of Borrowers. Owners should read carefully. They will be obligated to reimburse FNMA costs and expenses in connection with the request for subordination.

Attachments. The second page of Form 236 furnishes a guide to the information the Mortgage Holder will want to review and approve. Suggested attachments are as follows:

  • Additional information (expanded responses to numbered items on form)
  • Most recent draft of easement
  • Most recent draft of Conservation Plan for conservation easements or Easement Plan for trail easements (sometimes referenced as a “map”) to be attached to the easement
  • “Before and after” appraisal
  • Subordination document that the Mortgage Holder is requested to sign

The Subordination Document

Inadequacies of Typical Forms

It is not difficult to find documents designed to subordinate debt obligations or lien priority as between two lenders. Debt subordinations, mortgage subordinations and other types of intercreditor agreements are commonly used in commercial finance. However, a conservation easement holder is not a lender and a conservation easement is not a mortgage. Is it necessary or appropriate to use a document aimed at sorting out debt collection issues between two lenders for the purpose of assuring enforcement of a conservation easement in perpetuity?

A review of commonly used commercial finance subordinations indicated that a more narrowly drawn document could satisfy the need to assure conservation easement survival because, for the most part, the lender’s interest in administering the loan does not impinge on the CE Holder’s interest in conserving natural and scenic resources. The point at which these separate interests collide is the occurrence of a default on the loan followed by the prospect of a foreclosure or other judicial sale. Survival of the conservation easement then becomes critical and is the key point to be addressed in a mortgage subordination to a conservation easement.

Commercial finance forms of subordination also fail to address head on an important issue of concern to donors of conservation easements and CE Holders -- preserving the right to receive the proportionate share of condemnation proceeds allocable to the conservation easement interest. Commercial finance forms tend to put one lender ahead of another as to proceeds derived from the mortgaged property. In the conservation easement context, neither has to be superior to the other. Proceeds can be divided between the mortgage and conservation easement interests so long as the CE Holder receives the proportionate share properly allocable to its interest.

Model Subordination

Pennsylvania Land Trust Association has made available a Model Mortgage Subordination and Commentary to complement its suite of model easement documents.

Consult with Counsel

Users of the Model Mortgage Subordination or other forms of subordination should consult with counsel to be sure that the subordination document used conforms to guidance made available by the IRS or courts interpreting the Code and Regulations.

Is a Mortgage Subordination Always Necessary?

While always desirable, obtaining the subordination of an existing mortgage may not be strictly necessary if the grant of conservation easement does not need to qualify as a charitable contribution for tax purposes.

Consents Can Provide Foreclosure Protection

Utility companies and other prospective holders of easements request, and often receive, consents from Mortgage Holders that operate to protect the later recorded interest in the event of a foreclosure. If the Mortgage Holder is satisfied that the easement is a benefit to the property or, at least, does not diminish the marketability or value of the collateral below an acceptable level, the Mortgage Holder records a form document consenting to the creation of the interest and promising not to divest the interest upon a foreclosure.

  • Perpetuity. This is not technically a subordination because the priority of the mortgage vis-a-vis the other interest has not changed. Subordination is ordinarily not needed unless the desired result is a re-ordering of the same type of interest (the first mortgage is put behind the later recorded mortgage, for example). Holders of interests other than liens simply want to protect their investment by seeking assurance that their later recorded interests survive a foreclosure sale. Conservation easements are no different from other servitudes in this regard. Foreclosure protection via a consent will ensure enforceability in perpetuity the same as a subordination.
  • Condemnation Proceeds. Typical forms of consents do not address proceeds of condemnation because the easement holder is free to assert a separate claim for the taking of its easement interest. That is true for the CE Holder as well unless the easement document provides otherwise -- and it generally will. Conservation easements drafted to meet the requirements of a qualified conservation contribution adopt the single claim procedure mandated by the federal tax code. The interest of the CE Holder is treated as if it were terminated by the taking and, instead of a separate claim, the CE Holder has the right to a percentage of the proceeds (the Proportionate Value) of the proceeds of the taking otherwise payable to the landowners. (If asserting its own claim is important to the CE Holder, then the granting document must be changed to provide for that.)

No Subordination and No Foreclosure Protection

If neither subordination nor foreclosure protection is available but the easement is highly desirable, the prospective easement grantee may evaluate the risk that landowners will default on the existing mortgage and consider alternatives to minimize that risk.

Risk Evaluation

To evaluate the risk of default, the prospective easement holder must inquire into the status of the existing mortgage: Are the landowners creditworthy? Have they been paying the mortgage regularly for a considerable period of time? What percentage of the loan has been paid or, by application of the proceeds of the easement purchase, will be paid down? What is the loan to value ratio after application of proceeds? Why is a refinance of the existing loan either unavailable or undesirable? Gathering this information allows the prospective easement holder to make a reasonably prudent business decision to move forward or not based upon its evaluation of its business risk.

Additional Assurances

If the prospective easement holder decides to move forward with the easement, it may want the landowners to furnish additional assurances to minimize the adverse consequences of a default on the mortgage. These assurances may include the personal guaranty of landowners secured by a mortgage on the property or other real estate interests; a security interest in bank, securities or other investment accounts; proceeds of policies of life insurance; or any other assets. The purpose of the guaranty and collateral is to be sure that, if easement holder has to invest funds to preserve its conservation easement in the property, it has recourse to other assets of the landowners to recoup that investment.

In the Absence of Subordination or Foreclosure Protection, What Happens in the Event of a Default?

If a mortgage becomes in default, the Mortgage Holder is required, prior to public sale of the mortgaged property by the county sheriff, to identify all interests to be divested by the sale, which would include a conservation easement accepted under and subject to the mortgage. The sale may occur as soon as 30 days after notices are issued. Terms of sale are usually cash or bank check equal to 10% of the bid on the sale date and the balance within 30 days after. Upon payment of the bid price, the sheriff deeds the property to the successful bidder free and clear of all the interests identified in the notice of sale.

If the CE Holder is the successful bidder, the CE Holder becomes the owner of the property free and clear of all interests, including the original conservation easement. The CE Holder is then in a position to resell the property under and subject to a conservation easement crafted to achieve the conservation objectives of the original easement. Alternatively, the CE Holder may request the sheriff to issue the deed under and subject to the conservation easement existing prior to the sale. If the sheriff is willing to do so, the CE Holder should assign its successful bid to a separate, but CE Holder controlled, entity to avoid extinguishment of the conservation easement by merger.

Risks of Bidding at Sale

The minimum bid by the CE Holder at the sale must be sufficient to pay the prior mortgage plus unpaid property taxes, transfer tax on the recording of the deed, and the sheriff's costs of sale, which typically includes a percentage of the bid price as a commission. The short timeframes for notice of the sale and delivery of the bid price may be difficult to meet unless the holder has the ability to use its own resources, or draw on a line of credit, to fund the acquisition. The feasibility of quick action in case of a default is an important factor when evaluating the risk of accepting a conservation easement under and subject to an existing mortgage.

Another risk is that other bidders may continue bidding over the CE Holder's minimum bid. If the conservation easement were a mortgage or other lien, the holder would continue to bid up to the amount secured by its lien because each dollar bid over the minimum is distributed by the sheriff after the sale to holders of other liens on the property in order of priority. But the conservation easement is not a mortgage lien; thus, it is not entitled to payment from proceeds of sale above the minimum bid but it is nevertheless subject to divestment from the sale if anyone other than the CE Holder is the successful bidder. A discussion of strategies to avoid, or mitigate against, undesirable outcomes of competitive bidding at the sheriff sale is beyond the scope of this guide; however, one protection that can be obtained prior to easement acceptance is an assignment to the CE Holder of any rights landowners may otherwise have to receive proceeds of a sale of the property due to a default on the prior mortgage.

Land Trust Standards and Practices

Practice 9H. “Title Investigation and Subordination” of Land Trust Standards and Practices provides as follows:

Mortgages, liens and other encumbrances that could result in extinguishment of the easement or significantly undermine the important conservation values on the property are discharged or properly subordinated to the easement.

The information on foreclosure protection furnished above is consistent with Practice 9H. The information furnished above, when no foreclosure protection is available, may not strictly comply with Practice 9H but is offered as a potential path to be considered when a highly desirable conservation easement is thwarted by an intransigent Mortgage Holder.

Improving the General Framework for Obtaining Subordinations

If an agreed upon protocol with FNMA/FHLMC for issuance of mortgage subordinations to conservation easements could be established and if the Internal Revenue Service could assure that the agreed upon form of subordination meets Internal Revenue Code requirements, this would greatly facilitate the donation of conservation easements by landowners of relatively modest means.

The Land Trust Alliance has initiated an attempt to provide guidance to companies servicing mortgages on behalf of FNMA by including in the FNMA Servicer’s Guide a protocol for how to handle requests for subordination. This may include a form of subordination of mortgage to conservation easement approved by FNMA. It would be a wonderful development if the same form of subordination was deemed acceptable both to FNMA and the IRS but, until that unlikely event occurs, counsel to owners and conservation easement holders will have to use their best judgment on how to achieve lender acceptability without falling afoul of the Internal Revenue Code and Regulations. 

Average
Your rating

Download as


See more...

Experts

Pregmon Law Offices
610-834-7411
Pregmon authored the Model Mortgage Subordination and Commentary and has considerable experience in obtaining mortgage subordinations on behalf of her clients.

Featured Library Items

A model legal document and accompanying guidance to help users in obtaining the "subordination" of a mortgage to a conservation easement. Download both the model and the commentary.
The Model Grant of Conservation Easement and Declaration of Covenants provides users with a state-of-the-art legal document together with an expansive commentary. Built on practitioner experiences and feedback, no easement document in the nation has benefited from more cycles of peer review. Downlo…
Use to provide public access to or along a waterway for fishing, boating or other recreational and educational uses. This model legal instrument may be used as a stand-alone document or may be coupled with a Grant of Conservation Easement to provide natural resource protections as well. The comment…
The Model Grant of Trail Easement is brief -- one page (exclusive of signatures) as compared to nearly five for the model Trail Easement Agreement. The Grant of Trail Easement is provided in recognition that brevity is sometimes the paramount concern of landowners. If establishing certainty as to l…
This model was crafted for the specific purpose of permanently protecting riparian buffers along waterways. The model is based on the 7th edition of the Model Grant of Conservation Easement and Declaration of Covenants, also published by the Pennsylvania Land Trust Association.
This widely used model is coupled with an expansive commentary that provides alternative and optional provisions and the reasoning behind each provision. Users can easily customize the document to handle a variety of potential trail types and uses. The model uses plain language and careful formatti…
Sample subordination of mortgage document used by The Compact of Cape Cod Conservation Trusts in Massachusetts.
(print edition of the ConservationTools.org guide) When a mortgage precedes an easement on a property, there is no guaranty of perpetual enforceability of the easement unless the mortgage holder signs a document (sometimes called a "mortgage subordination") that allows the easement to survive a fo…
(print edition of the ConservationTools.org guide) A landowner may convey to another person the rights to create a trail, open it for public use and maintain it without the owner giving up ownership and enjoyment of the land through which the trail passes.
(print edition of the ConservationTools.org guide) A riparian buffer protection agreement limits activities on all or a portion of a property to advance conservation purposes while keeping the property in the control of the landowner. 13 pages.

Acknowledgements

Patricia L. Pregmon, attorney at law, is the primary author, and Andy Loza, the editor and contributing author.

The Pennsylvania Land Trust Association prepared this guidance with support from the William Penn Foundation and the Pennsylvania Department of Conservation and Natural Resources Bureau of Recreation and Conservation “Growing Greener” Program

Disclaimer

Nothing contained in this or any other document available at ConservationTools.org is intended to be relied upon as legal advice. The authors disclaim any attorney-client relationship with anyone to whom this document is furnished. Nothing contained in this document is intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to any person any transaction or matter addressed in this document.
comments powered by Disqus