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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.
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.
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:
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.
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.
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.
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.
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:
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.
Pennsylvania Land Trust Association has made available a Model Mortgage Subordination and Commentary to complement its suite of model easement documents.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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
Copyright © is held by the Pennsylvania Land Trust Association
Text may be excerpted and reproduced with acknowledgement of ConservationTools.org and the Pennsylvania Land Trust Association.