The New Jersey Supreme Court recently clarified its rules regarding mortgage priority, holding that a factoring company’s secured first mortgage can be trumped by a law firm’s later-filed mortgage where the factoring company knew of the law firm’s mortgage but continued to make discretionary loans to the borrower. Though the court recognized that other states’ laws would preclude this result, it nevertheless held that New Jersey common law and statute required this outcome under the circumstances.
In Rosenthal & Rosenthal, Inc. v. Benun, the plaintiff factoring company entered into factoring agreements for two business entities, both personally guaranteed by the daughter of the principal of the two business entities (the Guarantor) and secured by two successive real property mortgages in Monmouth County. The mortgages contained an anti-subordination clause as well as a “dragnet clause” requiring that the mortgages would not only secure the personal guaranty but would also secure “all obligations and indebtedness of every kind” that the Guarantor incurred to the factoring company in the future.
In March 2007, the Guarantor executed a third mortgage on the Monmouth County property in favor of a law firm for $1.679 million in unpaid legal fees for her father and his business entities. The plaintiff factoring company had notice of the third mortgage, but continued to make discretionary advances to the father’s business entities. Ultimately, the business entities went bankrupt and the Guarantor defaulted on her personal guaranty, leaving $4 million in obligations to the factoring company and $3 million in unpaid legal fees. The total indebtedness was far in excess of the value of the real property securing the debts.
The plaintiff factoring company moved to foreclose on the Guarantor’s real property, arguing that its mortgages had priority over the law firm mortgage. The trial court granted the factoring company’s motion for summary judgment on the priority issue, but the appellate court reversed.
Affirming the appellate court's reversal, the Supreme Court held that under New Jersey law, the priority of an advance mortgage depends on whether the obligations secured by the mortgage are discretionary or mandatory and whether the lender in the primary position has actual knowledge of the later-executed mortgage. Where, as here, the advances made by the factoring company were discretionary and the factoring company had actual notice of the later-executed mortgage, all discretionary advances made after receiving notice became subordinate to the later-executed mortgage.
The Supreme Court explained that the rule has its foundation in New Jersey common law. The rule was also supported by state statute. The court recognized that several other states had modified their mortgage laws to foreclose the possibility of subordination. The court also recognized that a contrary rule would eliminate “any ambiguity and foster uniformity of interpretation and application.” The court concluded that any change to New Jersey's scheme “is best addressed to the Legislature.”
Companies with New Jersey factoring agreements containing anti-subrogation clauses should review those agreements to determine whether advances under the agreements are discretionary, and, if so, should establish procedures for ceasing advances upon the filing of a lien or mortgage on property securing the factoring obligations.
