The South Carolina Court of Appeals rejected the replacement mortgage doctrine on Nov. 25, 2020 and held a home equity line of credit had priority over a subsequent mortgage that secured refinancing of a mortgage prior in time and senior to the HELOC. In ArrowPointe Federal Credit Union v. Bailey, linked here, the Court of Appeals relied on South Carolina’s statutory race-notice framework to find the home equity line creditor had priority because it recorded its lien before the second mortgage was made and recorded. Appellant filed a motion to reconsider on Dec. 9, 2020, and no action had been taken as of Dec. 30, 2020.

The replacement mortgage doctrine allows a lender to refinance and satisfy a senior mortgage and retain the same priority as the mortgage that is being replaced. The Court of Appeals held that the replacement mortgage doctrine “is an equitable doctrine and the minority approach,” and that the adoption of the doctrine was a matter for the General Assembly. See Op. No. 5784, 2020 WL 6937879, at *5-6 (S.C. Ct. App. Nov. 25, 2020). The Court of Appeals thus affirmed the home equity lien’s priority and the special referee’s decision to allow the home equity line creditor’s foreclosure of the property.

The case arose from the following series of mortgage loans:

• The borrowers obtained a $256,500 first-lien mortgage that was recorded on Oct. 20, 2009 (“Original Mortgage”).
• One week after the Original Mortgage was recorded, the borrowers obtained a $99,000 home equity line of credit (“HELOC”). The HELOC was secured by a mortgage recorded on Nov. 4, 2009.
• Less than a month later, the borrowers obtained a $296,000 mortgage from the Original Mortgage lender. The $296,000 mortgage (“Refinancing Mortgage”) both paid off the Original Mortgage and cashed out equity. The lender then released the Original Mortgage and, on Dec. 15, 2009, recorded the Refinancing Mortgage.

The Original Mortgage lender did not have actual knowledge of the HELOC when it originated the Refinancing Mortgage. When the borrowers obtained the Refinancing Mortgage they affirmed that “there [were] no outstanding home improvement loans, mortgages, deeds of trust, or equity lines of credit, recorded or unrecorded.” Id. (alterations in original). And, according to the opinion, the parties to the transaction intended the HELOC to be junior in priority to the Original Mortgage.

The borrowers defaulted on the HELOC, and the home equity line creditor, ArrowPointe, brought a foreclosure action. During the proceedings the Appellant abandoned its equitable subrogation argument and relied on the replacement mortgage doctrine. Appellant also argued below that “even if ArrowPointe was prejudiced, it was only prejudiced to the extent the Second Mortgage was greater than the First Mortgage.” The special referee held the replacement mortgage doctrine “was not the law of the State of South Carolina,” and found “as a matter of law, [Refinancing Mortgage] does not take priority over the [HELOC].” Id. (quoting Special Referee’s order).

Appellant argued that South Carolina common law supports application of the replacement mortgage doctrine as set forth in the Restatement (Third) of Property (Mortgages) § 7.3 (1997 & June 2020 Update). See id. at *3. Under the Restatement, a second mortgage would replace the first mortgage in priority over a lien recorded between the first and second mortgages if the first mortgage is released as part of the same transaction that creates the second mortgage, unless the second mortgage materially prejudices a junior holder, or unless a subsequent lien is recorded before the first mortgage is recorded. Id. The Court of Appeals disagreed, relying on South Carolina’s race-notice statute, S.C. Code Ann. § 30-7-10 (2007), and found the lender’s constructive notice of the HELOC to be determinative.

The argument in favor of the replacement mortgage test was based in part on prior South Carolina precedent signaling an opening for consideration of that doctrine. In Matrix Financial Services Corp. v. Frazer, 394 S.C. 134, 714 S.E.2d 532 (2011), in denying equitable subrogation, the South Carolina Supreme Court noted that the Restatement (Third) of Property (Mortgages) section 7.6 (and South Carolina case law) did not support equitable subrogation in that case, but that court expressly did “not decide whether a lender that refinances its own debt could attain priority under the theory of replacement and modification illustrated in section 7.3 of the Restatement . . . .” Id. (citing Matrix at 138, 714 S.E.2d at 534). The Court of Appeals acknowledged that “a significant number of courts have adopted the Restatement or followed its logic.” The court left the issue of the replacement mortgage doctrine for the General Assembly.