Real estate transactions often involve multiple lenders or lienholders, each with a financial interest in the same property. When this occurs, the order of payment if the property is sold or foreclosed—known as lien priority—can significantly impact both lenders and borrowers.
A subordination agreement allows for this order to be changed under specific circumstances. This article will explore how these agreements function in Maryland, their uses, and their legal implications.
Priority of Liens in Maryland
In Maryland, the order in which liens are paid is generally governed by the principle known as first in time, first in right. This means liens take priority based on when they were recorded in the official land records of the county where the property is located.1Maryland General Assembly. General Provisions Article § 14-805 – Priority of Liens When a property owner secures a debt with their real estate, the creditor files a document, like a mortgage, with the Clerk of the Circuit Court for that county.2Maryland Courts. Land Records Overview This recording establishes the lien’s place, with earlier recorded liens holding a superior claim over later ones. For instance, a purchase mortgage recorded at sale usually has priority over a later home equity line of credit.
Several types of liens can attach to real property in Maryland. Mortgages are common for financing property purchases. Judgment liens can arise if a creditor wins a lawsuit against a property owner and records the judgment. Tax liens for unpaid property taxes are another category and often hold a special, higher priority by law, sometimes even over previously recorded liens.
Lien priority is particularly important during a foreclosure sale. When a property is sold to satisfy debts, proceeds are distributed to lienholders based on their priority. The highest priority lienholder is paid first. If funds remain, the next highest is paid, and so on. If sale proceeds do not cover all liens, those with lower priority may receive partial payment or nothing.
Legal Basis for Subordination
The established order of lien priority in Maryland, based on recording time, can be changed. The legal basis for altering this order is the principle of freedom of contract. Maryland law allows parties in a real estate transaction to agree to modify their lien priority. While Maryland’s Real Property Article sets default payment rules, it doesn’t stop parties from contractually agreeing to a different arrangement through a subordination agreement.
For a subordination agreement to be effective in Maryland, it must meet standard contract law requirements, including mutual agreement on the terms, something of value exchanged, clear terms, and a lawful purpose.
Maryland courts have consistently recognized and enforced valid subordination agreements. These agreements are upheld because they can facilitate complex real estate financing. For example, when a property owner refinances a primary mortgage, the new lender usually requires its loan to have first-priority. If other liens exist, like a home equity line of credit, the refinancing lender will likely require the existing junior lienholder to sign a subordination agreement. This ensures the new mortgage takes precedence over the existing junior lien.
Typical Provisions in Agreements
The ability to reorder lien priority is put into practice through the subordination agreement document. These agreements contain common provisions defining the scope and terms of the subordination.
Parties Named
A subordination agreement must accurately identify all involved parties: the subordinating party, the benefiting party, and the property owner. This includes their full legal names. The agreement also needs a precise legal description of the property.
Term Clauses
The core of a subordination agreement is its term clauses, specifying how the priority changes. These provisions state that an existing lien (the subordinated lien) will rank lower than another specific lien (the senior lien). The agreement identifies the senior lien with details like the loan amount, date, and lender’s name.
These clauses also define the amount of debt being subordinated, which can include principal, interest, and certain fees of the new senior loan. The agreement might also state if subordination applies to future changes or renewals of the senior loan. Clear terms are important because they outline the financial risk for the party agreeing to lower its lien’s priority.
Signatory Requirements
A subordination agreement in Maryland must be properly signed by authorized individuals, particularly from the party agreeing to lower its lien’s priority. This signature indicates consent.
Signatures on these agreements are usually notarized. Notarization helps confirm the signature’s authenticity. If an entity (like a corporation) is signing, it must be done by someone with the authority to legally commit the entity.
Filing and Recording
Once signed, a subordination agreement should be made part of the public record by filing it with the Office of the Clerk of the Circuit Court in the Maryland county where the property is located.
Recording the agreement provides constructive notice to others, like potential buyers or future creditors. This means the law considers everyone to have knowledge of a properly recorded document because the information is publicly available. Recording protects the priority of the lender whose lien is elevated against later claims.
To be accepted for recording, a subordination agreement in Maryland must meet certain requirements.3Maryland General Assembly. Real Property Article § 3-104 – Prerequisites to Recording It generally must:
- Be in writing
- Be signed
- Be acknowledged (often through notarization)
- Legibly list the names of the parties involved
- Include an adequate legal description of the property
Successfully recording the agreement makes it a permanent part of the county’s land records, officially changing lien priority as stated. This ensures anyone searching title records will see the reordered priorities.
Failing to record a subordination agreement, or recording it incorrectly, carries risks. While an unrecorded agreement might still be binding between the parties who signed it, it may not be effective against third parties who are unaware of it. Prompt and proper recording is important to ensure the agreement has its full legal effect.
Enforcement in Legal Proceedings
If disputes over lien priority involving a subordination agreement arise, legal action in the Circuit Court for the county where the property is located may be needed. These courts interpret and enforce these agreements.
A common situation is a foreclosure. During foreclosure, the court decides the order for distributing sale proceeds. A recorded subordination agreement is presented as evidence by the party benefiting from it to claim a senior position. Maryland courts review such agreements to ensure they are applied as intended if valid.
Another option is a declaratory judgment, where a party asks the court to formally state the rights and duties under the agreement, which is useful if there’s uncertainty about its impact on other liens.
If a court finds a subordination agreement valid, its order upholds the changed lien priorities. This directly affects fund distribution in a foreclosure. For example, if a junior lienholder agreed to make their lien secondary to a new mortgage, and foreclosure proceeds don’t cover all debts, that junior lienholder might receive less or nothing, while the lender who obtained subordination is paid first.
Properly created subordination agreements are enforceable in Maryland, allowing parties to contractually reorder lien priorities.