CHAPTER 7.06. Circuity of Lien

• Jurisdiction: United States

7.06. Circuity of Lien

Courts have historically struggled with the effect of a subordination agreement on the priority of intervening liens. In other words, if there are three lienholders, A, B, and C, who are in an alphabetical order of priority, and if A subordinates its lien to that of C, in what position of priority is B's lien? This has been referred to as the "circuity of liens" problem.⁶⁵

There appear to be two approaches among the jurisdictions to resolve the "circuity of liens" issue. The majority approach is the so-called partial subordination approach. This approach, discussed below, was taken by the Colorado court in Tomar Dev., Inc. v. Friend.⁶⁶ The minority of jurisdictions follow what is called the complete subordination approach. Under the latter, when A subordinates to C, B moves up in priority ahead of A and C—the order of priority becomes B, then C, and then A. The effect in a foreclosure is therefore obvious. B gets paid first, then C, and then A. Courts taking the majority approach have criticized the complete subordination approach as resulting in a windfall to the intermediary lienholder, contrary to the presumed intent of the subordinating parties.

In Tomar, the Colorado court of appeals wrestled with this question. The Colorado court, analyzing both the majority and the minority positions, followed the majority and applied the partial subordination approach. The court recognized that the benefit of the partial subordination approach is that it does not affect the rights or lien position of those persons not in privity to the subordination agreement (e.g., the intermediary lienholder), as such a person is not a beneficiary of the subordination agreement and should not be entitled to a windfall by leapfrogging in priority one who is a party to the subordination agreement.⁶⁷ As at least one authority has written, the intermediary lienholder acquired its lien subordinate to that of the senior lienholder with every expectation of that subordinate position.⁶⁸ Any contractual change of the identities of the senior lienholder and a lienholder more junior to that of the intermediary lienholder does not change that expectation.

To continue the earlier hypothetical, partial subordination would result in C now in first position and A now in third position, but B remains in the same priority as before the subordination. Moreover, the partial subordination approach does not disadvantage B given that while C's interest is secured first, it is...