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Appellate Division applies rarely used equitable doctrine to preserve HOA

The Superior Court of New Jersey’s Appellate Division recently found that sums owed by a bank to a Homeowners’ Association (HOA) after the bank acquired a portion of a residential community at a foreclosure sale were not discharged despite the sequence of recordation, in direct contravention of New Jersey’s recording statute.

In Fulton Bank of N.J. v. Casa Eleganza, LLC, No. A-2859-20, 5 (App. Div. Aug. 11, 2022), a bank challenged the ruling of the Chancery Division which held that 1) the bank must pay fees it owed to the HOA and 2) the HOA Declaration of Covenants – which was recorded subsequent to the first mortgage – was not extinguished. The Appellate Division affirmed the Chancery Division’s ruling, citing the rarely applied doctrine of equitable subrogation.

This result is somewhat anomalous. New Jersey is a race-notice jurisdiction (pursuant to N.J.S.A. 46:26A-12), meaning that when two parties claim valid ownership to a piece of property, the party that records their deed first prevails – provided that the party that recorded first had no actual knowledge of the party that recorded second’s previously-acquired interest in that property. Thus, because here the first mortgage was recorded prior to the HOA Declaration of Covenants, the ordinary result would be that the foreclosure sale extinguished the bank’s obligations under the Declaration.

Instead, the court applied the infrequently used doctrine of equitable subrogation to alter the result that would have attained under a strict application of New Jersey’s race-notice statute. Under that equitable doctrine, a court has the power to modify the ordinary sequence of priority as determined by the state recording statute in order to attain an equitable result. Here, the court chose to apply the doctrine because it determined that if the usual sequence of priority applied to extinguish the bank’s obligation to pay and cancel the HOA Declaration of Covenants, prejudice would result to the individual homeowners who already own lots, and to the municipality, which issued major subdivision approval in reliance on the creation of an HOA. As noted by the Chancery Division, the HOA and the Declaration were a condition of the subdivision approval. Moreover, the other homeowners relied on the existence of the HOA and the Declaration of Covenants when they purchased their homes, and it would thus be inequitable to void the HOA and the Declaration.

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