decided: April 28, 1978.
IN RE DISTRIBUTION OF PROCEEDS FROM SHERIFF'S SALE OF PREMISES 250 BELL ROAD, LOWER MERION TOWNSHIP, MONTGOMERY COUNTY, PENNSYLVANIA. APPEAL OF JOHN H. MCCOY AND WILLIAM L. O'HEY, JR., IN NO. 289. APPEAL OF BOENNING & SCATTERGOOD, INC., IN NO. 322
Nos. 289 and 322 January Term 1976, Appeal from the Judgment of the Superior Court at Nos. 302, 362, 440 October Term, 1975 reversing the order dated October 30, 1974, of the Court of Common Pleas, CIVIL ACTION-LAW, for the County of MONTGOMERY, at No. 73-15375
Henderson, Wetherill, O'Hey & Horsey, Edward Fackenthal, Norristown, for appellants at No. 289 and appellees at No. 322.
Waters, Fleer, Cooper & Gallagher, Thomas E. Waters, Norristown, Rawle & Henderson, George M. Brodhead, L. Carter Anderson, Philadelphia, for appellant at No. 322 and appellee at No. 289.
Edward N. Kurland, Philadelphia, for appellee, Jay Vending, Inc.
Charles Blasband, Norristown, for appellee, Michael Margolies.
Eagen, C. J., and O'Brien, Roberts, Pomeroy, Nix, Manderino and Packel, JJ. Manderino, J., concurs in the result. Packel, J., did not participate in the decision of this case.
[ 479 Pa. Page 224]
OPINION OF THE COURT
This case involves two appeals from an order of the Superior Court reversing an order of the Court of Common Pleas of Montgomery County. The Court of Common Pleas sustained exceptions to a sheriff's schedule of distribution of proceeds from the sale of real estate. In dispute is the allocation of such proceeds among competing creditors of the property owners.
The parties to this appeal are appellants, Boenning and Scattergood, Inc. [Hereinafter: Boenning], holder of a 1966 judgment, and John H. McCoy, holder of a 1971 mortgage, and appellees, Michael Margolies, holder of a 1971 mortgage dated later than McCoy's, Jay Vending, holder of a 1973 judgment, and William L. O'Hey, Jr., also holder of a 1973 judgment.
The controversy arises from the following facts:
On April 14, 1966, Boenning entered judgment on a note for $30,500 against John and Helen Jennings [Hereinafter: Jennings] in the Court of Common Pleas of Montgomery County. On July 3, 1970, Boenning initiated execution proceedings against real property owned by Jennings at 250 Bell Road, Lower Merion Township, Montgomery County. Although issued, the writ of execution was never recorded in the judgment index. Thereafter, Jennings, in an attempt to challenge the underlying debt, moved to open judgment and requested a stay order. The stay was issued on July 13, 1970, pending resolution of the judgment's validity. On July 29, 1972, the stay order was discharged by the trial court,
[ 479 Pa. Page 225]
and that dismissal was affirmed per curiam by the Superior Court in Boenning & Company v. Jennings, 222 Pa. Super. 712, 294 A.2d 739 (1972).
Boenning immediately reinstituted execution proceedings by securing a second writ on August 23, 1972, which it again did not index. Jennings obtained an injunction from the United States District Court for the Eastern District of Pennsylvania staying execution proceedings; in December, 1973, however, the United States Court of Appeals for the Third Circuit reversed. Jennings v. Boenning & Co., 482 F.2d 1128 (3rd Cir. 1973).
Boenning then instituted its third execution -- again, without indexing the writ -- and the property was listed for sheriff's sale on February 20, 1974. On that day, the property was also scheduled for sale as a result of foreclosure of a first mortgage held by The Equitable Life Assurance Society. The property was sold on the scheduled date pursuant to Equitable's writ, and the sum of $85,000 was realized from the sale. Certain liens for taxes, costs of execution, and the first mortgage of Equitable had undisputed priority to the proceeds of the sale. After satisfaction of these claims, the sum of $66,679.50, which was insufficient to pay the remaining creditors in full, was available for distribution. Accordingly, the matter in controversy is the validity and priority of the competing liens.
The liens being asserted against the remaining funds are as follows:
Debt Date of Lien with Interest
1. Boenning Judgment April 1966 $48,500.00
2. McCoy Mortgage August 1971 30,000.00
3. Margolies Mortgage December 1971 17,500.00
4. Jay Vending Co. Judgment June 19, 1973 21,000.00
5. McCoy Judgment June 20, 1973 1,300.00
6. O'Hey Judgment June 20, 1973 21,000.00
McCoy's mortgage was executed and recorded on August 6, 1971, more than five years after entry of the Boenning judgment, while execution proceedings on that judgment
[ 479 Pa. Page 226]
were stayed pending disposition of Jennings' petition to open judgment. Depositions disclose that, at the time of his mortgage, McCoy was aware of the Boenning lien and knew that it would have priority over his mortgage unless Jennings was successful in challenging the debt. McCoy's attorney was a partner in a law firm which also represented Jennings against Boenning. McCoy accepted a second mortgage on Jennings' realty on counsel's assurances that the Boenning lien would be invalidated.
The Margolies mortgage was recorded on December 22, 1971. Jay Vending entered judgment against Helen Jennings on June 19, 1973. Like the McCoy lien, both of these liens appeared of record more than five years after entry of the Boenning judgment; but unlike McCoy, there was no showing that the lienholders had any knowledge of the Boenning judgment or the proceedings to open.
The Boenning judgment had been entered in the judgment index more than seven years prior to the sheriff's sale on February 20, 1973. Accordingly, Boenning was not included in the proposed schedule of distribution. Boenning filed exceptions to the schedule claiming that its lien was valid and had been improperly omitted. The Court of Common Pleas sustained the exceptions on the theory that Boenning's judgment lien was revived as to McCoy because the latter had actual knowledge that a writ of execution on the judgment had been issued and docketed within five years of the judgment. Thus, the court held that the claim of McCoy was junior to that of Boenning despite Boenning's failure to index his writ of execution.*fn1
[ 479 Pa. Page 227]
However, the court also found that Boenning's lien was not revived against subsequent creditors with no actual knowledge of the execution proceedings. The court, therefore, concluded that, while Boenning was superior to McCoy who, in turn preceded Margolies and Jay Vending, the latter two creditors should take before Boenning. This order of rank results in a circular lien, with A (Boenning) having priority over B (McCoy) and B having priority over C (Margolies and Jay Vending), but C having priority over A.
The Court of Common Pleas applied the Pennsylvania temporal priority rule to break the circle and realign the parties: first in time, first in right.*fn2 Accordingly, the court directed that Boenning's lien be included in the distribution of proceeds and be given priority over all other liens.
On appeal by the remaining parties, the Superior Court reversed and applied a different rule. The court ordered that distribution be made according to a formula applied in Day v. Munson, 14 Ohio St. 488 (1863), and advocated by Judge Dixon, dissenting in Hoag v. Sayre, 33 N.J.Eq. 552 (1881). As applied, the formula gave priority to Jay Vending and Margolies over Boenning to the extent that the sale proceeds exceeded the amount of McCoy's lien. Consequently, the Superior Court ordered distribution as follows:
[ 479 Pa. Page 2281]
. Boenning Judgment $13,470.50
2. Strawbridge and Clothier
Judgment (Undisputed) 1,650.00
3. McCoy Mortgage 16,529.50
4. Margolies Mortgage 17,500.00
5. Jay Vending Co. Judgment 17,529.50
The issue before us is to determine the applicable rule of distribution in a circular lien situation which arose from the failure of one party to make a required filing. For the reasons hereinafter stated, we hold that the subordination rule is to be applied where the circuitry results from a failure to file.
There are at least three situations out of which a circular lien may arise: (1) where the first of three or more claimants waives his priority in favor of another claimant; (2) where there are inconsistent statutory or judicial rules of priority; and, (3) where one of the claimants fails to make a required filing. Pennsylvania has applied the temporal priority rule of distribution in all three situations.*fn3 We are
[ 479 Pa. Page 229]
now concerned only with the failure-to-file situation and expressly confine today's holding to that type of circuitry.
A circularity involving failure-to-file arises from the operation of Pennsylvania's race-notice recording system where proper recording of an interest or lien is necessary for priority as to all except those with actual notice of the prior lien.*fn4 Successive mortgages may be used to illustrate: A takes a first mortgage which he fails to file. B takes a second mortgage, with notice of the mortgage to A, and files. C takes a third mortgage, without notice of the mortgage to A. A has priority over B (because of B's knowledge); B has priority over C because of prior filing; C has priority over A (because of A's failure to file and C's lack of knowledge). In this situation, the circularity arises because of A's failure to file. On a theory of fault, A seems to be the appropriate person to bear the loss.
However, the opposite result is reached by the Pennsylvania temporal priority rule, with C bearing the loss. The Pennsylvania approach is to revert to the common law rule that "first in time is first in right" and distribute the fund to the competing claimants in the chronological order of their claims. A rationale for the Pennsylvania rule was supplied in Dowling v. Vallett, 70 Pa. Super. 481, 484 (1918) (citations omitted);
[ 479 Pa. Page 230]
"The last of three or more liens in the order of their succession being superior to the first but inferior to the second gains no practical advantage from its superiority, because it could not be preferred to the first without being preferred also to the second, to which it is subsequent. . . ."
The Pennsylvania method gives A, who is paid first, an unwarranted advantage over C whose priority over A is disregarded. B is treated fairly because the fund is applied to pay his claim after A's prior claim has been paid. C is treated unfairly because he is paid only after A and B have been paid in full, even though A's unfiled mortgage has, according to the filing statute, become "void" as to C who, by hypothesis, came in without knowledge of A.*fn5
A seemingly more equitable method of distribution than the Pennsylvania rule was adopted by the Superior Court in this case. The court applied a formula used to distribute proceeds in Day v. Munson, supra, and detailed as follows by Judge Dixon dissenting in Hoag v. Sayre, supra at 562-63:
"1. Deduct from the whole fund the amount of B's lien, and apply the balance to pay C. This gives C just what he would have if A had no existence.
2. Deduct from the whole fund the amount of A's lien, and apply the balance to pay B. This gives B what he is entitled to.
3. The balance remaining after these payments are made to B and C is to be applied to A's lien."
[ 479 Pa. Page 231]
The following rationale for the Dixon formula has been suggested.*fn6 The Dixon approach is designed to satisfy the reasonable expectations of the parties. B bargained for the fund minus A's claim and C bargained for the fund minus B's claim. Each is entitled to share as a junior lienholder. A's expectation was to be a first lienholder, but his failure to record deprives him of this position in so far as it is necessary to protect the other claimants.*fn7
The principal defect of the Dixon formula is that is produces disparate results depending on the size of the fund and the amounts of competing claims. When the fund is small, A may take the entire amount while B and C receive nothing. As the fund increases, A's share decreases until B's and C's claims have been paid in full.*fn8 Thus, the results arrived at by using the Dixon formula can be as inequitable as those produced by the Pennsylvania rule.*fn9 Neither the
[ 479 Pa. Page 232]
Dixon formula nor any of the substitute formulas based on Dixon has been applied by any court.*fn10 See n.9, supra.
By contrast, many jurisdictions have used the subordination rule to resolve all three types of circuities. In most jurisdictions, the subordination rule is the generally accepted solution in cases of circularity which result from a waiver agreement.*fn11 It also is the rule most frequently applied to resolve circuities arising by operation of law.*fn12 The rule was also applied in many of the older failure-to-file circularity cases.*fn13
[ 479 Pa. Page 233]
Where the subordination rule is applied, the amount of A's claim is set aside from the fund to pay C and the balance, if any, is paid to A; thereafter, the balance of the fund, if any, is paid to B; the remaining balance, if any, is paid to C and A in that order.
Thus, C, by virtue of the subordination agreement, is paid first, but only to the amount of A's claim, to which B was in any event junior. B receives what he had expected to receive: the fund less A's prior claim. If A's claim is smaller than C's, C will collect the balance of his claim only after B has been paid in full. A, the subordinator, receives nothing until B and C have been paid except to the extent that his claim exceeds the amount of C's claim.
In applying the subordination rule to a failure-to-file circuitry, subordination of A, the nonfiler who is at fault, is the obvious choice and C is the obvious choice to receive the benefit of the subordination because he took without knowledge.
The subordination rule is, admittedly, subject to the same criticism made of the Dixon formula -- viz., that it produces anomalous results in actual distributions. For example, under the subordination rule, B, who gets nothing when A's claims equals or exceeds the fund, progressively moves to a better position as A's claim decreases. C is in the opposite position; the larger A's claim, the better C fares. Whether or not A takes anything depends on the size of C's claim: whenever C's claim equals or exceeds A's, A takes nothing until B and C have been paid in full; the smaller C's claim, the more A takes.
The subordination rule is, however, superior to Dixon in one important respect, i. e., under no circumstance can A, the party most at fault, take the entire fund while B and C receive nothing, a hazard which is inherent in the Dixon
[ 479 Pa. Page 234]
formula. Moreover, the results which the subordination rule produce are no less predictable or less equitable then those produced by the Dixon formula. Furthermore, when the subordination rule is applied to a circuitry situation involving fault, i. e., neglect in failing to file or in imperfect filing, the nonfiler bears the loss. This is an equitable result in contrast to that produced by the Pennsylvania rule.
Therefore, the record is remanded to the Court of Common Pleas of Montgomery County for distribution consistent with this opinion following a determination of the validity of the Margolies mortgage.