United States: NJ Appellate Division Holds That HOA Declaration Trumps Prior Recorded Mortgage In Certain Instances

The New Jersey Appellate Division, in a published opinion, recently held that in certain instances, a recorded homeowners' declaration of covenants can trump a prior mortgage. See Fulton Bank of N.J. v. Casa Eleganza, LLC, 473 N.J. Super. 387 (App. Div. 2022). In Casa Eleganza, Plaintiff Fulton Bank of New Jersey ("Plaintiff") acquired title via mortgage foreclosure sale to a portion of the residential community Iron Gate at Galloway ("the Property"). The defaulted mortgage Plaintiff had foreclosed on was originally recorded on June 8, 2007, following which, on June 25, 2007, the Irongate at Galloway Homeowners' Association (the "HOA") recorded a Declaration of Covenants (the "HOA Declaration") encumbering the Property.

Plaintiff sold the Property to a third party. However, at closing, the HOA demanded that Plaintiff pay it $12,651.35 for capital contributions, HOA fees, legal fees, and unpaid landscaping bills that had been incurred during the time Plaintiff held title. Plaintiff refused to pay and moved to "divest" the land from the HOA's covenants, contending that the HOA had no ability to seek these damages as the HOA Declaration had been recorded after the recording of the original mortgage. Plaintiff argued that as New Jersey is a "race–notice" jurisdiction, only the terms of the original mortgage could govern, and the Property thus had to be treated as unencumbered by the HOA Declaration's obligations.

Plaintiff's action was dismissed by the trial court, which refused to discharge the sums owed by holding that such an outcome would be inequitable and antithetical to the purpose and characteristics of common interest communities and homeowner associations. The matter then proceeded to the New Jersey Appellate Division where the dismissal was affirmed, again in reliance upon the unique nature of common interest communities, but also upon the "equitable subrogation" doctrine.

In doing so, the Appellate Division first observed that common interest communities–like Iron Gate at Galloway–constitute a unique class of real property ownership, as they are designed to diffuse property maintenance and upkeep expenses among the community at large, ensure certain standards and uniformity of behavior amongst owners, and assist in preserving property values. The Court noted that to make this ownership concept possible and ensure its continuance, it was necessary that properties located within these communities were able to be subjected to declarations which ran with the land in perpetuity and bound both current and future owners.

While New Jersey employs a "race-notice" approach to the recording of property interests, the Court nevertheless held that the HOA Declaration was operative and bound the Property despite it having been recorded after the original mortgage. In doing so, the Court noted in order to effectuate and preserve the aforementioned common interest goals, and in light of the fact the community would have never been approved by the township in the first place absent the creation of the HOA, the Court held that equity demanded a modification of the normal sequence of priority and the enforcement of the HOA Declaration. The Court also held this outcome was necessary to prevent innocent property owners from suffering the consequences of the unpaid HOA bill, as Plaintiff could not be permitted to force itself into a position "better than any other purchaser responsible for assessments and HOA responsibilities during a period of ownership."

In so holding the Court relied upon the concept of "equitable subrogation," a doctrine which, although "rarely applied," allows a court to "alter the ordinary sequence of priority to satisfy principles of equity" when payment of another creditor's debt puts another creditor or a property owner in a more advantageous priority on a property than the creditor/owner normally would have been. See Sovereign Bank v. Gillis, 432 N.J. Super. 36, 44 (App. Div. 2013); U.S. Bank Nat'l Ass'n as Tr. v. Deely, 466 N.J. Super. 387, 397 (App. Div. 2021). The principle rests on unjust enrichment grounds. Likewise, the Court reasoned that here the Plaintiff knew it was foreclosing on a property in a common interest community.

Take-aways

Despite New Jersey being a race-notice jurisdiction, a court still retains significant discretion and can look to modify conventional sequences of priority in an effort to safeguard principles of its perceived notions of equity, particularly with regard to common interest communities.

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