Updates
April 24, 2020

Today, the Texas Supreme Court issued a significant decision in favor of Texas home-equity lenders in Federal Home Loan Mortgage Corporation v Zepeda, No. 19-0712, answering “yes” to the following certified question from the United States District Court of Appeals for the Fifth Circuit: “Is a lender entitled to subrogation, where it failed to correct a curable constitutional defect in the loan documents under §50 of the Texas Constitution.”

In 2007, Sylvia Zepeda obtained a loan from CIT Group/Consumer Finance, Inc. to purchase a home. Years later, Zepeda refinanced her debt with a home equity loan from Embrace Home Loans, Inc., which paid the balance of Zepeda’s debt to CIT Group. Thereafter, Zepeda sent a letter to Embrace providing notice that the home-equity loan did not comply with Article XVI, § 50(a)(6)(Q)(ix) of the Texas Constitution because Embrace had not signed a form acknowledging the home’s fair market value on the date the loan was made. The letter requested that the defect be cured within 60 days. Embrace did not cure the defect. After the home-equity loan was sold to Freddie Mac, Zepeda sent another letter providing notice of the defect and offering an opportunity to cure but Freddie Mac did not respond. Subsequently, Zepeda sued to quiet title.

Both Zepeda and Freddie Mac moved for summary judgment, with the former arguing that Freddie Mac does not possess a valid lien on her property because it failed to cure the constitutional defect within 60 days of notification and the latter arguing that it is subrogated to CIT Group’s lien because its predecessor Embrace paid off the balance of CIT Group’s loan to Zepeda. The United States District Court for the Southern District of Texas, in granting Zepeda’s motion and denying Freddie Mac’s motion, concluded that Freddie Mac was not entitled to equitable subrogation because it was negligent in failing to cure the constitutional defect in the loan documents.

Freddie Mac appealed and the Fifth Circuit certified the above-mentioned question to the Texas Supreme Court, which noted that:

[c]ommon law subrogation has coexisted with this constitutional scheme for more than a century. In the mortgage context, the doctrine allows a lender who discharges a valid lien on the  property of another to step into the prior lienholder’s shoes and assume that lienholder’s security interest in the property, even though the lender cannot foreclose on its own lien. This Court has  recognized the doctrine in the §50 contexts since at least 1890.

The Court went on to state that “a lender’s right to subrogation is ‘fixed’ when the prior, valid lien is discharged” and that it has previously “honored equitable subrogation claims against homestead property when a refinance, even though unconstitutional, was used to pay off valid liens.” The Court also reiterated that “subrogation helps the homeowner” and “stressed that the doctrine of equitable subrogation works to protect homestead property” because without it, “lenders would be hesitant to refinance homestead property due to increased risk that they might be forced to forfeit their liens.”

 In closing, the Court succinctly stated:

Home-equity loans have been legal in Texas for about 24 years, but subrogation has been part of the common law for more than a century. On this historical and procedural record, we believe  that revisiting the wisdom of subrogation, in this case, is unwarranted.

The Zepeda opinion represents a resounding victory for Texas home-equity lenders and confirms the following well-established subrogation principle: “Under Texas law, a lender who discharges a prior, valid lien on the borrower’s homestead property is entitled to subrogation, even if the lender failed to correct a curable defect in the loan documents under §50 of the Texas Constitution.”

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