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Marshaling of Assets

Marshaling of Assets

Marshaling of assets is an equitable principle which, when applied, attempts to minimize the damage that will result to third-party owners and subordinate mortgagees when a senior mortgage is foreclosed. The principle is applicable where, for example, a mortgage is placed upon multiple parcels (or upon a larger parcel of land which thereafter is subdivided), with the individual parcels then being sold or mortgaged to others without the benefit of partial releases being obtained from the senior mortgagee.

A few examples will best explain the doctrine of marshaling of assets. Assume Owner gives to Lender #1 a mortgage upon Blackacre and Whiteacre (or gives a mortgage on a large farm that is thereafter subdivided into Blackacre and Whiteacre). Then assume that Owner sells Blackacre to Third Party, but due to an oversight no partial release (or discharge) is obtained from Lender #1.

It is clear from the above that Lender #1's mortgage still encumbers both Blackacre (now owned by Third Party) and Whiteacre (still owned by Owner). What happens if Owner, who is obviously still liable on the underlying note, defaults? Which property or properties can Lender #1 foreclose against and in what order must it pursue those properties in connection with the collection of its debt? This is where marshaling of assets comes in.

The doctrine of marshaling of assets in the above case would be applied under the "inverse order of alienation" rule. This rule requires that a mortgagee, where land subject to its lien has been alienated in separate parcels successively, satisfy its lien out of the land remaining in the grantor (the Owner in this case), if possible, and, if that is insufficient, then to proceed against the parcels alienated in the inverse order of their alienation.

If the Third Party (who had purchased Blackacre) had mortgaged that parcel to Lender #2 then the doctrine of marshaling of assets would be applied by using the "two funds" rule. That rule applies when one lender (in this case, Lender #1) has two funds out of which it may be paid, while another lender (in this case, Lender #2) has only one. That is, under the facts here Lender #1 would have both Blackacre (now owned by Third Party) and Whiteacre (still owned by Owner) as security for its debt, while Lender #2 would have only Blackacre as the security for its loan. In this case the "two funds" rule would require that Lender #1 proceed first against Whiteacre and then, if that security is insufficient to satisfy its debt, proceed next against Blackacre.

It's obvious that both the "inverse order of alienation" rule and the "two funds" rule are inexorably intertwined. But one thing must be emphasized at this point: although one or both of the rules might be applicable to a particular situation neither rule can be applied in such a way as to prevent Lender #1 from proceeding against Third Party's property in every case. That is, the rule of marshaling assets sets out the order in which Lender #1 can proceed against the various available collateral properties. It does not wholly prohibit Lender #1 from proceeding against Third Party's (or Lender #2's) property if the value of the first collateral is insufficient.

The rules concerning marshaling of assets are more complicated than as stated above and, as in other areas of real estate law, are subject to a plethora of exceptions. For example, if the purchaser (in this case, Third Party) purchases Blackacre and agrees to assume the mortgage to Lender #1 the rules do not dictate that Lender #1 must proceed against Whiteacre first. In fact, the rule is reversed—under the assumed facts the rule requires Lender #1 to proceed against Blackacrebefore proceeding against Whiteacre.

There are other exceptions to the rule concerning marshaling of assets but the basic rule is as stated above. In any of its forms, however, the rule's purpose is to give an equitable result where one might otherwise not be obtained. In this regard, the doctrine is closely associated with the concept of equitable subrogation. In fact, the two rules grow out of the same equitable concept that one who succeeds to property unaware of a lien ought not to be jeopardized thereby, at least to the extent of the consideration paid.

The problems that doctrine of marshaling of assets attempts to address can be easily avoided by securing partial releases from the primary mortgagee. But even if such partial releases are overlooked the application of the doctrine can provide relief, at least to some degree.