Equitable Conversion is the doctrine whereby equity adjusts the title to real property according to the parties' intentions, contrary to the record. An excellent article by Kristen V. Bellouny in the August 21st issue of the New York Law Journal's Landtitle section considers mortgage tax implications in light of this doctrine. The following discussion concerns its effect on a particular situation involving builders and lenders.

Usually equitable conversion is found when a deed is given as security for the payment of money though deeds are given to secure the performance of other obligations, as well. In either case there is no intent to convey the fee title.

Other types of equitable relationships can fall within this doctrine, too. Among these are vendor/vendee which comes into being at the time of signing the contract and continues until delivery of the deed at closing. The vendor is said to have bare legal title, holding the title in trust for the vendee subject to his or her lien for the purchase price. The vendee becomes the equitable owner.

Such equitable interests give rise to liens, often referred to collectively as equitable mortgages. Each party has the right to appeal to equity in the event of default and to have his or her interest foreclosed rather than forfeited.

Mortgagor/Mortgagee Relationship

Because the intent is to give security and not a fee interest courts of equity impose a mortgagor/mortgagee relationship on the grantor and grantee and do not permit a forfeiture of the grantor's interest. The grantee, likened to a mortgagee, is required to foreclose the grantor's equity of redemption in order to gain the fee title. Contracts or recitals providing for forfeiture are not enforced.

An equitable interest, although a lien, can lose its priority to certain other liens. The recording statute protects subsequent bona fide purchasers for value who are without notice of the equitable lien. For example, a grantor who is not paid the full purchase price at closing has an automatic grantor lien for the balance which attaches simultaneously with delivery of title. However, if he does not thereafter record a mortgage (the legal lien) a subsequent lender with no knowledge of the equitable lien can record a mortgage and gain priority over the grantor. A subsequent judgment creditor, on the other hand, cannot gain priority over the equitable lien, with or without notice or recording of a mortgage, because a judgment creditor is not a purchaser.

Effect of Recording

Under Real Property Law 320 a deed intended as security "must be considered a mortgage" but, unless the instruments "operating as a defeasance...or explanatory of its being desired to have the effect only of a mortgage, or conditional deed" are recorded at the same time the recording statute does not protect its priority. It does not constitute notice because it is not duly recorded (i.e. indexed as a mortgage) and will lose priority over subsequent bona fide purchasers' liens.

Nevertheless, anyone searching the record and finding a deed is on notice that the grantor has alienated his title somehow. What about the lender who takes a mortgage from a grantee?

Mortgage from Grantee

A situation involving this problem was recently brought to our attention. An owner of real property conveyed to a builder during the course of construction pursuant to a contract which called for reconveyance upon completion of the work. The deed contained a recital that it was given pursuant to a building contract. The grantor made substantial payments to the builder at various times before and during construction.

At some point before completion the builder borrowed money, giving a mortgage on the subject real property to secure the loan. No deed was ever given back to the grantor. Eventually, the mortgage went into default and the lender attempted to foreclose. The grantor asserted that he had an equitable lien because of the contract with the builder and that it was superior to the lender's mortgage. As a contract vendee, grantor referred to himself as a mortgagee with respect to his contractual right to reconveyance from the builder.

Although the lender argued that it should be able to rely on the deed, the grantor countered that the deed recital gave notice of the grantor's interest. That, coupled with evidence that the lender was aware that this practice is common and that lenders frequently prefer to deal directly with the builder, hurt the lender's position. The court concluded that the deed was a mortgage and that title is in the grantor. Although a court an order delivery of a deed in order to "clear up" title it is not actually necessary to reconvey.

While the vast majority of such arrangements probably go according to plan it is apparent that lenders cannot rely on a mortgage from the builder for protection. Possibly the best course of action would be to avoid a conveyance to the builder in the first place. At a minimum the equitable owners must join in the mortgage or subordinate their interest to it.