A recent Massachusetts Appeals Court decision regarding whether an unrecorded purchase and sales agreement takes precedence over a mortgage has elicited strong response from the local banking industry. Bankers say the decision sets a concerning precedent and will have major implications on the lending business if it stands.

The Massachusetts Appeals Court issued its decision in the Queeno v. Colonial Co-operative Bank case in May, finding in favor of the plaintiffs and putting a mortgage behind a purchase and sales agreement in the priority pecking order.

“This court concluded that an unrecorded purchase and sales agreement had priority over a recorded bank mortgage in the chain of title to the property that was the subject of both the mortgage and the agreement, where the bank had actual notice of the agreement and its details prior to its issuance of the mortgage, and where the plaintiffs, by virtue of the agreement, had acquired and equitable interest in the land,” the court’s decision read.

The decision is just one piece of an eight-year battle. On June 6, 1997, Cameron and Melinda Queeno entered into an agreement with Mark Cote and Daniel Cote, developers, for the purchase of land in Westminster and the construction of the Queenos’ home. According to the appeals court decision, which included background of the legal battle, the agreement stated that the Queenos would pay $321,415 for the land and the construction of the home. They put down a deposit of slightly more than $16,000 to cement the deal. The agreement was not recorded at the registry of deeds.

On June 18, 1997, the developers applied for a construction loan with Gardner-based Colonial Co-operative Bank. Along with the application, the developers supplied a copy of the agreement to the bank, which it retained.

Approximately one month later, the bank gave the developers a six-month construction loan for $241,500 for a pre-sold home. The background in the court decision said the bank did not request the Queenos “subordinate their rights” under the agreement to the bank’s mortgage. Subsequently, the mortgage was recorded at the Worcester County Registry of Deeds.

Soon after, construction was delayed because of the developers’ financial problems. Within the court’s decision, it states that the developers refused to convey the property to the Queenos and refused to finish constructing the home. In the summer of 1998, the Queenos were given a temporary occupancy permit. The developers and the local building inspector gave consent for the Queenos to move in.

In November 1998, the developers transferred parcels of real estate, including the Queenos’ property, to another company. The Queenos brought action against the developers and the real estate agent holding the deposit in escrow. They were granted a lis pendens, or notice of pending action, in December 1998. The developers stopped making payments on the mortgage and the bank began foreclosure proceedings. In October 1999, the bank received judgment in their favor for a foreclosure on the property. In their complaint against the bank, the Queenos sought an order that wouldn’t allow the bank to convey the property to anyone other than them. In November 1999, a lis pendens and a preliminary injunction were granted in the Queenos’ favor.

Claiming that because the agreement was not recorded and the mortgage had priority over the agreement, the bank filed a summary judgment motion. A Superior Court judge ruled that determining whether the unrecorded purchase and sales agreement took priority over the mortgage was the only issue to consider. A judge granted partial summary judgment in favor of the bank. The judge also ordered the Queenos’ lis pendens dissolved and allowed the bank to foreclose on the property and sell it to the general public. However, the lis pendens was reinstated by a justice of the appeals court. The Queenos appealed and the Appeals Court reached its recent decision, which now is causing members of the local banking and real estate industries to question the impact it will have on business.

Henry H. Thayer, partner at Boston-based Rackemann, Sawyer & Brewster and chair of the joint Real Estate Bar Association/Abstract Club Amicus Brief Committee, said the Appeals Court decision, if it stands, should not be used as a precedent in other court decisions. Thayer said the committee he chairs, which submits “friend of the court” briefs, is split on whether the recent decision by the Appeals Court is the correct one.

Colonial Co-operative Bank’s attorney, Blake Godbout, said his client is asking the state’s Supreme Judicial Court for further appellate review of the case.

For the Record

“We disagreed with the appellate court’s decision and we are very concerned about the broader implications,” Godbout said. “Consequently, we immediately filed a petition for further appellate review and were informed that the [Massachusetts Bankers Association] and Colonial Co-operative Bank, through [attorney Stanley Ragalevksy, partner at Boston-based law firm Kirkpatrick & Lockhart Nicholson Graham], filed an amicus letter requesting the Supreme Judicial Court accept our petition for further appellate review.”

In a letter dated June 10 to the Supreme Judicial Court on behalf of the Massachusetts Bankers Association and Colonial Co-operative, Ragalevsky said there are several issues within the decision that could adversely affect the banking industry.

He notes that the public recording system is important to the real estate and mortgage process.

“Lien priority must generally be determined upon the basis of recorded public records, not subjective knowledge,” Ragalevsky said.

Steven LaFortune, the Queenos’ attorney and partner at LaFortune & LaFortune in Andover, responded in a June 20 letter to the SJC. “It has been well settled that if a bank had actual or constructive notice of an unrecorded P&S [purchase and sales] agreement before recording its mortgage, the unrecorded P&S has priority in the chain of title ahead of the mortgage,” LaFortune wrote, adding his opinion that this interpretation of the law has been established in Massachusetts since the 1930s.

LaFortune did not return phone calls regarding the decision.

Ragalevsky pointed out that the Appeals Court decision as it stands now will make the availability of construction financing more difficult to obtain for builders. It would be unlikely, he said, that banks would consider financing the construction of a pre-sold home in Massachusetts for a builder if its lien priority might be superseded by another claim because the bank made the loan knowing that the builder and borrower entered into an unrecorded agreement to sell the home.

If the decision stands, the most reliable, least risky way a lender might finance construction of a home in the future would be to require a homebuyer obtain construction financing directly from a bank with a “builder tie-in,” Ragalevsky said. This means the consumer purchases land from a builder, obtains a construction loan and contracts with the builder to construct a home. Thayer, however, said this method is troublesome.

“Extra work will be involved,” Thayer said. “That’s more complicated” than lending to a builder, he said.

Besides affecting residential construction loans to builders, Ragalevsky said the decision plays a role in other types of lending such as commercial construction loans, consumer bridge loans and lines of credit.

“No good can come from a judicial determination that the traditional lien priority of a lender can be routinely subverted in favor of unrecorded agreements where there has been no bad act or inequitable conduct on the part of the lender,” Ragalevsky said.

Ragalevsky said despite the bank financing the construction, there has apparently never been a closing on the property title and the builder allowed the Queenos to move in and they have not completed their obligation under the purchase contract with the builder.

LaFortune said the Queenos have, in fact, always sought to close the deal on their home. They could not do so because Colonial Co-operative would not honor the Queeno’s P&S agreement “because the bank disputed that the Queenos’ P&S agreement had to be honored,” LaFortune wrote. He also alleged that the developer refused to close on the home and improperly transferred its title to the property to another developer. The bank then tried to assign the mortgage to the new developer, even though it knew there was an existing P&S agreement.

Ragalevsky said the decision raises questions because the Queenos’ rights under their purchase agreement with the builder are contractual rights, not an interest in real estate.

“Such contractual rights have historically been considered personal property, as opposed to real property,” Ragalevsky said.

In order for the Queenos to have an interest in real estate, Ragalevsky said a deed conveyance to them by the builder of an interest in real estate would have to occur. No deed has been delivered and title was never transferred to the Queenos, Ragalevsky said.

A final concern Ragalevsky noted in the letter is the decision is likely to “promote unnecessary and unproductive litigation and erode the statutory [deed] recording system.” In addition to setting a precedent that is likely to generate more litigation, Ragalevsky said the case itself is not yet resolved. That is because, despite the court’s decision, Colonial Co-operative may still have legal or equitable claim against the property or the Queenos to recover the $241,500 construction loan.

LaFortune disputes this, saying the recording statute “only gives a party priority in the chain of title if it recorded its interest in the property first and it did not have actual notice of another party’s interest in the property before it recorded its interest.” LaFortune added that a P&S agreement does constitute a legal and equitable obligation to convey the property to the holder of the agreement.