The opinion of the court was delivered by: Verniero, J.
On appeal from the Superior Court, Appellate Division.
Plaintiffs instituted this action to compel specific performance of a building contract involving construction of a new home. Their complaint, as amended, also seeks to void defendant's mortgage interest in the same parcel or, alternatively, to impress a superior lien on the property for the money that they had advanced toward the purchase price. As contract purchasers of real property, plaintiffs acquired a vendees' lien on the property. We must determine the extent to which that unrecorded vendees' lien should be granted priority over defendant's recorded mortgage that was given to finance the home construction.
We hold that the priority of an unrecorded vendee's lien does not extend to those payments voluntarily made by the vendee after the lender properly records its mortgage. However, because the issue is essentially one of first impression in New Jersey, we decline to apply our holding to the present dispute. In view of the uncertainty of the law at the time of these transactions, we conclude that plaintiffs' vendees' lien should be given priority as against defendant's mortgage interest for the full amount of their initial deposit, and all sums later advanced toward the contract price.
Harry and Betty Ann Cox executed a standard-form contract with RKA Corporation (RKA) for the purchase of real estate located in Pennsauken, New Jersey (the property). Under the contract, RKA was to construct a new home for plaintiffs on the property. The purchase price was $106,880. Plaintiffs paid an initial deposit of $12,000 to RKA on August 25, 1994, the date they signed the contract. The contract specified that the balance of the purchase price would be due "at settlement." The settlement date was originally scheduled for October 31, 1994 but the parties understood that the closing would not occur until plaintiffs sold their existing home. Plaintiffs were not represented by an attorney in this transaction.
Unbeknownst to plaintiffs, RKA then sought a construction loan from Roebling Savings and Loan Association (Roebling) in the amount of $80,250. When it applied for the construction loan, RKA supplied Roebling with a copy of the contract entered into with plaintiffs. The fact that the property was under contract or "pre-sold" to plaintiffs was a factor considered by Roebling in granting the loan. Roebling was never in communication or contact with plaintiffs regarding the project.
On October 21, 1994, RKA settled the construction loan with Roebling, which took back a mortgage on the property as security for the loan. At that time, RKA's principal, Richard Niel, executed an affidavit of title certifying that "no other persons have legal rights in this property." Roebling paid RKA an initial advance on the loan in the amount of $43,335. On December 12, 1994, Roebling made a second advance to RKA in the amount of $30,896. The lender duly recorded its mortgage in the Office of the Register of Deeds of Camden County on December 14, 1994.
Following the recording of Roebling's mortgage, plaintiffs made a series of payments to RKA towards the balance of the purchase price:
$2,267 on January 3, 1995; $2,000 on March 15, 1995; $3,000 on June 15, 1995; $2,000 on July 28, 1995; and $61,958.53 on August 3, 1995. None of the payments was due on those dates. As noted, the contract did not require any payment beyond the initial deposit until the date of settlement. In total, plaintiffs paid RKA $83,225.53 prior to the settlement date (the $12,000 deposit and $71,225.53 in additional advances). Plaintiffs and RKA never closed title.
On or about November 28, 1995, the Coxes commenced this action for specific performance against RKA. RKA defaulted on the construction loan from Roebling, and the lender took steps to foreclose its mortgage. Plaintiffs amended their complaint to name Richard Niel as a defendant and to allege breach of contract, misapplication of trust funds, actual fraud, and consumer fraud. In a second amendment, plaintiffs named Roebling as a defendant and sought to void the Roebling mortgage or, in the alternative, to impress a superior lien on the property for all monies that they had advanced to RKA.
A default judgment was entered against RKA and Richard Niel in the amount of $83,225.53 for breach of contract and $249,676.59 for treble damages under the Consumer Fraud Act, N.J.S.A. 56:8-19. In respect of Roebling's mortgage, the trial court concluded, after a bench trial, that Roebling had taken its mortgage with knowledge of plaintiffs' interest in the property. Specifically, the court determined that plaintiffs' equitable interest, including the $12,000 deposit and all monies paid to RKA, constituted a lien superior to Roebling's recorded mortgage. In all other respects the court sustained the validity of Roebling's mortgage.
In an unreported opinion, the Appellate Division affirmed. In support of its disposition, the court relied on the fact that, as previously noted, Niel's October 21, 1994, affidavit declared "no other persons have legal rights in the property." According to the Appellate Division:
[That affidavit] constituted a lie under oath by Niel which Roebling was aware of because it knew of the Cox contract.
We think the trial judge correctly concluded that, given its knowledge of the Coxes' interest in the property, Roebling should have made further inquiry at that time. . . . [I]f Roebling had made inquiry of the Coxes or even copied them with the false affidavit, the Coxes would have been on notice of Roebling's interest in the transaction and would never have continued to advance the additional [monies]. This is not to suggest that Roebling was an evildoer, only that its inaction in the face of Niel's mendacity which caused catastrophe to the Coxes is an "unusual equity" which warrants striking the balance, otherwise in equipoise, in favor of the Coxes.
One member of the panel, Judge Carchman, dissented, concluding that the quantum of plaintiffs' relief should be limited to the amount of their initial deposit. Roebling appeals to this Court as of right. R. 2:2-1(a)(2).
The resolution of this dispute turns on the interplay among certain equitable principles and the policy undergirding New Jersey's recording statutes, N.J.S.A. 46:15-1 to 46:26-1. We begin with the equitable principles, the most important of which concerns the common-law concept of the vendee's lien.
New Jersey has recognized and enforced the notion of a vendee's lien at least as far back as 1830. Copper v. Wells, 1 N.J. Eq. 10 (Ch. 1830) (finding complainant's claim for permanent and valuable improvements made to land following agreement of sale is a lien in equity on property).
Our courts, in affirming the existence and validity of vendees' liens, generally refer to . . . the trust relationship which arises between the parties upon the execution of a contract of sale of realty. When such contract is entered into, in the eyes of equity the contract is regarded for most purposes as though specifically executed and the original estate of each of the parties is regarded as "converted." The vendee becomes the equitable owner of the land and the vendor of the purchase money, and the vendor is considered the trustee of his estate in the land for the vendee. When the vendee pays a portion of the purchase money, the vendor becomes a trustee for him and the vendee acquires a lien just as if the vendor had executed a mortgage to him of his estate to the extent of the payment received. [Mihranian, Inc. v. Padula, 134 N.J. Super. 557, 563-64 (App. Div. 1975) (citations omitted), aff'd, 70 N.J. 252 (1976).]
The vendee's lien arises only "`when the vendor is in some default for not completing the contract according to its terms, and the vendee is not in default so as to prevent him [or her] from recovering the purchase-money paid.'" Reilly v. Griffith, 141 N.J. Eq. 154, 164 (Ch. 1947) (quoting 4 John Norton Pomeroy, A Treatise on Equity Jurisprudence § 1263, at 775 (5th ed. 1941)), aff'd o.b., 142 N.J. Eq. 724 (E. & A. 1948). The purchaser is granted a vendee's lien "on the theory that `with each payment, the purchaser performs pro tanto [for so much] and is thereby equitably vested with a ratable portion of the estate.'" Mihranian, supra, 134 N.J. Super. at 564 (quoting 3 American Law of Property § 11.78, at 195-96 (1952)); Black's Law Dictionary 1100 (5th ed. 1979).
In the event the vendor cannot properly convey title, "the purchaser, as the equitable owner, pro tanto, may assert his [or her] rights in a court of equity to recover any payments made." Mihranian, supra, 134 N.J. Super. at 564 (internal quotation marks omitted). "If the vendor is not the absolute owner, the purchaser's lien attaches only to the extent of the vendor's interest, which may be converted into money by judicial sale[.]" Ibid. (internal quotation marks omitted).
Related to the concept of the vendee's lien is that of equitable conversion, a judicially-created doctrine "adopted for the purpose of giving effect to the intention of . . . contracting parties." 27A Am. Jur. 2d Equitable Conversion § 1, at 483 (1996); Jacobs v. Great Pac. Century Corp., 197 N.J. Super. 378 (Law. Div. 1984), aff'd, 204 N.J. Super. 605 (App. Div. 1985), aff'd, 104 N.J. 580 (1986). Succinctly stated, the doctrine of equitable conversion is not a fixed rule of law but proceeds on equitable principles that take into account the result to be accomplished. It is a mere fiction, resting on the principle that equity regards things which are directed to be done as having actually been done where nothing has intervened which ought to prevent performance. It merely means that where there is a mandate to sell real property at a future date or to employ money for the purchase of land, the property will be considered in equity as that species of property into which it is directed to be converted. [27A Am. Jur. 2d Equitable Conversion § 1, at 483-84 (footnotes omitted).]
Although the purchaser may be deemed to be vested with a certain equitable interest, the doctrine of equitable conversion does not extinguish the seller's legal title in the property. 27A Am. Jur. 2d Equitable Conversion § 13, at 496. "The seller's position is analogous to that of the mortgagee who retains legal title as security for the purchase price. The vendor has an interest that he or she can sell or mortgage that is measured by the amount the buyer owes under the contract." Ibid. (footnotes omitted).
Against that common-law backdrop, the Legislature has enacted New Jersey's recording statutes. N.J.S.A. 46:21-1 provides, in pertinent part, that whenever any deed or instrument . . . which shall have been or shall be duly acknowledged or proved and certified, shall have been or shall be duly recorded or lodged for record with the county recording officer of the county in which the real estate or other property affected thereby is situate or located such record shall, from that time, be notice to all subsequent judgment creditors, purchasers and mortgagees of the execution of the deed or instrument so recorded and the contents thereof.
Additionally, N.J.S.A. 46:22-1 provides that
[e]very deed or instrument . . . shall, until duly recorded or lodged for record in the office of the county recording officer in which the affected real estate or other property is situate, be void and of no effect against subsequent judgment creditors without notice, and against all subsequent bona fide purchasers and mortgagees for valuable consideration, not having notice thereof, whose deed shall have been first duly recorded or whose mortgage shall have been first duly recorded or registered; but any such deed or instrument shall be valid and operative, although not recorded, except as against such subsequent judgment creditors, purchasers and mortgagees.
By those enactments, New Jersey is considered a "race-notice" jurisdiction, which means that as between two competing parties the interest of the party who first records the instrument will prevail so long as that party had no actual knowledge of the other party's previously-acquired interest. Palamarg Realty Co. v. Rehac, 80 N.J. 446, 454 (1979). As a corollary to that rule, parties are generally charged with constructive notice of instruments that are properly recorded. Friendship Manor, Inc. v. Greiman, 244 N.J. Super. 104, 108 (App. Div. 1990) ("In the context of the race notice statute, constructive notice arises from the obligation of a claimant of a property interest to make reasonable and diligent inquiry as to existing claims or rights in and to real estate."), certif. denied, 126 N.J. 321 (1991).
This Court has recognized the underlying purpose of the recording statutes:
"An historical study of the [Recording] Act, as well as an analysis of the cases interpreting it, leads to the conclusion that it was designed to compel the recording of instruments affecting title, for the ultimate purpose of permitting purchasers to rely upon the record title and to purchase and hold title to lands within this state with confidence. The means by which the compulsion to record is accomplished is by favoring a recording purchaser, both by empowering him to divest a former non-recording title owner and by preventing a subsequent purchaser from divesting him of title. This ability to deprive a prior bona fide purchaser for value of his property shows a genuine favoritism toward a recording purchaser. It is a clear mandate that the recording purchaser be given every consideration permitted by the law, including all favorable presumptions of law and fact. It is likewise a clear expression that a purchaser be able to rely upon the record title." [Palamarg, supra, 80 N.J. at 453 (quoting Donald B. Jones, The New Jersey Recording Act - A Study of its Policy, 12 Rutgers L. Rev. 328, 329-30 (1957)).]
Courts have thus held that the integrity of the recording scheme is paramount. "`[A]bsent any unusual equity' the stability of titles and conveyancing requires the judiciary to follow that course `that will best support and maintain the integrity of the recording system.'" Friendship Manor, supra, 244 N.J. Super. at 113 (quoting Palamarg, supra, 80 N.J. at 453).
With those principles and statutes in mind, we must now determine whether and to what extent plaintiffs may recover their expended funds. That plaintiffs are entitled to a vendees' lien for monies paid to RKA is plain. Plaintiffs' payments, seemingly made in good faith, entitle them to be equitably vested with a ratable portion of the estate. Mihranian, supra, 134 N.J. Super. at 564. Our law is clear and settled on that point.
What is not so clear is how to determine the priority or value of plaintiffs' lien vis-a-vis Roebling's recorded mortgage. Jurisdictions are not uniform in their approach to that question and we have found no reported New Jersey case addressing the issue precisely. See generally John P. Ludington, Annotation, Right of Vendee Under Executory Land Contract to Lien for Amount Paid on Purchase Price as Against Subsequent Creditors of or Purchasers from Vendor, 82 A.L.R.3d 1040 (1978).
In Mihranian, supra, 134 N.J. Super. at 560, the plaintiff entered into a written contract with the defendant, Samuel J. Padula (Padula), for the sale of land in Dover Township, New Jersey. At the time of the contract, the plaintiff made an initial deposit of $10,000. Pursuant to the contract Padula was required to obtain subdivision approval of several lots on the property within a specified time period. Failure by Padula to obtain the subdivision approval would render the contract null and void, in which event the plaintiff's deposit would be returned. Ibid. Padula did not have legal or equitable ownership of the property when he executed the contract with the plaintiff. Ibid. The parties contemplated that Padula was going to enter into a contract with Bond and Mortgage Company of New Jersey (Bond and Mortgage) for the purchase of the property. To facilitate Padula's purchase of the property, the contract between Padula and the plaintiff provided that Padula could pay the plaintiff's $10,000 deposit over to Bond and Mortgage. Ibid. Padula did enter into the contract with Bond and Mortgage and paid over the initial $10,000 deposit that he received from the plaintiff. At about the same time, the plaintiff signed an addendum and increased the deposit by $5,000 for a total of $15,000. Id. at 561. The additional $5,000 was not paid over to Bond and Mortgage.
Padula failed to get the subdivision approval and the plaintiff elected to terminate the contract. Thereafter, the plaintiff commenced an action against Padula and Bond and Mortgage seeking to recover the full $15,000 deposit and to establish a vendee's lien on the premises. Along with the complaint, the plaintiff filed a lis pendens. Ibid.
Subsequent to the filing of the plaintiff's complaint, Padula assigned his rights under his contract with Bond and Mortgage to a third party, Villa Madrid, Inc. (Villa Madrid). Villa Madrid closed on the property with Bond and Mortgage and obtained legal title to the subject property through a deed. A $10,000 credit on the purchase price was given to Villa Madrid because of the original deposit made by Padula from the plaintiff's funds. Ibid.
The Appellate Division found that Villa Madrid took the property subject to the plaintiff's vendee's lien in the amount of $15,000. Id. at 566. The court held that the plaintiff had a valid vendee's lien for the payments it made toward the purchase price of the land and that Villa Madrid took title subject to that lien. Ibid. The court placed primary importance on the fact that the lis pendens placed other parties on constructive notice of the plaintiff's lien claim. Thus, although the Mihranian court upheld the vendee's lien against a subsequent party, it did so because the vendee in that case filed a lis pendens providing notice to the full extent of the vendee's payments. See also 4B New Jersey Practice, Civil Forms § 105.2, at 436 (James H. Walzer) (1998) (stating that once lis pendens is filed, it serves as notice to "any person claiming an interest or lien upon the lands through any defendant in the suit").
Other jurisdictions have similarly found that a vendee's lien has priority over a third party's mortgage interest to the extent that the third party has notice of the value of the vendee's equity in the property. Two cases in particular resemble the present dispute.
The first is Stanovsky v. Group Enter. & Constr. Co., 714 S.W.2d 836, 837 (Mo. Ct. App. 1986). There, the plaintiffs entered into a contract with a home builder for the purchase of property and construction of a home. The plaintiffs paid a deposit of $12,300. The builder applied to the lender for a construction loan of $84,000. Attached to the loan application was the contract executed by the plaintiffs and the builder. Ibid.
The lender approved the loan and recorded its mortgage interest. Ibid. The builder failed to complete construction and the final closing on the property was aborted as a result of the lender's initiation of foreclosure proceedings. The lender purchased the property at the foreclosure sale and recorded its interest. The plaintiffs contended that, as a matter of law, they were entitled to an equitable vendee's lien against the real estate, superior to the lender's lien. Id. at 838.
The court held that the plaintiffs had a valid vendee's lien on the property for the amount of earnest money they paid toward the purchase price of the property, namely $12,300. Id. at 839. In reaching its decision, the court found the lender had notice of the plaintiffs' interest because, as part of the loan application, the builder provided the lender with the plaintiffs' contract, which revealed the payment of the earnest money. Id. at 838-39. In those circumstances, the court found the lender had notice of the plaintiffs' inchoate lien interest at the time it granted the construction loan.
In the second case, Stahl v. Roulhac, 438 A.2d 1366, 1367 (Md. App. 1982), the plaintiffs executed an agreement of sale with a home builder for the purchase of property and construction of a home for $110,000. At the time they entered into the contract, the plaintiffs made a down payment of $10,100; the balance of the purchase price was due at the time of settlement. Ibid. At the time of the agreement, the property was subject to a first mortgage executed by the builder to a lender to secure a land-acquisition loan. Ibid.
Subsequent to the agreement, the builder executed a second mortgage to the same lender to obtain a construction loan. The lender took that second mortgage with knowledge of the agreement between the builder and the plaintiffs. The lender based its loan decision on the existence of the contract and the loan commitment forms. The builder defaulted on the loan prior to the completion of the plaintiffs' home. That default resulted in a foreclosure sale of the property. Ibid.
The proceeds from the sale satisfied the lender's first recorded interest and yielded a surplus in the amount $101,781. The plaintiffs claimed they had a valid vendees' lien that had priority over the lender's second recorded mortgage, and that they were entitled to the amount of their deposit as well as amounts they had expended toward the completion of the project. In addition to the $10,100 deposit, the plaintiffs had used their own funds for the construction of the driveway and other ...