We are preparing a modification agreement for a first mortgage loan that extends the maturity date and increases the loan amount. Do we have any obligations to the junior lienholder?

A senior lienholder generally is not required to obtain a junior lienholder’s consent when modifying the senior loan. However, a recent Illinois appellate case found as a matter of first impression that increasing the principal of the senior loan without such consent could prejudice the rights or impair the security of the junior lienholder, resulting in the senior lender relinquishing its priority with respect to the increased amount.

In 2017, an Illinois appellate court considered for the first time the status of the lien priorities between a senior lender and a junior lender when the senior lender increased the amount of its loan in a modification agreement. Since no Illinois court had previously addressed the issue, the court noted that in other states, if a senior lender modifies the terms of its note or mortgage “such that it prejudices the rights or impairs the security of any junior lenders, their consent is required.” Absent such consent, courts in other states have held that the senior lender relinquishes its priority with respect to the modified terms (i.e., the increased loan amount).

The Illinois appellate court found that a senior lienholder’s modification agreement increasing its original $3.4 million loan by $51,000 was “materially prejudicial” to the junior lienholder’s security interest. As a result, the court held that the junior lienholder would have a superior lien as to the additional $51,000 that the senior lienholder loaned to the borrowers. Additionally, the court noted that a more severe outcome could occur if a senior lienholder’s modification has “substantially impaired” a junior lienholder’s loan, in which case a court could subordinate the senior lienholder entirely to the junior lienholder.

In light of this decision, a court may find that your bank’s lien as to the additional loan amount is inferior to the junior lienholder’s priority. For this reason, we recommend consulting with your bank counsel to determine the likely impact of the modification agreement on your bank’s lien priority.

For resources related to our guidance, please see:

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 732 (2nd Dist. 2017) (“Although no Illinois court has yet addressed this issue, courts in other states have uniformly held that, while a senior lender and a mortgagor can agree to modify the terms of the underlying note or mortgage without first notifying or obtaining the consent of any junior lenders, if the modification is such that it prejudices the rights or impairs the security of any junior lenders, their consent is required.”)

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 732 (2nd Dist. 2017) (“A senior lender’s failure to obtain a junior lender’s consent results in the modification being ineffective as to the junior lender and the senior lender relinquishing to the junior lender its priority with respect to the modified terms.”)

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 732 (2nd Dist. 2017) (“As the increase of the loan was materially prejudicial to Bowling Green’s security interest, the result is that Bowling Green will have a superior lien as to the additional $51,000 that Gold Coast Bank loaned to the defendants.”)

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 732 (2nd Dist. 2017) (“While this sanction ordinarily creates only the partial loss of priority, in situations where the senior lender’s actions in modifying the note or mortgage have substantially impaired the junior lender’s security interest or effectively destroyed its equity, a court will wholly divest the senior lender of its priority and elevate the junior lender to a position of superiority.”)

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 733 (2nd Dist. 2017) (“Unlike in Koloff and Gluskin, Gold Coast Bank’s modification of its loan did not substantially impair Bowling Green’s security interest and rights as a junior lienholder. As the minimal impairment to Bowling Green’s rights can be remedied by denying priority to the $51,000 that Gold Coast Bank loaned to the defendants in the modification agreement, we do not believe that it would be equitable to subordinate Gold Coast Bank’s entire lien to Bowling Green’s. Indeed, denying priority to only the $51,000 restores Bowling Green to the position it bargained for by agreeing to accept a second lien on the property as security for its loan.”)

Bowling Green Sports Center, Inc. v. G.A.G. LLC, 77 N.E.3d 728, 732–733 (2nd Dist. 2017) (“As the Burney court observed, only in ‘rare’ cases will a court find that the senior lender has so substantially impaired the security interest of the junior lender that the priorities will be rearranged. . . . For example, in Koloff v. Reston Corp., No. Civ. A. 12281, 1993 WL 106062 (Del. Ch. Mar. 26, 1993), the chancery court rearranged the priorities because the senior lender had increased its loan to the borrowers from $2.2 million to $20 million.”)