## Facts

- A seller owned 28 lots and agreed to sell them to developers for $365,000, including a purchase-money deed of trust intended to be junior to a future construction loan.
- The transaction was restructured so the seller’s purchase-money deed of trust was reduced to $69,500 and expressly made junior to the construction lender’s deeds of trust, with priority established by recordation sequence.
- An escrow company prepared 28 deeds of trust in favor of the lender (one per lot) and a seller deed of trust stating it was junior; all were recorded on April 22, 1966.
- Days later, the escrow company reconveyed the single seller deed of trust and recorded 28 replacement seller deeds of trust (one per lot) to reflect the seller’s interest.
- The lender disbursed construction loan funds into a loan account; the seller alleged the lender allowed approximately $300,000 to be used for nonconstruction purposes.
- When funds were exhausted, the buyers abandoned the partially completed project, and foreclosure proceedings were initiated under the lender’s deeds of trust.
- The seller sued the lender and escrow company alleging fraud, breach of duty, and seeking equitable relief affecting lien priorities; the trial court sustained demurrers without leave to amend and dismissed.
- The seller appealed from the judgment of dismissal.

## Issues

1. Whether the complaint stated claims against a construction lender based on allegations that the lender allowed diversion of construction loan proceeds, impairing a subordinating seller’s security.
2. Whether the complaint adequately alleged that the escrow holder owed duties to the seller regarding preparation, recordation, and handling of deeds of trust affecting the seller’s lien position.
3. Whether the pleaded facts supported potential equitable relief altering lien priorities where junior status was allegedly induced or maintained through misconduct.
4. Whether it was an abuse of discretion to deny leave to amend in a complex real-estate financing dispute.

## Decision

- The court held that, under demurrer standards, the complaint’s material factual allegations had to be accepted as true and liberally construed.
- The court concluded the seller alleged sufficient facts to proceed on at least some theories against the lender and escrow holder, including claims tied to diversion of construction funds and escrow-related duties affecting the seller’s security.
- The court held the pleaded facts could support equitable remedies affecting priorities where subordination was allegedly induced or rendered unfair by misrepresentations or improper handling of the transaction.
- The judgment of dismissal was reversed in part, affirmed in part as to theories that could not be stated, and the matter was remanded for further proceedings; denial of leave to amend was improper to the extent defects might be curable.

## Legal Principles

- On demurrer, courts assume the truth of properly pleaded material facts and construe pleadings liberally to determine whether any relief is available on the alleged facts.
- A construction lender may face liability to a subordinating seller where the lender knows subordination was given in reliance on construction funds improving the property and the lender knowingly or negligently permits diversion of proceeds that foreseeably impairs the subordinated security.
- An escrow holder is a limited agent and fiduciary as to escrow matters and may owe duties of care and fidelity to parties whose interests are directly affected by documents the escrow holder undertakes to prepare, record, reconvey, or otherwise handle.
- Equitable relief may be available to address lien-priority consequences where junior status results from material misrepresentations or misconduct; equity may look to the substance of the parties’ dealings rather than formal labels.
- Leave to amend should be granted where there is a reasonable possibility a pleading defect can be cured, particularly in complex financing transactions.

## Conclusion

The appellate court reinstated the action in significant part, holding that the seller’s allegations—especially that the lender permitted diversion of construction funds and that the escrow holder mishandled documents affecting the seller’s lien—were sufficient at the pleading stage to proceed and potentially support equitable relief regarding lien priorities, and that further amendment should not have been categorically denied where curative amendment was plausible.


Middlebrook-Anderson Co. v. Southwest Sav. & Loan Ass'n, 18 Cal. App. 3d 1023 (Ct. App. 1971)