## Facts

- Heck’s held leasehold interests in shopping-center parcels in Whitley County, Kentucky, under lessors Keck and Roberts.
- In 1978, to secure approximately $9.446 million, Heck’s executed documents intended to encumber its leasehold interests in favor of lender-trustees, including a leasehold mortgage, a leasehold assignment, and a fee subordination agreement by the lessors.
- The 1978 mortgage instrument referenced schedules incorporated by reference, including a schedule containing legal descriptions and a supplemental indenture describing additional collateral (e.g., fixtures, rents, and profits).
- The 1978 mortgage documents were defectively executed under Kentucky formal requirements, so they did not create an enforceable legal mortgage.
- Because the parties’ intent to create a mortgage was clear and funds were advanced in reliance on that intent, the transaction was treated as creating an equitable mortgage in favor of the successor trustee-lender, State Street.
- In 1991, Heck’s granted First National a properly executed and recorded mortgage on the same leasehold property, creating a valid legal mortgage.
- After Heck’s defaulted on the 1978 debt, State Street sought priority over First National, asserting that its earlier equitable mortgage prevailed because First National took with notice of the prior interest.

## Issues

1. Whether a later, valid, recorded mortgage has priority over a prior equitable mortgage when the later mortgagee took with notice (actual, constructive, or inquiry) of the earlier equitable mortgage.

## Decision

- The Kentucky Supreme Court reversed the trial court and the Court of Appeals.
- The court held that a later, valid, recorded mortgage does not take priority over a prior equitable mortgage if the later mortgagee had notice of the prior equitable mortgage.
- The court concluded the record contained ample circumstantial evidence supporting a finding that First National had notice of State Street’s earlier equitable mortgage.
- The court ordered priority to State Street’s equitable mortgage over First National’s later recorded legal mortgage.

## Legal Principles

- An equitable mortgage arises when parties clearly intend specific property to secure a debt and value is advanced in reliance on that intent, even if the instrument fails as a legal mortgage due to technical defects.
- In a race-notice jurisdiction, recording protects only subsequent purchasers or mortgagees who give value and take without notice; a mortgagee with actual, constructive, or inquiry notice is not a bona fide encumbrancer without notice.
- A later mortgagee with notice cannot use recording to defeat a prior equitable interest; the prior equitable mortgage retains priority.

## Conclusion

The court held that State Street’s earlier equitable mortgage was enforceable and took priority over First National’s later recorded mortgage because First National was not a protected race-notice mortgagee where it took with notice of the prior equitable interest.


State Street Bank & Tr. Co. v. Heck’s, Inc., 963 S.W.2d 626 (Ky. 1998)