Marshalling. What Even Is It?

There's a concept that shows up rarely but occasionally on Real Property questions called marshalling. It's sometimes referred to as the two funds rule of marshalling and it applies as follows:

Marshalling applies when two or more parcels of land are each subject to at least one mortgage and one of the parcels is subject to competing mortgages. For example, assume 2 parcels of land and further assume that the same debtor has taken out mortgages on both parcels. Parcel 1 is encumbered by 2 mortgages, a senior mortgagee (Bank A) who recorded first and a junior mortgagee (Bank B) who recorded after the senior. Parcel 2, on the other hand, is encumbered by only one mortgage with the same senior mortgagee as in parcel 1 (Bank A). 

When the debtor defaults, Bank A, as the senior mortgagee, would generally have the choice to foreclose either on Parcel 1 or on Parcel 2. In other words, the senior mortgagee (Bank A) would have the right to foreclose on Parcel 1 before foreclosing on Parcel 2, even though that decision would negatively affect the junior mortgagee on Parcel 1 (Bank B).

But the two funds rule of marshalling changes this analysis. With this rule, the junior (Bank B) can request that the senior (Bank A) first foreclose on Parcel 2 since there are no subordinate interests on Parcel 2. Bank A will have to abide by that request, assuming that Bank A will not be materially harmed by doing so. 

The policy behind the two funds rule of marshalling is one of fairness. If Parcel 2 upon foreclosure produces enough money to pay off Bank A's entire loan, parcel 1 won't get subjected to foreclosure until Bank B is ready to do so. And, the theory goes, this will avoid unnecessary harm to Bank B.