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March
2008
Court of Appeals Decides Dorean Priority Issue
By Chris Burti, Vice President and Senior Legal Counsel,
Statewide
T
itle, Inc.
T
he Dorean Group, formerly headquartered in
Oakland
,
California
, used independent agents to promote its program of fraudulent mortgage
elimination until the principals were convicted in 2006 in
California
.
T
he scheme was enticing to homeowners who were in financial trouble or who were
susceptible to anti-government tax avoidance schemes.
After paying a substantial fee, the homeowner agreed to place the title
to their home in a family trust.
T
hey then presented the lender with a document that contained dozens of
“legal” challenges to the loan. Dubbed a “CPA Report” or a “Private
International Remedy Demand”, these documents outlined issues that were
claimed to be “violations” of federal laws committed by the lender.
T
he lender was directed to respond with proof of the validity of the loan. When
the lender failed to respond, a “power of attorney” that was not
executed by the lender was filed which purported to give the trustees
authority to act on behalf of the lender. Using the power of attorney, a
“Discharge of Mortgage” was filed certifying that the loan had been fully
paid.
T
ypically, the next step was to refinance with a new lender. Once a new loan was
obtained, the homeowner, their Dorean Group Agent and the Dorean Group
participants would divide the funds.
T
his new loan would then also be “eliminated” using the same scheme.
In
North Carolina
, Wake County Superior Court Judge J.B. Allen granted summary judgment on
January 31, 2007 in an action brought at the behest of the North Carolina
Attorney General against the Dorean Group, defendants Scott Heineman and Kurt
Johnson, as well as against defendant Joyce Earl Delancy (JED) Lambeth.
T
he judgment granted a permanent injunction against the defendants’ promotion
of or engaging in any “mortgage elimination” or debt elimination activities,
and prohibited their filing any documents with any North Carolina Register of
Deeds or Clerk of Court in connection with any of these activities.
T
he North Carolina Attorney General’ office obtained certified copies of the
judgment and with the assistance of members of the North Carolina Bar
Association’s Real Property Section had them recorded in the affected 22
counties with the Register of Deeds with regard to the specific documents filed
by the defendants in those counties.
As
one would expect, conflicting claims of priority were bound to arise between the
original mortgagees and refinancing lenders due to the fraudulently cancelled
deeds of trust. Until the scheme became widely known, both sets of lenders were
victims of the scam and can be described as having done nothing wrong. As a
result of the priority conflict, the North Carolina Court of Appeals in Household
Realty Corporation v. Lambeth , COA07-362, filed on February 5, 2008, was
faced with choosing sides and settled on protecting the original lender based
upon a balancing of the equities as defined by our North Carolina Supreme Court
in Union Cent. Life Ins. Co. v. Cates, 193 N.C. 456 decided in 1927.
T
his matter arises out of a fraudulent mortgage
elimination scheme participated in by the defendant Lambeth as orchestrated by
the principals of the Dorean Group as noted above.
T
he fraudulent mortgage elimination scheme ultimately victimized the appellant,
Fremont Investment & Loan, and the appellees, Household Realty Corporation
and HSBC Mortgage Services, Inc.
Lambeth
acquired the real property by Special Warranty Deed in 1997. In early 2000, he
borrowed $400,000.00 from Axiom Financial Services as evidenced by a note
secured by a properly recorded deed of trust on the subject property. Axiom
assigned the note and the deed of trust to Household. In 2004, Lambeth recorded
a quitclaim deed transferring all of Lambeth's rights and interest in the
Property to Heineman and Johnson, as
T
rustees of the “Lambeth Family
T
rust” without notice to, or the
consent of, Household.
T
he purported trustees mailed Household a
document package typical of the scheme which purported to appoint Heineman as
“attorney-in-fact” for Household, and authorized Heineman and Johnson to
prepare and record all necessary documents for “proper reconveyance” of the
Lambeth Property if Household didn’t respond appropriately. Household obviously did not respond at all to the outrageous
demand.
Subsequently,
the Dorean Group fraudulently cancelled the Household Deed of
T
rust by recording unauthorized
release documents with the Register of Deeds. As the court describes the
process, they first recorded a “‘Substitution of
T
rustee,’ representing that Heineman was the ‘attorney-in-fact’ for
Household Mortgage Services, and further purporting to substitute Lambeth as
T
rustee under the Household Deed of
T
rust. Immediately thereafter, the
Dorean Group fraudulently recorded a so-called ‘Full Reconveyance’ wherein
Heineman, as the purported
T
rustee for Household under the Household Deed of
T
rust, represented that (i) all sums secured by the Household Deed of
T
rust had been paid, and (ii) the Household Deed of
T
rust and the Household Note had been surrendered to the
T
rustee for cancellation. Both
statements were false.
T
he Full Reconveyance also purported to reconvey the estate to the Lambeth Family
T
rust.”
Before
Household learned of the cancellation, Lambeth obtained a new loan from
Fremont
in the amount of $367,000.00 and secured by a deed of trust on the
property. According
to the court “
Fremont
purportedly relied on an examination of the records of the Guilford County
Register of Deeds, up to and including 12 September 2004, to determine that the
Lambeth Property was unencumbered at the time Lambeth executed the Fremont Deed
of
T
rust on 22 October 2004.”
In
2006, the trial court in a summary judgment order that was not appealed held
that the Household Deed of
T
rust was fraudulently cancelled and should be reinstated as a lien on the
Lambeth Property.
T
he judgment did not address the effective date of the reinstatement of the
Household Deed of
T
rust and left the priority issue between the Household Deed of
T
rust and the Fremont Deed of
T
rust open. Subsequently in 2006, Judge Albright ruled in favor of Household,
restoring the Household Deed of
T
rust as a lien upon the Lambeth Property, effective from its original
recordation date and having priority over the Fremont Deed of
T
rust.
T
he trial court apparently applied the rule of
law considered in First Fin. Savings Bank,
Inc. v. Sledge, 106 N.C. App. 87, (1992), in determining that the Household
Deed of
T
rust had priority over the Fremont Deed of
T
rust as Fremont contended that its application was in error.
Fremont
contended that Monteith v. Welch, 244 N.C. 415, (1956), was controlling. In
Monteith, the purchasers of the
secured property paid the trustee the balance owed in order to pay to the
beneficiaries.
T
he trustee cancelled the Deed of
T
rust, but failed to pay the beneficiaries, who then sued to reinstate their deed
of trust.
T
he North Carolina Supreme Court rejected the purchasers’ argument that they
were entitled to rely on the trustees' cancellation of the lien and ruled that
as they had notice of the senior lien, they were not innocent purchasers.
T
he Court noted that “[t]he cancellation made by [ the trustee] could not, in
any event, protect [the purchasers] unless it was made before they purchased and
in fact purchased relying on its validity.”
Id.
at 420.
T
he Court of Appeals did not find the argument
of the applicability of Monteith persuasive
and observed that citation to the Fourth Circuit unpublished opinion in Smith
v. United Carolina Bank, 1995 U.S. App. LEXIS 696 (4th Cir. Jan. 13, 1995)
was inappropriate.
T
he
fourth
Circuit referencing the quote above, stated: “From this passage, we discern
the following rule of North Carolina law: a subsequent lien creditor with a
properly recorded deed of trust enjoys priority, despite the unauthorized
cancellation of a prior deed of trust, if the subsequent creditor obtains its
deed of trust after the cancellation has occurred, in reliance on the
cancellation's validity, and without knowledge that the cancellation was
unauthorized.”
T
he North Carolina Court of Appeals succinctly
disposed of the statement of the fourth circuit as follows: “
T
his ‘passage,’ however, was plainly obiter
dictum, and does not constitute the Court's holding in Monteith.
Furthermore, any purported rule of law that the Fourth Circuit formulated in an
unpublished opinion based on that dictum
is not controlling on this Court.”
“Here,
the trial court correctly determined that the law stated by our Supreme Court in
Union Cent. Life Ins. Co. v. Cates,
193 N.C. 456, 137 S.E. 324 (1927),
and followed in First
Financial, is the long-standing rule in
North Carolina
, and thus controls the resolution of this case.”
T
he Court of Appeals quotes Union
Central, for the rule that as
“between a mortgagee, whose mortgage has been discharged of record solely
through the act of a third person, whose act was unauthorized by the mortgagee,
and for which he is in no way responsible, and a person who has been induced by
such cancellation to believe that the mortgage has been canceled in good faith .
. . the equities are balanced, and the lien of the prior mortgage, being first
in order of time, is superior.”
T
his rule makes perfect sense in a jurisdiction
that relies on a strict observance of its recording acts. While one should be
entitled to rely on the record, a party without fault cannot lose their interest
in their property through the use of a forged instrument by another party. Were
the rule otherwise, there would be no way for a property owner to rely on the
recording system for proof of title and protection of their interests.
In
First Financial, the mortgagors
borrowed money from First Financial Savings Bank, Inc. and secured the
obligation by a deed of trust on five lots.
T
he mortgagor negotiated a release of one of the lots and upon paying the
required release fee obtained an unrecorded release deed from the Bank.
Without their knowledge he altered the release deed to include lots three
more lots and recorded it. In the subsequent action to set aside the
release deed as it pertained to unreleased lots, the trial court granted summary
judgment in favor of First Financial, and the Court of Appeals
affirmed, citing Union Central,
and stating: “
T
he law in this State is clear regarding material alterations of written
instruments.
T
he discharge of a perfected mortgage upon public record by the act of an
unauthorized third party entitles the mortgagee to restoration of its status as
a priority lienholder over an innocent purchaser for value.” In the current
opinion the Court declares that the “law as enunciated in Union
Central, and followed in First
Financial, is the rule in North Carolina, and Monteith
did not overturn it.”
Fremont
contended that First
Financial requires the mortgagee to lose priority over an innocent purchaser
if the mortgagee is negligent with respect to the release of the mortgage and
that Household's failure to respond to the Administrative Demand was negligent
and should preclude its Deed of
T
rust from being reinstated with priority.
T
he court points out that the trial court made
the following specific finding of fact:
“9. Household did not reply to the Administrative Demand and filed no document
on the public record with respect to the [Lambeth] Property prior to the
Unauthorized Cancellation, even though Defendant Lambeth stopped paying on the
Note in May 2004; however, the existence of the mortgage elimination scheme was
not well known to mortgage companies such as Household and Fremont at the time
and the Court does not find that Household's failure to take affirmative action
was unreasonable or breached any duty Household owed to Fremont.”
T
he trial court also made the following
conclusion of law:
“7.
T
he Court, having found that Household was not negligent in its handling of the
Administrative Demand and the Unauthorized Cancellation, concludes that
Household did not breach any duty it owed that caused injury to
Fremont
.”
Fremont
next contended that the trial court applied a tort law negligence standard to
determine that Household was not at fault for the Unauthorized Cancellation of
its lien and argued that the “balancing of the equities” rule in Union
Central instead requires determination of whether the mortgagee whose deed
of trust was fraudulently cancelled was “in any way responsible” for the
result.
T
he Court of Appeals begged the question and
determined that “regardless of the test applied in this case, Household's
actions or inactions do not preclude Household from having its Deed of
T
rust reinstated as the superior lien.”
T
he court observed that in First Financial there was no breach of duty because“[t]here are
neither cases nor statutes which require a mortgagee to record a release deed
prior to delivering it to the mortgagor…” and “here, there were neither
statutes nor case law that imposed any duty on Household to respond to the
Administrative Demand.
T
he Dorean Group's cancellation of the Household Deed of
T
rust was an unauthorized act, and Household was in no way negligent for the
Dorean Group's act.” Furthermore, Household was “in no way responsible”
for the Unauthorized Cancellation of the Household Deed of
T
rust, or “any injury
Fremont
sustained as a result of the Dorean Group's fraud.”
T
he court was not persuaded by
Fremont
’s contention that the “Administrative Demand provided Household with a
‘roadmap’ of the fraud several months before it occurred.”
T
he Court of Appeals upon reviewing the Administrative Demand, the trial court
correctly found that the “38-page Administrative Demand, or so-called
‘roadmap,’ was a confusing compilation of, among other things: (i) various
cartoons; (ii) various articles; (iii) a power of attorney; (iv) a ‘Notice of
Intent to Correct
T
itle’; (v) a so-called ‘Affidavit of
T
ruth’; (vi) a letter from a purported certified public accountant; (vii) and
various propaganda.
T
o characterize this document as bizarre and absurd would be an understatement.
T
he Administrative Demand was wholly inadequate to raise Household's suspicions
of potential impending wrongdoing by the Dorean Group, especially since, as the
trial court found, ‘the existence of the mortgage elimination scheme was not
well known to mortgage companies such as Household and Fremont at the time’
the Administrative Demand was delivered to Household.”
Clearly,
the Courts will not likely require a senior mortgagee to be omniscient or
prescient in order to avoid being taxed with the losses resulting from forgery
of cancellation. One can make a strong case for the argument that the subsequent
lender could more easily avoid the loss by verifying the purported satisfaction
prior to funding.
T
his argument falls somewhat flat in practice as lenders may not be any more
accommodating to other lenders than they are to attorneys trying to determine
the status of uncancelled Deeds of
T
rust. We are not suggesting that this opinion creates some kind of new standard
of care for title examiners.
What
significance should this opinion have for real property practitioners? It has
never been considered prudent to rely on the indices without actually examining
the instruments in the chain of title. It might now be considered advisable for
title examiner to take a little extra time in examining cancellation
instruments. One complaint consistently heard about the new satisfaction
provisions of Chapter 45 emerging in the last decade or so is that they make it
far too easy to fraudulently obtain a satisfaction of a mortgage. As such
practices occur, one can be reasonably sure that an uninsured junior mortgagee
losing a priority dispute will be very likely to try to shift the loss to the
title examiner. If the evidence of the fraudulent nature of the satisfaction
scam is readily apparent on the face of the instrument or even merely arguably
so, a little extra time checking on the status of the lien may well prevent this
problem from ever arising in the first place.
Dirt
T
ales From
T
he Deed Vault
By
John Dillard
, Vice President and Legal Counsel, Statewide
T
itle, Inc.
Sam Smartbuyer received a notice from an attorney
that said they were instituting foreclosure proceedings against the house he had
purchased a couple of months back. He
took the notice to the attorney who had closed his purchase to see what this was
about. His attorney advised him that
the bank that was foreclosing had been the seller’s lender, but that the
seller had filed bankruptcy and had wiped out that deed of trust.
T
he attorney showed Sam a copy of the Order of Discharge in Chapter 7 Bankruptcy.
T
he bankruptcy petition had listed the deed of trust as a debt to be discharged
and the order had said the debts of
the seller had been discharged or as Sam’s attorney put it “wiped out”.
He told Sam not to worry about the foreclosure, it was all a mistake and
that he would send a copy of the bankruptcy order to the foreclosing attorney
and get things straightened out.
T
he foreclosing attorney received Sam’s attorney’s letter and Order of
Discharge, but proceeded with the foreclosure.
T
he question for us to consider is whether it is proper for the foreclosure to go
forward once the foreclosing attorney has been placed on notice that the deed of
trust being foreclosed upon was the subject of a Chapter 7 Bankruptcy.
A relatively common misunderstanding of the effects of a discharge under
Sec. 524 of the Bankruptcy Code (11 U.S.C. 524) can lead to a serious omission
on a title opinion.
T
he purpose of this article is to attempt to help point out the issues that
should concern a title examiner when a closed bankruptcy case is discovered in
the chain of title.
T
he basic principle at play here is how bankruptcy treats judgments and/or liens
and that will differ according to the personal liability and the in rem
liability of the judgment/lien. Once docketed, judgments acquire two
personalities, personal and in rem.
T
he personal liability relates to the ability of the judgment debtor to
satisfy the debt by payment.
T
he in rem liability is
that liability that attaches to all real property owned or subsequently acquired
by the judgment debtor while the judgment remains unsatisfied. It is this
second liability that survives the discharge since Sec. 524 of the Bankruptcy
Code only provides relief from the first liability, the personal obligation of
the debtor to pay the judgment debt.
T
here are some exceptions under Sec. 522(f), which we will discuss at a future
time.
And in fact the copy of the Bankruptcy Order that Sam’s attorney
produced said exactly that. It said
the personal obligation of the
debtor had been discharged. It did
not mention that the deed of trust was discharged, although the deed of trust
had been listed as a debt in the Chapter 7 petition.
T
he effect of this means the deed of trust remains a lien on the property and
once released from the automatic stay, the bank is free to foreclose their lien.
If the sale does not raise enough money to satisfy the lien and
associated costs the bank is prevented from pursuing the debtor on a deficiency
since the debtor’s personal liability was discharged in bankruptcy.
In other words, the personal liability (ie, obligation on the note) is wiped out
in bankruptcy, whereas the in rem
liability (ie, the lien against real estate) remains in place after the
bankruptcy.
For the real estate practitioner and title examiner, whenever you come
across a bankruptcy in a title search give careful reading to what that order
says so as to avoid the kind of problem Sam’s attorney caused him.
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