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Issue  162  Article  275
Published:  1/1/2009

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Case Tests Distribution of Foreclosure Surplus
Chris Burti, Vice President and Senior Legal Counsel

The ability of a mortgagee to rescind an erroneous cancellation was first confirmed by the North Carolina Court of Appeals in G.E. Capital Mortgage Servs., Inc. v. Neely, 135 NC App 187 (1999) and subsequently codified in 2005 by a new statute, N.C.G.S. Section 45-36.6 authorizing a document of rescission to be recorded.

The statute provides:
        (b)    If a person records a satisfaction or affidavit of satisfaction of a security instrument in error or if a security instrument is satisfied of record erroneously by any other means, the person or the secured creditor may execute and record a document of rescission. The document of rescission must be duly acknowledged before an officer authorized to make acknowledgments. Upon recording, the document rescinds an erroneously recorded satisfaction or affidavit and the erroneous satisfaction of record of the security instrument and reinstates the security instrument.
        (c)    A recorded document of rescission has no effect on the rights of a person that:

            (1)    Records an interest in the real property described in a security instrument after the recording of the satisfaction or affidavit of satisfaction of the security instrument or the erroneous satisfaction of record of the security instrument by other means and before the recording of the document of rescission; and

            (2)    Would otherwise have priority over or take free of the lien created by the security instrument as reinstated under Chapter 47 of the General Statutes.

There has been little judicial guidance as to the effect of subsection (c) upon the priority of an erroneously cancelled mortgage with respect to matters of record prior to the cancellation and the statute does not speak to the issue directly. By implication, it can be argued that such priority is unaffected by the erroneous cancellation after rescission.

Branch Banking and Trust Company v. Schiphof, COA08-159, filed on September 16, 2008 affirmed the trial court’s distribution of surplus foreclosure proceeds contested as the result of the filing of an erroneous satisfaction and a subsequent rescission of satisfaction.

BB&T appealed from judgment ordering surplus foreclosure proceeds to be distributed to Linda S. Schiphof's judgment lien creditors and to Christina Schiphof Turner. The bank instituted a foreclosure of its junior Deed of Trust from Schiphof. Schiphof and Turner were the record owners of the foreclosed property at the time of the Foreclosure sale. The property was sold subject to any and all superior liens, and so stated in the substitute trustee's deed and there were surplus proceeds of the sale, which totaled $42,837.61. BB&T filed a Petition for Surplus Proceeds of Foreclosure Sale alleging that it was entitled to all surplus proceeds derived from the foreclosure sale. Schiphof and Turner filed an Answer and Counterclaim alleging that one-half the surplus proceeds should be distributed to the judgment lien creditors of Schiphof and one-half to Turner.

BB&T was also the holder of a senior note and Deed of Trust given by Schiphof and her deceased Husband. Prior to the foreclosure, BB&T, in error, recorded a certificate of satisfaction of the senior Deed of Trust. Following discovery of its error, the bank filed a Rescission of Satisfaction. However, it was recorded after the expiration of the upset bid period of the foreclosure and was stipulated by the parties as not having priority.

Schiphof’s one-half interest in the equity of redemption was also encumbered by judgments in favor of Citibank, Providian National Bank, BB&T, and Citibank SD which became liens against Schiphof's interest after the recording of the BB&T Deed of Trust in 1985 and after the recording of the deed of trust that was the subject of the Foreclosure. The trial court ordered one-half of the surplus foreclosure proceeds to be distributed to Schiphof's judgment lien creditors and the remaining one-half to Turner.

BB&T appealed, contending that the judgment was in error as it had priority in the surplus foreclosure proceeds and was entitled to disbursement of those proceeds and arguing that it held  “a valid, first priority lien upon the Subject Real Property, enforceable against the Surplus Proceeds and enforceable against all but the new owner of the Subject Real Property, . ..”

The Court of Appeals stated that BB&T's Rescission of the Mistaken Satisfaction filed after the raised bid period in the foreclosure sale had no effect on the rights of the successful bidder pursuant to N.C. Gen. Stat. § 45-36.6(c)(1). The high bidder took the real property free from the encumbrance of BB&T's senior Deed of Trust which no longer attached to any real property.

BB&T conceded this point, but cited In re Castillian Apartments, Inc., 281 N.C. 709, (1972) as determining that surplus foreclosure proceeds retain the character of the real property foreclosed and thus its Deed of Trust should attach to these proceeds with priority. The Court of Appeals cited a prior North Carolina Court of Appeals decision, Smith v. Clerk of Superior Court, 5 N.C. App. 67, (1969) as rejecting a similar argument on the basis that it applied only to matters respecting junior liens upon the foreclosure of a first Deed of Trust.

The court noted that In re Castillian Apartment, Inc. involved a determination of the rights of the holder of a second lien Deed of Trust that instituted proceedings to recover surplus funds from a foreclosure of the first. In that case, the North Carolina Supreme Court determined that the lien of the second deed of trust attached to the foreclosure sale surplus. Smith, however, involved a determination of the rights of a senior lien holder attempting to recover surplus funds from a foreclosure sale of junior lien. In that opinion the Court of Appeals stated that, “the surplus funds . . . did not constitute real estate. The surplus funds represented the general funds of the plaintiffs, the owners of the premises and the grantors in the deed of trust which was foreclosed.”

“…Schiphof and Turner were one-half owners of the equity of redemption and entitled to one-half the surplus proceeds, with Schiphof's one-half subject to payment of her judgment lien creditors.”

The Court clearly assumes the position implied by N.C.G.S. Section 45-36.6(c) that the priority of an erroneously cancelled mortgage with respect to matters of record prior to the cancellation is unaffected by the erroneous cancellation after the time of the recording of the rescission document. Otherwise, Smith would not be relevant and BB&T would have a “junior” lien on the property just like those of the judgment creditors.  The issue left to be determined would then be the respective priority between the judgment liens and the BB&T Deed of Trust.

As an interesting aside, it may have been possible for BB&T to avoid the issue of who was entitled to the surplus proceeds altogether. In the court’s recitation of the relevant facts, we note that the surplus proceeds approximately equaled the amount owed to BB&T on the first lien debt and that judgment liens are junior to both deeds of trust held by BB&T. The provisions of N.C.G.S. Section 45‑21.9A permit the simultaneous foreclosure of two or more security instruments as follows:

When two or more mortgages or deeds of trust held by the same person are secured in whole or in part by the same property, and there are no intervening liens, except for ad valorem taxes, between such mortgages or deeds of trust, the obligations secured by such mortgages or deeds of trust may be combined and the property sold once to satisfy the combined obligations if (i) powers of sale are provided in all such instruments; (ii) there is no provision in any such instrument which would not permit such a procedure; (iii) all the terms of all such instruments requiring compliance by the lender in connection with foreclosure sales are complied with; and (iv) all requirements of this Chapter governing power of sale foreclosures are met with respect to all such instruments.  The proceeds of any sale shall be applied as provided in this Chapter.  As between the combined obligations being foreclosed, proceeds shall be applied in the order of priority of the instruments securing them, and any deficiencies shall be determined accordingly.

In foreclosing both deeds of trust in the same action, BB&T would have been entitled to have all of the sale proceeds applied to the satisfaction of both debts in order of priority and any surplus thereafter would have been of no concern.

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