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Issue  194  Article  328
Published:  1/1/2012

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Reformation Priority Relates Back Over Chapter 44A Lien
Chris Burti, Vice President and Senior Legal Counsel

In a unanimous opinion, the North Carolina Court of Appeals recently held to the position taken in its 1991 opinion of Noel Williams Masonry v. Vision Contractors of Charlotte, Inc.. In that case the court determined that the equitable remedy of reformation relates back to the date of recording of the original instrument in instances where intervening creditors were not relying on the record in extending credit. In its opinion for S.T. Wooten Corporation v. Hillsborough Residential Associates, LLC. COA11-649, December 6, 2011, the court also determined that alleged misstatements regarding collateral matters would not give rise to the equitable defense of unclean hands.

In October 2006, the defendant property owner purchased the subject property. The deed mistakenly described the estate conveyed as a "one-half fee simple interest" in the property rather than the entire undivided fee simple interest contemplated by the parties. The following February the defendant lender made a construction loan in the amount of $14 million to fund the development of the property. The deed of trust securing the loan described the full undivided interest in the property as collateral for the loan. The plaintiff, a prospective subcontractor, inquired of the lender as to whether the credit extended was sufficient to cover the cost of the proposed work on the property. This was confirmed and in September of 2007, plaintiff entered into a contract with the general contractor and began work on the property. At some point, the parties to the original deed discovered the scrivener's error, and recorded a corrected deed conveying a full undivided fee simple interest in the property to Hillsborough on November 2, 2007. Upon learning of the error and recordation of the corrected deed, the lender rerecorded its original deed of trust in September of 2008. The plaintiff still had no knowledge of the error in the deed at that time.

The plaintiff completed its work on the property in May of 2009 and when payment was not forthcoming, timely filed a claim of lien, also filing a suit for money owed contending that its lien had priority over the deed of trust with regard to the one-half interest in the property not conveyed in the original deed. The lender answered and asserted a counterclaim seeking reformation of the 2006 deed and a declaratory judgment decreeing that its deed of trust was superior to plaintiff's lien on the property. The trial court granted lender's motion for summary judgment reforming the deed and declaring the deed of trust superior to plaintiff's lien. On appeal, plaintiff contended that legal precedent established that the plaintiff's lien was superior to that of the deed of trust with respect to the one half undivided interest in the property which was not originally conveyed, and that the equitable claim for reformation of the 2006 deed from was barred by unclean hands. The Court of Appeals was unconvinced.

The plaintiff contended that it is protected from a reformation claim and enjoyed the same priority over the lender's deed of trust as would a purchaser in good faith over a deed of trust containing an invalid description citing Lowery v. Wilson, 214 N.C. 800, 200 S.E. 861 (1939). The Court of Appeals states that in the Lowery opinion, the North Carolina Supreme Court opined "that a mortgagee of a recorded mortgage, which contained an error as to the amount secured thereby, was not entitled to reformation of the mortgage as against judgment creditors, who occupy the same position as a purchaser in good faith for value ... We believe plaintiff's reliance on Lowery is misplaced, however, as the Court applied the registration statutes in reaching its decision and explicitly acknowledged that parol trusts and those created by operation of law are not governed by the registration statutes." The Court of Appeals further observes with appropriate citation that constructive trust is a trust created by operation of law when a grantor, through a mutual mistake, conveys less than was intended. The grantor holds the balance of the property in constructive trust for the grantee. As this was the situation here, the Court determined that the equity principles of reformation apply rather than the legal principles of the registration statutes.

The panel found Noel Williams Masonry v. Vision Contractors of Charlotte, Inc., 103 N.C. App. 597, 406 S.E.2d 605 (1991) to be controlling. Noel Williams "and the instant case are remarkably similar". There, the defendant obtained a secured construction loan from a lending institution for development of a tract of land. An attachment containing the property description was not attached to the deed of trust at the time the instrument was initially recorded. Defendant, Vision Contractors, subsequently hired three subcontractors who filed liens for money owed when Vision Contractors later defaulted on its payments to them. Upon discovering that the deed of trust failed to contain the legal description, the lending institution rerecorded it. The subcontractors brought an action to establish the priority between the deed of trust and their liens. The trial court reformed the deed of trust to include the description and held that reformation related back to the date of recording of the original deed of trust. Williams Masonry and this case are remarkably similar. As a result of the scrivener's error in the deed, McKee Trust held, by operation of law, the half of the property mistakenly not conveyed in constructive trust for Hillsborough. The plaintiff contracted with Front Street assuming that the lender financing the project had a superior interest in the property and did not learn of the mistake until long after commencing work.

The plaintiff also contended that the lender was not entitled to equitable relief claiming that it had unclean hands because it misrepresented the line of credit. The Court of Appeals describes the clean hands doctrine as denying equitable relief "‘only to litigants who have acted in bad faith, or whose conduct has been dishonest, deceitful, fraudulent, unfair, or overreaching in regard to the transaction in controversy.' Collins v. Davis, 68 N.C. App. 588, 592, 315 S.E.2d 759, 762 (1984), aff'd, 312 N.C. 324, 321 S.E.2d 892 (1984)." However, an equitable remedy is not barred if the conduct alleged to form the basis of an assertion of unclean hands is merely collateral to the transaction for which equitable relief is sought. The Court of Appeals determined that the lenders "alleged wrongdoing" in stating that there were sufficient funds in the loan to cover the work was collateral to the transaction in controversy and that the trial court did not abuse its discretion in reforming the original erroneous deed.

It seems likely that situations will rise with significant frequency where a title examiner will find a reformation action in the title chain, parallel to that action an action by a lien claimant perfecting an N.C.G.S. Chapter 44A lien and in each action the other claimant was not made a party. As all interested parties were not made party to either action, the respective priority of their claims will not have been established at law. One cannot assume that the equitable principles set out in these cases will be applied to any particular situation, rendering title insurance coverage inadvisable as an attempted resolution to such unanswered issues.

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