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Issue  205  Article  339
Published:  5/1/2013

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Foreclosure Priority; N.C.G.S. Sec. 45-37(b) Unconstitutional as Applied and Equitable Subrogation Denied
Chris Burti, Vice President and Senior Legal Counsel

In this case, the trial court granted summary judgment in favor of Fannie Mae, also known as the Federal National Mortgage Association (FNMA) by relying on the provisions of N.C.G.S. Section 45-37(b) to conclude that the plaintiff's lien on the property had expired. As argued by plaintiff and conceded by the defendant FNMA, the trial court's reliance on N.C.G.S. Section 45-37(b) was determined to be improper. The opinion also deals with the subject of the Doctrine of Equitable Subrogation and, unfortunately, does little to provide guidance on the circumstances where a North Carolina court should find a subsequent lender entitled to the equitable relief of subrogation in having paid off a loan that was senior to a recorded junior lien.

The opinion in this case discloses that in 1992, a corporation acquired an apartment complex for $5,150,000. The corporation obtained sellers' purchase money financing in the sum of $4,600,000 and borrowed the remaining $550,000 from the Trust of which the plaintiff was trustee. In 1994, the corporation conveyed the property to a single purpose limited liability company formed for the purpose of holding title to the property. The plaintiff and his son were the member managers of LLC but were not the identical parties as the beneficiaries of the trust.

Following the transfer, the LLC executed a purchase money demand note payable to the Trust in the amount of $600,000 secured by a properly recorded Deed of Trust encumbering the property. A demand for payment was made in December of 1994. The LLC defaulted, made several payments to the Trust over the years, but failed to remedy the default. The last payment to the Trust was received in November 2008. Long after the Trust loaned funds to the corporation for the initial acquisition of the property, Wachovia Bank, N.A. ("Wachovia") loaned additional funds to the LLC secured by a Deed of Trust, Assignments of Rents, Security Agreement, and Financing Statement (the "Wachovia loan") encumbering the property. In connection with the Wachovia loan, the Trust also executed a subordination agreement subordinating its interest in the property to Wachovia's interest.

Subsequently, the LLC refinanced its debt to Wachovia, borrowing funds from Lend Lease Mortgage Capital, L.P. ("Lend Lease") and Lend Lease assigned its interest to FNMA. The LLC subsequently defaulted; FNMA foreclosed on the property and was the last and highest bidder. The Trust then demanded that FNMA satisfy the original Trust Note claiming that the Trust was owed principal and interest totaling $3.5 Million.

In October of 2011 the plaintiff filed a declaratory action against FNMA and the other defendants seeking a judgment affirming the validity and enforceability of the Trust's deed of trust and its assignment of rents provision. The plaintiff also sought to foreclose on the property pursuant to the Trust Deed in a separate action. FNMA appealed the Clerk's Findings of Fact and Order of Foreclosure to the superior court. Furthermore, FNMA asked the court in the declaratory action for a temporary restraining order and a preliminary injunction to enjoin the foreclosure action. The trial court entered an order granting summary judgment in favor of FNMA that reversed the order in the foreclosure action entered by the Assistant Clerk of Superior Court and the plaintiff appealed.

On appeal, the plaintiff raised the issues of whether the trial court erred by granting summary judgment in favor of FNMA and by reversing the order of foreclosure entered by the Assistant Clerk of Superior Court. The opinion notes that whether the Trust's lien on the property remains valid, enforceable, and superior to FNMA's lien is determinative of whether the trial court erred in entering summary judgment in favor of FNMA

The Court of Appeals begins its analysis by noting that that "'North Carolina is a 'pure race' jurisdiction, in which the first to record an interest in land holds an interest superior to all other[s]

. . . .' Rowe v. Walker, 114 N.C. App. 36, 39, 441 S.E.2d 156, 158 (1994); see also N.C. Gen. Stat. §§ 47-18 and -20 (2011)." While this catchy phrase is often quoted by courts and pundits alike, in fact, North Carolina can best be described as a 'modified pure race state' otherwise the constructive record notice would have disposed of the issue and there would have been no basis for an argument based upon the doctrine of equitable subrogation as will be discussed. The statement of the Court of Appeals ignores the fact that in this state we recognize that a forged deed does not convey title, that a fraudulent or erroneous deed may be reformed in equity, that a constructive trust may be recognized and that the doctrine of equitable subrogation may afford a remedy of constructive lien priority over an intervening lien to one reasonably satisfying a senior lien as well. As the North Carolina Supreme Court has so aptly stated in Bourne v. Lay & Co., 140 S.E.2d 769, 264 N.C. 33 (N.C., 1965) "Actual knowledge, however full and formal, of a grantee in a registered deed of a prior unregistered deed or lease will not defeat his title as a purchaser for value in the absence of fraud or matters creating estoppel ." (emphasis added and citations omitted)

If this case had turned merely on the issue of record priority, the Trust clearly would have had a secured interest with priority over that of FNMA. However, FNMA argued the Trust's interest in the property either expired pursuant to N.C. Gen. Stat. § 45-37(b) or that equitable subrogation gave their deed of trust the same priority as Wachovia's prior deed of trust. The court begins its analysis with a discussion of the statutory lien expiration found in N.C.G.S. Section 45-37 both before and after its 2011 amendment. The trial court's relied on N.C.G.S. Section 45-37(b) in granting summary judgment in favor of FNMA concluding that the Trust's lien on the property had expired. This was in error as argued by the plaintiff, as conceded by FNMA and as determined by the Court of Appeals.

The statute in question establishes a conclusive presumption that the terms of a qualified deed of trust have been satisfied fifteen years after the due date. The Court cites the North Carolina Supreme Court in Smith v. Davis, 228 N.C. 172, 45 S.E.2d 51 (1947) for the doctrine that the conclusive presumption established in N.C.G.S. Section 45-37(b) does not apply in favor of those whose deed of trust is recorded prior to the date the presumption arises as the conclusive presumption arises only in favor of creditors and purchasers for valuable consideration who rely on the presumption when contracting the indebtedness. Since FNMA's deed of trust was recorded only six and a half years after the plaintiff's deed of trust was recorded it could not have relied on the presumption at the time it made the loan. Thus, the trial court was held to have erred in entering summary judgment in favor of FNMA in this regard.

Nonetheless, FNMA contended that the trial court's grant of summary judgment was appropriate because it argued that the plaintiff's deed of trust expired pursuant to the provisions of the new N.C.G.S. Section 45-36.24 adopted in 2011. The new statute, when applicable, provides that "the lien of a security instrument automatically expires, and the security instrument is conclusively deemed satisfied of record pursuant to G.S. 45-37 at the earliest of the following times…".  The significance of the new language is succinctly stated by the Court of Appeals: 

"Whereas N.C. Gen. Stat. § 45-37(b) contains the limiting language, '[i]t shall be conclusively presumed that the conditions are . . . complied with or the debts secured thereby paid . . . as against creditors or purchasers for valuable consideration . . . from and after the expiration of 15 years

from whichever . . . occurs last[]', N.C. Gen. Stat. § 45-37(b) (emphasis added), N.C. Gen. Stat. § 45-36.24(b) contains no such limiting language. Besides the stated exceptions, N.C. Gen.

Stat. § 45-36.24(b) is absolute in providing that 'the lien of a security instrument automatically expires, and the security instrument is conclusively deemed satisfied of record . . . at the earliest of the [listed] times[.]' N.C. Gen. Stat. § 45-36.24(b) (emphasis added). There is no language in N.C. Gen. Stat. § 45-36.24(b) that would prevent a lien from expiring as to a party acquiring an interest in the collateral before the expiration of the fifteen-year period." The plaintiff argued that the new statute is also not controlling because the statute is unconstitutional as applied to this case because it retroactively impairs its vested rights. The Court of Appeals agreed and its analysis is sufficiently straightforward to not compel further discussion here.

On the issue of equitable subrogation, FNMA also contended that the doctrine as expressed in North Carolina entitled its deed of trust to be subrogated to the priority of the Wachovia deed of trust  senior to that of the plaintiff's deed of trust with the result that FNMA's foreclosure extinguished the lien of the plaintiff's deed of trust. The Court of Appeals held that the doctrine did not apply. While the outcome of the case may have been correct, we take issue with what may be described as an inartful analysis by the Court at this point. The Court acknowledges that it is required to support the trial court's summary judgment order if it properly can and states the case for FNMA as follows:

In Wallace v. Brenner, 200 N.C. 124, 156 S.E. 795 (1931), our Supreme Court explained that equitable subrogation does not arise in favor of a "mere volunteer" who advances funds that are used to discharge a prior encumbrance. Id. at 131, 156 S.E. at 798. But, where money is expressly advanced in order to extinguish a prior encumbrance, and is used for this purpose, with the just expectation on the part of the lender of obtaining a valid security . . . the lender . . . may be subrogated to the rights of the prior encumbrancer whose claim he has satisfied, there being no intervening equity to prevent. It is of the essence of this doctrine that equity does not allow the encumbrance to become satisfied as to the advancer of the money for such purposes, but as to him keeps it alive, and as though it had been assigned to him as security for the money. Id. at 131, 156 S.E. at 798-99 (internal quotation marks and citations omitted). Applying this rule to the facts in Wallace, the Court found that where the lender seeking subrogation was not a mere volunteer and was not guilty of culpable negligence, and where the intervening lienor was not prejudiced, it would be inequitable not to grant the lender subrogation.6 Id. at 133, 156 S.E. at 799. "The exceptions to the general rule to the doctrine of subrogation [are]: (1) The relief is not granted to a volunteer;

(2) nor where the party claiming relief is guilty of culpable negligence; (3) nor where to grant relief will operate to the prejudice of the junior lienholder." Wallace, 200 N.C. at 132, 156 S.E. at 799.

The Court then goes on to distinguish the case law by stating:

However, in Peek v. Wachovia Bank & Trust Co., our Supreme Court inferred that equitable subrogation was only entitled to those "excusably ignorant" of an intervening lien. 242 N.C. 1, 15, 86 S.E.2d 745, 755 (1955) ("[A]s a general rule one who furnishes money for the purpose of paying off an encumbrance on real or personal property, at the instance either of the owner of the property or of the holder of the encumbrance, either upon the express understanding or under circumstances from which an understanding will be implied, that the advance made is to be secured by a first lien on the property, will be subrogated to the rights of the prior lienholder as against the holder of an intervening lien, of which the lender was excusably ignorant ."). (emphasis added). Although excusable ignorance was not determinative in Peek, in First Union Nat. Bank of North Carolina v. Lindley Laboratories, Inc. , this Court relied on the language in Peek and determined the lender was not entitled to equitable subrogation, because it was not excusably ignorant of an intervening lien. 132 N.C. App. at 130-31, 510 S.E.2d at 188-89.

It should be noted that the plaintiff's arguments on this issue were conclusory, as were the Court's determinations, but since FNMA did not argue all of the essential elements of its entitlement, if any, to subrogation and didn't brief the element of excuse, the issue arguably wasn't properly before the Court. The Court of Appeals determined that FNMA failed to successfully take steps to guarantee itself first priority as since plaintiff's lien was recorded, "FNMA cannot claim excusable ignorance" and "… we see the potential for prejudice to the third-party beneficiaries of the trust if FNMA was subrogated to the status of Wachovia. As a result, we hold that subrogation would be inequitable in this instance." In appellate decisions considering the remedy of equitable subrogation which forms the bases for the relief sought in this case, Peek v. Wachovia Bank & Trust Company , 86 SE 2d 745 (1955) is most often quoted as it was here. The doctrine was quoted and applied in First Union cited by this Court. In both cases it was, in our view, inartfully analyzed and discussed. The problem with using the quoted language in this case is that the First Union opinion dealt with the question of whether or not the party seeking equity was "excusably ignorant of an intervening lien" and the opinion there as here did not go sufficiently beyond the recording act issues to determine whether, as in Wallace, FNMA's or its predecessor in interest was "guilty of culpable negligence (emphasis added)" as well as determining whether granting the equitable relief of "subrogation would be inequitable in this instance".

Part of the problem is that the existing opinions offer little guidance on what  a court might consider excusable ignorance with regard to equitable subrogation, but it can be convincingly argued that relief in equity is not limited by Wachovia or First Union strictly to 'excusable ignorance' but rather is available for what might be better termed as excusable neglect. There is an extensive body of law in North Carolina with regard to the availability of relief to a party due to the intervening neglect of an attorney with respect to relief from judgment pursuant to Rule 60 of the North Carolina Rules of Civil Procedure. While this relief is statutory, it is fundamentally equitable in nature. In Mayhew Elec. Co. v. Carras , 223 S.E.2d 536, 29 N.C.App. 105 (1976), the North Carolina Court of Appeals states with respect to what constitutes excusable neglect adequate to support a Rule 60 Motion to set aside a judgment: "'Where a defendant engages an attorney and thereafter diligently confers with the attorney and generally tries to keep informed as to the proceedings, the negligence of the attorney will not be imputed to the defendant.' Jones v. Fuel Co ., 259 N.C. 206, 209, 130 S.E.2d 324, 327 (1963)."

In North Carolina where a lender reasonably relies upon a North Carolina licensed attorney to carry out specific loan closing instructions, generally tries to stay informed as to the transaction and the closing attorney negligently or wrongfully fails to carry out those instructions, it can be fairly said that the lender is clearly not "guilty of culpable negligence (emphasis added)". In this case the pleadings, arguments, briefs and opinion suggest that there was a factual dispute as to whether the  actions of FNMA's predecessor in interest at the time the loan was made and FNMA's lack of action in the approximately ten years that intervened were reasonable. The Court of Appeals states conclusively: "Furthermore, where FNMA had notice of the Trust's lien, FNMA could have taken steps to guarantee itself first priority. FNMA, however, failed to successfully do so." The problem as we see it is that, arguably, this determination of these facts was not properly within the province of the Court of Appeals. Whether FNMA's failure or its predecessor in interest's failure is culpable negligence is a question of disputed fact and thus, is typically not susceptible to an order of summary judgment. In English v. Holden Beach Realty Corp., 41 N.C.App. 1, 254 S.E.2d 223 (1979) the North Carolina Court of Appeals states: "Moreover, it is an established rule of law that estoppel, or the existence thereof, is generally a question of fact for determination by the jury. 31 C.J.S. Estoppel § 163, p. 784. The rule has been approved in North Carolina. Stereo Center v. Hodson, 39 N.C.App. 591, 251 S.E.2d 673 (1979); Peek v. Wachovia Bank & Trust Co., 242 N.C. 1, 86 S.E.2d 745 (1955)." (emphasis added). Under the doctrine set out in such precedent, the trial court should have made whatever findings of fact might exist as to whether FNMA's predecessor in interest was reasonable in its reliance upon the closing attorney and whether FNMA's long delay in seeking any kind of relief resulted in it being "guilty of culpable negligence" or whether that unreasonably prejudiced the plaintiff such that "subrogation would be inequitable in this instance". Countrywide Home Loans Servicing, LP v. States Res. Corp. (N.C. App., 2011) 619-20 (2006) provides some guidance in a Role 60 challenge as to when reliance is not excusable.

We note one other area where the opinion may lead those relying upon it to stray from established precedent. In American Gen. Fin. Servs., Inc. v. Barnes , 175 N.C. App. 406, 623 S.E.2d 617, having somewhat analogous facts as those of this case, the refinancing of the prior loan involved the lender loaning more funds than just the payoff of the senior loan. The American General Court assumed that the cash-out portion of the refinance loan, standing on its own, somehow prevented the application of the equitable doctrine of subrogation. That Court said that even if the plaintiff was excusably ignorant, subrogation "would place {the junior lien holder} in a worse position because it would be subordinate to the additional sum of $1,573.00 that American General provided".  We note however, that the concept of bifurcated priority has clearly been established in North Carolina. In the case of Carolina Builders Corp. v. Howard-Veasey Homes, Inc., 72 N.C. App. 224, 324 S.E.2d 626, cert. den. 313 N.C. 597, 330 S.E.2d 606, (1985), the equitable doctrine of instantaneous seisin is clearly set forth. In Dalton Moran Shook Inc. v. Pitt Development Co., 113 N.C. App. 707, 440 S.E.2d 585, (1994) the Court of Appeals modifies this doctrine to the extent that a deed of trust securing the purchase price of property as well as a construction loan is superior to an existing materialmen's lien only to the extent that the deed of trust secures the purchase price of the property. The subrogated lien of the lien claimant enjoys priority over the construction loan funds advanced by the lender. Applied in this case, any increase in the loan obligation over the Wachovia indebtedness would be junior in priority to the lien of the plaintiff here if the equities were determined to be otherwise in FNMA's favor rather than being determinative as to whether the equitable relief would prejudice the trust beneficiaries. Dalton also was a summary judgment case and the order was overturned and remanded for further findings. It is possible that had the Court remanded this case for trial, the issue might have arisen.

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