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Issue  270  Article  424
Published:  3/1/2021

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Home Realty v Red Fox Red Fox Country Club Owners Ass'n
Prior Mortgage Cuts Off Subsequent Covenants

Chris Burti, Vice President and Senior Legal Counsel

The opinion of the Court in Home Realty v Red Fox Country Club Owners Ass'n (COA20-125) 11/17/2020 the Court of Appeals reaffirms that absent estoppel, the foreclosure of a prior deed of trust cuts of restrictive covenants recorded afterward.

In 1966, 582.29 acres of property including 231.20 acres upon which Red Fox Country Club Golf Course was operating was conveyed to Tryon Development Company ("Tryon"). Ten days later, Tryon recorded restrictive covenants governing a subdivision called Red Fox Run ("1966 Restrictions"). Tryon also recorded plats depicting several sections of the subdivision. These restrictions did not to apply to the remaining acreage that included the golf course.

After a number of lots had been sold, Tryon severed the golf course property consisting of 231.20 acres from the original 582.29-acre tract and conveyed it and another tract, (Property) to Red Fox Properties, Inc., by deeds recorded in 1971 and who then conveyed them to Capstone Development Company ("Capstone") in 1983. The deed to the tract that did not include the golf course explicitly excluded the 70 lots that had been sold by that time.

Capstone gave a deed of trust that encumbered the Property in the amount of $2,600,000 to ("Hooper deed of trust") and then transferred the Property to Red Fox, Ltd., who subsequently, recorded Amended & Restated Restrictions for Red Fox Country Club and Provisions for Red Fox Country Club Owners Association ("1986 Restrictions"). These 1986 Restrictions applied to the Property acquired from Capstone and the properties of 40 homeowners who ratified them. The 1986 Restrictions created  Red Fox Country Club Owners Association ("the Association") and stated in part that the "Recreational Amenities shall be conveyed to the Association as Common Properties upon the sale of ninety (90%) percent of the Participating Membership in Red Fox Country Club but not later than January 1, 1996."

Red Fox, Ltd., next conveyed the Property to Red Fox Limited Partnership who subsequently recorded a deed of trust encumbering the Property as collateral for a $3,000,000 loan from North Carolina Federal Savings & Loan Association ("NCFS&L deed of trust"). Immediately thereafter the trustee for the 1984 Hooper deed of trust recorded an agreement subordinating the Hooper deed of trust lien to the NCFS&L deed of trust.

Four years later, the substitute trustee commenced foreclosure of the Hooper (junior by subordination) deed of trust, serving notice on Red Fox Limited Partnership, Capstone, and the District Director for the Internal Revenue Service. Adrian Hooper was the high bidder at the foreclosure sale and assigned the bid to RF Acquisition Co., Inc. ("RF Acquisition"), an entity of which he was President and to whom the substitute trustee conveyed the Property.

In 1992, the substitute trustee for the NCFS&L deed of trust (senior to the Hooper deed of trust via subordination) conducted foreclosure proceedings conveying the Property to Resolution Trust Corporation, Receiver for NCFS&L who then conveyed the Property to the plaintiff by a deed recorded in 1992. In 2018, the plaintiff filed a complaint seeking to quiet title to the Property and requesting a declaratory judgment that restrictions recorded in 1986 had been extinguished by a 1990 foreclosure and were no longer in force to encumber or restrict the Property. The trial court granted judgment on the pleadings in favor of the plaintiff and dismissed the defendants' counterclaims with prejudice.

On appeal. the defendants argued several issues both procedural and substantive, however, we will only discuss the substantive matters at this time. The Court of Appeals discusses the defendants' arguments that the trial court erred by entering judgment on the pleadings in favor of plaintiff, because the foreclosure of the Hooper deed of trust was not properly conducted; by holding as a matter of law that the 1986 Restrictions were extinguished as to the 40 property owners who had ratified them; and by dismissing with prejudice Defendants' counterclaims.

The defendants argued that the foreclosure proceedings for the Hooper deed of trust were defective as a matter of law and as a result, the trial court erred in entering judgment on the pleadings in favor of the plaintiff because there were genuine issues of fact in dispute. The opinion points out that the Hooper deed of trust that encumbered the Property in the amount of was recorded on 27 June 1984. In February 1986, Capstone transferred the Property to Red Fox, Ltd. On 23 December 1986, Red Fox, Ltd., recorded the 1986 Restrictions. Accordingly, title acquired by RF Acquisition to the Property upon the foreclosure on the Hooper deed of trust related back to 27 June 1984 and extinguished the 1986 Restrictions. The Court of Appeals states:

Defendants seem to argue in their reply brief that, because Plaintiff purchased the Property at a second foreclosure sale on the NCFS&L deed of trust, which was recorded after the 1986 Restrictions, that this sequence of events should cause us to disregard the extinguishment of the 1986 Restrictions by the prior Hooper foreclosure. Defendants cite no authority to support this argument, and our own research reveals no authority supporting a theory that, after the 1986 Restrictions were extinguished as to the Property by the Hooper foreclosure, the benefits and burdens created by the 1986 Restrictions were resurrected with respect to the Property and reattached to the Property when it was later conveyed at the foreclosure sale on the NCFS&L deed of trust.

While the record shows the trustee for the 27 June 1984 Hooper deed of trust recorded a subordination agreement at 11:15 on 30 December 1986, which subordinated the Hooper deed of trust lien to the lien created by the NCFS&L deed of trust, that instrument did not waive the priority of the 27 June 1984 Hooper deed of trust over the Amended & Restated Restrictions subsequently recorded by Red Fox, Ltd., on 23 December 1986. N.C. Gen. Stat. § 47-20 ("Instruments registered in the office of the register of deeds shall have priority based on the order of registration . . . .").

This opinion is important to real property practitioners because it makes it absolutely clear that a subordinated deed of trust may be foreclosed until the foreclosure of the deed of trust that has priority because of the subordination and that whatever rights are cut off by that foreclosure remain cut off after interest of the purchaser at the foreclosure of the subordinated deed of trust are cut off by the subsequent foreclosure of the deed of trust with subordination priority.

The defendants also argued that the foreclosure proceedings on the Hooper deed of trust could not extinguish the 1986 Restrictions because they proceedings were defective in that they were not given notice of the proceedings pursuant to N.C.G.S. Section 45-21.16(b) which required notice of the hearing be given to "any person owning a present or future interest of record in the real property which interest would be affected by the foreclosure proceeding . . .". the defendants contended that they were record owners entitled to notice because they had a future interest in the Property by virtue of the terms of the 1986 Restrictions asserting that:

(a) the Association, of which each property owner was a member, was created; and (b) Red Fox, Ltd., as the owner of the Property, committed to convey "Recreational Amenities . . . to the Association as Common Properties upon the sale of ninety (90%) percent of the Participating Membership in Red Fox Country Club but not later than January 1, 1996." This commitment to convey the Property, Defendants argue, created a future interest in real property in the Association and its members. Defendants contend that it was Plaintiff's burden to "prove that the foreclosure sale met the requirements of law then in effect in order to apply any principles of law that arise out of the foreclosure," and that "[i]t was not necessary for Defendants to plead in their Answer the 'lack of notice.'"

The plaintiff argued that the defendants were not record owners entitled to notice under the statute and that they were barred because this defense was not pleaded and thus, they could raise it to defeat the plaintiff's motion for judgment on the pleadings and the Court of Appeals concurred with appropriate discussion and citation to statue and controlling case law on this procedural issue.

The defendants next argued that the trial court erred by holding that the 1986 Restrictions were extinguished as to the property owners who ratified them because that are enforceable by the ratifying owners and subsequent purchasers of their properties because the Restrictions run with the land. However the opinion points out the consistent doctrine in North Carolina that:

"The purpose of foreclosure is to allow the mortgagee to realize on the security as it existed at the time the mortgage was executed. Consequently, . . . junior easements on the servient estate are terminated by out-of-court foreclosure under a power of sale found in a senior mortgage or deed of trust . . . ." Jon W. Bruce & James W. Ely, Jr., The Law of Easements & Licenses in Land § 10:41 (2020). As our Supreme Court explained,

If subsequent judgment creditors or litigants over the equity of redemption could "tie up" a first mortgage and effect its terms, it would seriously impair a legal contract. It may be "hard measure" to sell, but this is universally so. The mortgagee has a right to have her contract enforced under the plain terms of the mortgage. To hold otherwise would practically nullify the present system of mortgages and deeds in trust on land, so generally used to secure indebtedness and seriously hamper business.

Leak v. Armfield, 187 N.C. 625, 628, 122 S.E. 393, 394 (1924).

As explained above, the 1986 Restrictions were extinguished by the foreclosure of the Hooper deed of trust. Thus, as a matter of law, the 1986 Restrictions no longer have force and effect on the Property. See St. Louis Union Tr. , 211 N.C. at 344, 190 S.E. at 530 ("Title acquired by foreclosure relates back to the date of the mortgage, so as to cut off intervening equities and rights."). Because the Property is no longer burdened by the 1986 Restrictions, the 40 ratifying property owners are not entitled to any rights in the Property arising from the 1986 Restrictions. See Dixieland Realty , 272 N.C. at 175, 158 S.E.2d at 10 (encumbrances that trustor imposed on property after execution and recording of deed of trust are extinguished by sale under foreclosure of senior instrument); Dunn , 148 N.C. at 282, 61 S.E. at 681 (sale under deed of trust extinguishes all encumbrances executed after deed of trust).

To address the possibility of such a conclusion the defendants also argued that the Supreme Court's opinion in Dixieland Realty should lead the Court of Appeals to make an equitable exception in this case to the general rule  

In Dixieland Realty, the Supreme Court affirmed the settled rule of extinguishment by foreclosure However, the Court formulated a narrow exception to the rule by holding that the foreclosure of the senior deed of trust did not extinguish the lien of the junior deed of trust, because the trustor who intended to convey the land described therein—the land the grantee expected to acquire as security for his debt—purchased the property at the senior mortgage sale following foreclosure. Id. at 180, 158 S.E.2d at 13-14. See also Restatement (Third) of Property (Mortgages) § 7.1 (1997) (It is "[o]nly in the rare instance where the mortgagor is the foreclosure purchaser do fairness and policy considerations dictate a departure from" the principle that foreclosure extinguishes junior liens and encumbrances). The instant case does not involve a trustor who purchased his own secured property at a senior mortgage sale following foreclosure. The "rare instance" utilized in Dixieland Realty is distinguishable and not applicable to the facts of this case. See id

The defendants also argued that the plaintiff should be equitably estopped from asserting that the 1986 Restrictions were extinguished by the Hooper foreclosure. Our supposition is that they cited Whitacre P'ship v. Biosignia, Inc., 358 N.C. 1 (2004) because the opinion cites this case noting that North Carolina courts have long recognized the doctrine of equitable estoppel, but observed that in Whitacre P'ship  the trustor acquired the property in foreclosure which was not the case here. Also, the 1986 Restrictions gave the owner of the Property a right of first refusal to purchase lots being resold and between 1992 and 2017, the plaintiff signed 115 waivers at the request of the sellers of the lots.  Defendants argued, "If it had been the belief of [Plaintiff]  that  the  1986  Restrictions  were  extinguished  by  the  foreclosure of  the Hooper deed of trust, the Waivers would not have been necessary."  However, the waivers that the plaintiff signed merely stated

(1) that the two declarations of restrictions granting the owner of the Property a right of first refusal had been recorded, and
(2) that the parties selling the lots "requested [Plaintiff] to approve said transfer[s] for the purpose of complying with and evincing compliance with" both declarations of restrictions.

The opinion notes that the waivers did not state that the 1986 Restrictions were still in effect or purport to convey any interest in the Property to the defendants and in signing them the plaintiff "was not denying the truth of any earlier representations or taking a position inconsistent with an earlier position. Thus, neither the principle of equitable estoppel nor the principle of quasi-estoppel should be applied under these facts to preclude Plaintiff from asserting that the foreclosure extinguished the 1986 Restrictions."

Defendants' Counterclaims

In arguing that the trial court erred by dismissing their counterclaims with prejudice, the defendants contended that that the Property can only be used as a golf course.  They based this argument upon their assertion that the Property is subject to an as easement by estoppel and the plaintiff should be equitably estopped from denying the easements created by the plaintiff's representations, including its use of unrecorded plats, when selling properties in the subdivision. 

The opinion asserts in response to these contentions that:

Defendants argue that they are entitled to easements created when Plaintiff sold properties based on (1) representations made in printed marketing materials displayed in the sales office—including unrecorded plats depicting a golf course and brochures describing a golf course community; and (2) oral representations made to prospective buyers in the sales office, in which Plaintiff indicated that the lots for sale were in a golf course community. Also, Defendants argue that the mere existence of an operational golf course and golf amenities at the time prospective buyers purchased their lots affirmed these representations. Defendants contend that they detrimentally relied on these representations and that Plaintiff should be "equitably estopped from denying the existence of the easements thus created" "by the sale of the property off the plats."  We disagree. The argument that courts should apply equitable estoppel principles to create an easement based on representations in a developer's marketing materials was rejected by this Court in Crooked Creek. See 254 N.C. App. at 394, 802 S.E.2d at 915. This Court explained:

While Crooked Creek subdivision may have been contemplated and marketed as a golf course community to induce Plaintiffs to purchase lots in the subdivision, no case has recognized an implied easement or restrictive covenants being imposed on undeveloped land, based upon statements in marketing materials. Courts have recognized marketing materials as further demonstrating the expressed intent of the developer, but only where a recorded instrument exists to demonstrate the intent to encumber and restrict the land.

Id.(citations omitted).

In this case, taking as true Defendants' allegations that Plaintiff represented to prospective purchasers that the Property would always be used as a golf course, Defendants fail to state a claim upon which relief may be granted, because there is no cognizable legal claim in North Carolina that an easement by estoppel restricting land has been created based on marketing materials, unrecorded plats, or plats not referenced by deed. (emphasis added by author) See id. The trial court did not err by dismissing Defendants' counterclaim seeking declaratory judgment on this basis.

The defendants implicitly argued that they were entitled to an easement-by-plat.  The court recognized that an easement may be created by plat, where the owner of land, "has it subdivided and platted into lots, streets, alleys, and  parks,  and  sells  and  conveys  the  lots  or  any  of  them with  reference  to  the  plat,  nothing  else  appearing,  he thereby dedicates the streets, alleys, and parks, and all of them,  to  the  use  of  the  purchasers,  and  those  claiming under them, and of the public .Gaither v. Albemarle Hosp., Inc., 235 N.C. 431, 443, 70 S.E.2d 680, 690 (1952)." With appropriate citation, the opinion recognizes that it is well settled doctrine in North Carolina that when the questioned areas on such plats are represented by dotted lines, as was the case here, no such easement is created.

Indeed, similar to the plats in Crooked Creek, the outer boundaries of the Property, and thus, the golf course, are either not marked at all or are depicted with dotted lines. The description, as illustrated by the plats, is insufficient to create a golf  course easement, as it "omits  one  or  more  of  the  boundaries,  and  leaves  the quantity of land undetermined." Stines, 81 N.C.  App.  at 101,  344  S.E.2d  at  548.  Because "[n]othing on the plat or referred to therein would enable a title attorney to determine  the  precise  boundaries  of  the  area  burdened  with  the [golf  course]easement," the plat is not capable of describing or reducing an easement in the golf course to a certainty.  Id. Accordingly, the trial court did not err by concluding that the subdivision plats did not create...

Hopefully this decision will add to the certainty of what many consider to be well settled doctrine.

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