The 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. The 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. They 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. The 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. Typically, 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. This 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.  The 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.  The 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.

This 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. The 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 Trustees of the “Lambeth Family Trust” without notice to, or the consent of, Household.

The 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 Trustby recording unauthorized release documents with the Register of Deeds. As the court describes the process, they first recorded a “‘Substitution of Trustee,’ representing that Heineman was the ‘attorney-in-fact’ for Household Mortgage Services, and further purporting to substitute Lambeth as Trustee under the Household Deed of Trust.Immediately thereafter, the Dorean Group fraudulently recorded a so-called ‘Full Reconveyance’ wherein Heineman, as the purported Trustee for Household under the Household Deed of Trust, represented that (i) all sums secured by the Household Deed of Trust had been paid, and (ii) the Household Deed of Trust and the Household Note had been surrendered to the Trustee for cancellation.Both statements were false. The Full Reconveyance also purported to reconvey the estate to the Lambeth Family Trust.”

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 Trust on 22 October 2004.”

In 2006, the trial court in a summary judgment order that was not appealed held that the Household Deed of Trust was fraudulently cancelled and should be reinstated as a lien on the Lambeth Property.   The judgment did not address the effective date of the reinstatement of the Household Deed of Trust and left the priority issue between the Household Deed of Trust and the Fremont Deed of Trust open. Subsequently in 2006, Judge Albright ruled in favor of Household, restoring the Household Deed of Trust as a lien upon the Lambeth Property, effective from its original recordation date and having priority over the Fremont Deed of Trust.

The 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 Trust had priority over the Fremont Deed of Trust 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. The trustee cancelled the Deed of Trust, but failed to pay the beneficiaries, who then sued to reinstate their deed of trust. The 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. The 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.

The 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. The 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.”

The North Carolina Court of Appeals succinctly disposed of the statement of the fourth circuit as follows: “This ‘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.”

The 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.”

This 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.  The 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: “The law in this State is clear regarding material alterations of written instruments. The 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 Trust from being reinstated with priority.

The 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.”

The trial court also made the following conclusion of law:
“7. The 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.

The 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 Trust reinstated as the superior lien.” The 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. The Dorean Group's cancellation of the Household Deed of Trust 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 Trust, or “any injury Fremont sustained as a result of the Dorean Group's fraud.”

The 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.”  The 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 Title’; (v) a so-called ‘Affidavit of Truth’; (vi) a letter from a purported certified public accountant; (vii) and various propaganda. To characterize this document as bizarre and absurd would be an understatement. The 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. This 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 Trust. 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.