The purpose of this memo is to provide a short summary regarding the process of North Carolina power of sale (i.e. non-judicial) foreclosures under a deed of trust.1 The non-judicial process is governed by North Carolina General Statutes Chapter 45, Article 2A.
Prior to Commencing Foreclosure
A. Note, Deed of Trust, Power of Sale. A power of sale foreclosure requires the existence of (a) a valid debt (b) that is secured by a deed of trust (c) which includes the right of the trustee to foreclose on the property under certain circumstances, typically an event of default. North Carolina law operates under the legal fiction that the trustee under the deed of trust is the one who holds title to the property, and can therefore proceed to sell the property at foreclosure sale.
B. Existing Default. Prior to commencing a foreclosure, the beneficiary under the deed of trust (hereafter, the “Lender”) should confirm that there is an existing default which triggers the power of sale, and that the borrower has been given all required notices (including any applicable cure period).
C. Title Search. The foreclosure statute requires that certain parties receive notice of the foreclosure proceeding (as more fully discussed below). Thus, the Lender must obtain a title search of the collateral property to identify all parties who must receive notice. The title search should be conducted shortly before filing the foreclosure to minimize the risk of title changes during the intervening period.
D. Outstanding Balance Letter. Within the thirty (30) day period prior to filing a foreclosure, the Lender must send the borrower a written statement of the outstanding balance secured by the deed of trust. The outstanding balance letter should include notice of the Lender’s intention to collect attorneys’ fees if the debt is not paid within five (5) days.
E. Substitution of Trustee. Typically, the existing trustee under the deed of trust is a title insurance company or a related third party. North Carolina foreclosure law requires the trustee proceeding with foreclosure to be a neutral third party who does not advocate for either the lender or the owner. Accordingly, the usual first step in filing a foreclosure is for the Lender to execute a “Substitution of Trustee” which changes the trustee under the deed of trust to a third party (typically a local attorney). This is a short document filed with the Register of Deeds in the county where the collateral property is located.
Filing the Foreclosure
A. Notice of Hearing. A foreclosure is started by the trustee executing and filing a “Notice of Hearing” (the “NOH”) with the Clerk of Superior Court in the county where the collateral property is located. The NOH is the equivalent of a complaint in litigation. The NOH includes information regarding the timing and location of a foreclosure hearing before the clerk of court, as well as information identifying the debt and the deed of trust being foreclosed.
B. Persons Entitled to Notice of the Foreclosure. The NOH must be served on the following persons (collectively the “Notice Parties”):
- All parties obligated to repay the debt secured by the deed of trust (typically the borrower and any guarantors);
- All parties entitled to notice under the terms of the deed of trust; and
- All record owners of the property (includes tenants under recorded leases, but not tenants under unrecorded leases; also does not include other lien claimants).
In addition, the Lender should serve any parties entitled to notice under the terms of subordination agreements, loan participation agreements, or other loan documents.2
C. Service of the Notice of Hearing. Typically, the NOH is served on the Notice Parties via the sheriff, certified mail, or overnight delivery. The trustee can also simultaneously post the NOH on the property and this can serve as proper service under certain circumstances. (Note: Posting of the property should only be used as a backup and the trustee / lender’s counsel should always attempt to actually serve the Notice Parties).
D. Timing of Hearing. All Notice Parties must be served no later than 10 days prior to the hearing (or 20 days if service is obtained by posting). In order to meet these timelines, the foreclosure hearing is typically scheduled 30 to 45 days from the date of filing. However, depending upon the particular county and the clerk’s caseload, the foreclosure hearing may be scheduled even further out.
The Foreclosure Hearing
A. Hearing before the clerk of court, not a judge. A power of sale foreclosure is called a “special proceeding” (this is the reason why the foreclosure case number follows the format 14 SP ____). Unlike a lawsuit which can only be tried before a judge, a power of sale foreclosure is tried in front of a clerk of court. The hearings are informal and are typically conducted in the clerk’s chambers. The hearings are typically not recorded by a court reporter.
B. Findings of Fact. The clerk must weigh the evidence presented at the foreclosure hearing (typically through live testimony of witnesses or through affidavits) and must enter a foreclosure order if it finds the following:
- a valid debt of which the party seeking to foreclose is the holder;3
- right to foreclose under the deed of trust;
- notice has been given to all the Notice Parties;
- the debt is not a home loan (rarely applicable in commercial foreclosures), or if a home loan, then certain required notices have been given; and
- the foreclosure is not barred due to the military service of the borrower or property owner.
If the clerk finds the existence of all these facts, the clerk must enter a foreclosure order and permit the trustee to proceed with the foreclosure sale.
C. Limited Jurisdiction of Clerk. The clerk’s ability to rule at a foreclosure hearing is limited. The clerk may not consider any equitable defenses, nor may it hear any arguments over the amount of the debt which is owed. If a property owner wishes to raise defenses to items other than the four findings of fact, it must do so by filing a separate lawsuit and seeking injunctive relief from a judge.
The Foreclosure Sale
A. Posting, Service and Publication of the Notice of Sale. The trustee then files and serves a Notice of Sale (“NOS”) on all of the Notice Parties, as well as (1) the IRS, if there is a federal tax lien; and (2) any lien holders who have filed a request for notice of sale with the Register of Deeds.4 The NOS must also be posted at the courthouse for a minimum of 20 days prior to the foreclosure sale. The NOS must be published in the local county newspaper which is approved for publishing legal notices for at least 2 consecutive weeks prior to the date of the foreclosure sale. The foreclosure sale is typically scheduled between 25 to 30 days from the entry of the foreclosure order and is conducted at the courthouse steps (or an area at the courthouse specifically designated for foreclosure sales).
B. Postponement of Foreclosure Sale. The Lender can direct the trustee to postpone the foreclosure sale. The trustee simply files a notice of postponement and announces the postponement at the originally scheduled time for the sale. There is no limitation on the number of times the foreclosure sale can be postponed. However, if the sale is postponed for more than ninety (90) days past the original sale date, then the NOS must be served, posted, and published in the paper again.
C. Process of Foreclosure Sale. Any party can attend and bid at the foreclosure sale. Typically, the trustee reads the NOS and then announces the credit bid being placed by the Lender (if the Lender does not attend the sale to bid in person). If a third party bids at the foreclosure sale, they must make a cash deposit with the trustee (typically equal to five or ten percent of the bid amount). The Lender is not required to place a cash deposit at the initial sale. There is no minimum incremental bid at a foreclosure sale (i.e. a party can bid $1 more than the prior bid). Once the foreclosure sale is concluded, the trustee files a Report of Sale with the court.
D. Upset Bid Period. After the Report of Sale has been filed, a ten-day upset bid period commences. During this period, any party (including the Lender if it was not the successful bidder at the sale) can place an upset bid. However, the upset bid must be a minimum of five percent (5%) greater than the prior high bid, and any upset bidder (including the Lender) must deposit a 5% cash deposit with the clerk of court. Upon the filing of an upset bid, a new ten-day upset bid period commences. The trustee is required to serve any upset bids on the Lender, prior high bidders, and the Notice Parties.
E. Conclusion of Foreclosure Sale. Once a ten-day upset bid period has passed with no upset bids being filed, the foreclosure sale becomes final. At this point, the trustee deeds the collateral property to the winning bidder (or its assignee) and files a Final Report of Sale to account for all funds spent or obtained through the foreclosure process. The clerk audits the Final Report and then the foreclosure special proceeding is closed.
F. Title to the Foreclosed Property. The foreclosure sale wipes out all junior lien interests against the collateral property, but has no affect on senior interests, including ad valorem real property taxes. The winning bidder will typically pay any outstanding ad valorem taxes at the same time as the trustee’s deed is recorded. The foreclosure also typically does not affect the validity of easements / rights of way on the property (whether junior or senior), although it is possible to cut off the rights of junior easement holders if they are given proper notice of the foreclosure.5
A. Personal Property. If the deed of trust is also a security agreement covering personal property, the personal property can be foreclosed on at the same time and in the same proceeding as the real property. Title to the personal property is typically transferred to the winning bidder through the trustee’s deed or a separate bill of sale.
B. Appeal. The foreclosure order entered by the clerk of court can be appealed directly to a Superior Court judge who will hear the matter de novo (i.e. as a new matter with new presentation of evidence). If the owner of the property appeals and wants to stay the foreclosure sale, it must post a bond with the clerk of court. The clerk has discretion to determine the appropriate amount of the bond, but as a matter of practice, most clerks set the bond at 1% of the outstanding debt. Failure to post a bond means that the foreclosure sale can continue.
C. Bankruptcy. A foreclosure action will be stayed by a bankruptcy filing of the owner of the property. However, a bankruptcy filing by a person who does not own the property (even if a guarantor or a borrower) does not stay the foreclosure. If the bankruptcy is filed prior to the foreclosure order being entered, then the Lender who obtains relief from the bankruptcy stay must start the foreclosure process from the beginning. However, if the bankruptcy petition was filed after entry of the foreclosure order, the Lender who gets relief from stay need not go through a new foreclosure hearing but need only re-notice the foreclosure sale.
D. Receivers. It is common practice in North Carolina to seek the appointment of a receiver over property in connection with the foreclosure of certain commercial asset types (apartment complexes, hotels, office buildings, shopping centers, etc.). Further information regarding the receivership process in North Carolina is available by contacting Parker Poe.
1 This memo does not address the topic of judicial foreclosures since those are the exception in North Carolina. Judicial foreclosures are typically only used when (1) there is a mortgage (which involves no third-party trustee) instead of a deed of trust; (2) the deed of trust does not contain power of sale language; or (3) there is some problem with the deed of trust (e.g., incorrect property description, etc.).
2 Particular care needs to be taken in serving the proper parties if any of the Notice Parties has died and an estate file has been opened.
3 This will require a copy of the promissory note and evidence that it has been assigned to the Lender, if the Lender is not the original holder. Some clerks will also require evidence of merger if the debt was originated in the name of a predecessor bank.
4 If the collateral property is a residential property with less than 15 units, the NOS must also be served on all tenants of the property, regardless of whether they have a recorded lease.
5 It is not standard practice to give notice of the foreclosure to easement holders since many easements / rights of way benefit the collateral property (e.g. utility easements). A Lender wishing to wipe out junior easements through a foreclosure should specifically identify the easements it does not want so that the easement holders can be given proper notice of the foreclosure.
For questions or for further information, contact Will Esser at 704.335.9507.
Disclaimer: The information contained in this memorandum is intended as a summary of relevant law and is not intended as legal advice.