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Foreclosures in North Carolina – Say Goodbye to Discovery and Res Judicata

    Client Alerts
  • January 04, 2017

Late December is a time of family, mistletoe and “presents under the tree.” It’s not usually the time when minds switch to the specifics of foreclosure procedure. Yet just before they retired for their Christmas break, the justices of the North Carolina Supreme Court dropped off a December 21, 2016 holiday present called In re Lucks which radically changes foreclosure procedure in North Carolina as we know it. Was it a timely present, a lump of coal, or maybe a little of each? You decide.

The Facts

The facts involved in Lucks are pretty dry. In 2006, Borrower executed a 30-year, $225,000 promissory note which was secured by a deed of trust on property in Buncombe County. At some later date, the note went into default. In 2013, a law firm claiming to be the substitute trustee under the deed of trust started a non-judicial foreclose. That foreclosure was dismissed by the clerk based on the failure of the law firm to present evidence that the firm had actually been appointed as the substitute trustee.

In 2014, a new law firm acting as substitute trustee commenced a non-judicial foreclosure. The clerk found that the prior dismissal acted as res judicata to bar the subsequent foreclosure and dismissed the second foreclosure. Lender (Deutsche Bank) appealed to the trial court. Before the trial court, Deutsche Bank submitted documentation to try to prove the chain of ownership of the note and prove that the second substitute trustee was correctly appointed. Unfortunately, the documentation which Deutsche Bank presented was inherently contradictory. The trial court ruled against the lender and “dismissed with prejudice” the foreclosure. The Court of Appeals reversed in a 2-1 split decision, and the borrower appealed to the NC Supreme Court.

The Law

The Supreme Court reversed the Court of Appeals and held that the trial court was correct to not grant the requested foreclosure based on the inconsistent documentation submitted by Deutsche Bank. In essence, the Court held that Deutsche Bank failed to meet its burden of proof.

If the Supreme Court had simply ended there, its opinion would not have been newsworthy. But the Court went much, much further and issued three wide-sweeping pronouncements regarding foreclosure procedure in North Carolina:

(i) The Rules of Civil Procedure don’t apply to non-judicial foreclosures. Prior Court of Appeals opinions had specifically held that the Rules of Civil Procedure did apply (including rules for discovery, the effect of the dismissal of proceedings, etc.). The Supreme Court specifically overruled all of these prior opinions and held that since power of sale foreclosures were non-judicial, therefore the Rules of Civil Procedure (applicable to judicial proceedings) simply do not apply.

(ii) The relaxed evidentiary rules applicable before the clerk also apply to de novo hearings on appeal before the trial court. As a typical matter, appeal hearings in front of the trial court were always conducted with much more formality, including a court reporter. However, the Supreme Court made it clear that when it comes to evidentiary standards, the same relaxed rules which apply before the clerk also apply on appeal.

(iii) The doctrines of res judicata and collateral estoppel do not apply to non-judicial foreclosures. The Supreme Court reached this determination in holding that the trial court was wrong to enter a dismissal “with prejudice” because res judicata and collateral estoppel principles only apply to judicial proceedings, not non-judicial foreclosures.

The Moral

There are several morals to be learned as we unwrap the Lucks opinion.

  1. No more discovery. Lenders no longer have to worry about borrowers serving them with discovery as part of a non-judicial foreclosure. Now if borrowers want to take some discovery, they are going to have to file a separate lawsuit against the lender to get it.
  2. Loose evidentiary standard before trial court. This is probably bad for lenders. Typically lenders are the ones who are more formal about their presentation of documents and evidence to the court. Borrowers are the ones who will cheer this part of the ruling as it provides them with an easier standard for presenting information to be considered as “evidence” before the trial court (i.e. don’t bother raising a hearsay objection in a foreclosure appeal if you are the lender).
  3. What’s the effect of an entered foreclosure order? This last moral is more of an open ended question. It is good for lenders that res judicata does not bar subsequent non-judicial foreclosures. But the Supreme Court’s language is very broad and could plausibly be read to say that orders of the clerk granting NC foreclosures have no res judicata effect. That would be a major change and one that is very bad for lenders. Before Lucks, a lender could sue for a deficiency against borrowers or guarantors and, if the obligors contested the validity of the debt, the lender could point to the prior foreclosure order (which contains a holding that the debt is a “valid debt”) and argue res judicata. The ability to make that argument was very helpful in deficiency actions and lender liability lawsuits and lower NC federal and state courts routinely applied res judicata principles to foreclosure orders. Is that argument now gone? Or can the Lucks opinion be limited to its facts and not apply to entered foreclosure orders? Only time will tell.

The true and final moral of Lucks, however? If you are a lender, pay attention to proving the chain of ownership of the note and authority of the substitute trustee. With a little extra care on preparation before the trial court, this case would never have ended up before the Supreme Court.