October 2001

A PUBLICATION OR THE TITLE COMPANY OF NORTH CAROLINA

     

REGISTER OF DEEDS CHANGES; ENTITY REINSTATEMENT - HOUSE BILL 1073 PASSES

G.S. 161-10(a), pertaining to recording fees charged by the register of deeds, was amended effective January 1, 2002. Generally, the fee for recording a deed, mortgage or deed of trust, memorandum of lease or any other document to which G.S. 161-10(a)(1) or (1a) applies will be $12.00 for the first page plus $3.00 for each additional page or fraction therof. (If a document consists of "multiple instruments", $10.00 for each additional instrument.) The probate fee is still $2.00. G.S. 161-10(a)(16) The cost for a certified copy will be $5.00 for the first page and $2.00 for each additional page or fraction thereof. G.S. 161-10(a)(19), which is new, pertains to a "non-standard document" not complying with G.S. 161-14(b). The fee will be $25.00 in addition to all other applicable recording fees.

G.S. 161-14(b), to which G.S. 116-10(a)(19) refers, becomes effective with respect to instruments executed on or after July 1, 2002. All instruments presented for registration shall (1) be 8 1/2 inches by 11 inches or 8 1/2 inches by 14 inches; (2) have a blank margin at the top of the first page of three inches and blank margins of 1/2 inch on the remaining sides of the first page and all sides of subsequent pages; (3) be typed in black on white pages in legible font (a font size no smaller than 10 points shall be considered legible) (blanks can be completed and corrections can be made in pen); (4) have text on one side only; and (5) state the type of the instrument at the top of the first page. If the instrument does not meet these requirements, it shall be registered after the fees noted above are collected. If the requirements are not met because the font size is smaller than 10 points, the register of deeds may register it without collecting the fee for a non-standard document if, in the discretion of the register of deeds, the instrument is legible.

G.S. 55-14-22 and G.S. 55-4-01(g) (corporations); G.S. 55A-14-22 and G.S. 55A-4-01(f) (non-profit corporations); G.S. 57C-6-03(c) and G.S. 57C-2-30(f) (LLCs) and G.S. 59-84.4(h) (registered and foreign limited liability partnerships) have been amended effective August 26, 2001. These amendments apply retroactively to applications for reinstatement made on or after December 1, 1999. Administrative dissolution under those sections no longer must be applied for within five years. In a subsequent newsletter, we will be discussing other changes, including those made by Senate Bill 842, entitled "Business Entity Changes" ratified and signed on August 27, 2001. (This can be accessed on www.ncleg.net.)

SUBORDINATION AGREEMENTS - PART 1

1. General Comments

A subordination agreement can be used to subordinate (1) the lien of of one deed of trust to the lien of another deed of trust; (2) the lien of a judgment, a filed or unfiled claim of lien under Chapter 44A or an assessment lien to the lien of a deed of trust or other lien; or (3) the rights of a tenant under a recorded or unrecorded lease to the lien of a deed of trust. The primary goal of any subordination agreement is to alter previous existing priority. The three main issues in assessing a subordination agreement are: (1) is the subordination an "automatic" subordination contained in, for example, a lease, a condominium declaration or a planned unit development declaration or is the subordination agreement one especially drafted for the occasion; (2) is the subordination absolute or conditional; and (3) is the subordination sufficiently definite so as to be valid? The Title Company is frequently asked to insure priority based upon a subordination of one interest to the insured interest. Subordination agreements are discussed in some detail in E. Urban and G. Whitney, North Carolina Real Estate, 21-80 (Harrison Co. Supp. 1999) ("Real Estate Book") and E. Urban, North Carolina Real Property Mechanics' Liens, Future Advances and Equity Lines, 41-17 and 51-2 (Harrison Co., Supp. 2000) ("Mechanics' Lien Book").

2. Validity of the Subordination agreement

In MCB Limited v. McGowan, 86 N.C. App. 607, 359 S.E. 2d 50 (1987), P agreed to buy property from D, and the contract obligated D to accept a purchase money deed of trust to secure a portion of the purchase price and stated, in reference to the obligation to be secured, that "[t]he $70,000.00 note shall be 1st deed of trust until Michael Buck [general partner of plaintiff] secures permanent financing of the building. At that time, note shall become 2nd deed of trust." D's deed of trust contained a lengthy subordination clause requiring D to subordinate to future construction and permanent financing loans arranged by P during development of the property. Subsequently, D subordinated to a construction loan deed of trust but refused to subordinate to a permanent loan deed of trust. The court, stating that the case was one of first impression in North Carolina, held that the subordination provisions in the contract ad deed of trust were void for indefiniteness, stating, "If any portion of the proposed terms is not settled, or no mode agreed on by which they may be settled, there is no agreement." The court found the reasoning of the California courts persuasive, stating that the subordination, at a minimum, must stipulate the amount and interest rate of the loan subordinated to. Particularly troublesome for the court was the fact that the contract clause contained neither element and the clause in D's deed of trust stated that D would subordinate to a future loan "in such amount as may reasonably requested by" P, requiring D and P to reach agreement in the future, a void provision.

There is no disputing that a subordination clause must be contractually definite. However, it is particularly unfortunate and hazardous to follow California's lead in this area by specifying what particular provisions such a clause must contain in addition to what is necessary to have a clear provision. For example, an automatic subordination clause that reads as follows should be upheld but, based upon the language in MCB Limited, might not be:

"[M-1] hereby agrees that its deed of trust shall be subordinate to any deed of trust given by a mortgagor or his successors or assigns securing a construction loan, regardless of whether some of the proceeds thereof are used for soft costs, including but not limited to, fees, interest, and expenses, or land acquisition and regardless of the amount of the loan or the interest rate charged thereon." Mechanics' Lien Book, 41-17. MCB Limited is criticized in  that book and in Note, Real Estate Finance - Subordination Clauses:  North Carolina Subordinates Substance to Form, 23 Wake Forest L. Rev. 575 (1988). Also see Smith v. Martin, 124 N.C. App. 592, 478 S.E. 2d 228 (1996) which follows MCB Limited.

The issues raised in MCB Limited could affect the subordinations discussed below. It would seem prudent for the Real Property Section to propose a statute to outline when a subordination agreement is valid, since the MCB Limited holding could also cause concern about the validity of subordination (of assessment lien) provisions in condominium or planned community declarations and subordination provisions in leases. A working draft of a statute might read as follows:

G.S. 47-20.6 Subordination Agreements

(a) Definitions. As used in this section,

(1) "Subordination agreement" means any document in which a subordinated interest is subordinated to a specifically described superior interest or to a superior interest that is within a specifically described class of interests.

(2) "Subordinated interest" means a lease, deed of trust, mortgage, or other lien or interest which would have priority in whole or in part a superior interest absent a subordination agreement.

(3) "Superior interest" means a lease, deed of trust, mortgage, or other lien or interest which would be subordinate in whole or part to a subordinated interest absent a subordination agreement.

(b) A subordination agreement is valid if it meets the definition of "subordination agreement" in subsection (a) and clearly identifies the subordinated interest and the superior interest. A subordination agreement shall subordinate the subordinated interest to a specifically named superior interest, a superior interest that is within a specifically described class of interests, or both. A subordination agreement shall not be invalid solely because it fails to set forth the amount secured by the superior interest or the interest rate of the indebtedness secured by the superior interest.

(c) A provision in a declaration of condominium or a declaration of a planned community subordinating an assessment lien to another interest is a valid subordination if the subordination provision is within the definition of "subordination agreement" set forth in this section, notwithstanding the fact that the association in whose favor the assessment lien arises has not executed the declaration or a separate subordination agreement.

(d) Subject to the provisions of this section, a subordination agreement shall comply with the law of contracts and the statute of frauds which is otherwise applicable.

(e) A trustee in a deed of trust need not join in a subordination agreement executed by the beneficiary in a deed of trust unless the deed of trust requires such joinder.

(f) A subordination agreement must be recorded in order to be valid against parties against which recording is required by G.S. 47-18, G.S. 47-20 or other applicable law.

Specific subordination problems are discussed below.

3. Subordination of one mortgage or deed of trust to another mortgage or deed of trust.

See MCB Limited, discussed in 2. above. In Smith v. Martin, cited in 2. above, the court followed MCB Limited's requirement that a subordination agreement subordinating a lien to a future loan must "at minimum, include terms which state the maximum amount of the future loan and the maximum rate of interest permitted on the loan." In view of these two cases, it is hazardous to rely upon an "automatic" subordination clause in, for example, a purchase money deed of  trust unless these requirements are met.

However, suppose that the purchase money mortgage did not contain an "automatic" subordination clause. If a subsequent separate subordination agreement is drafted subordinating the purchase money deed of trust to a subsequent deed of trust and that subordination agreement identifies the purchase money deed of trust and subsequent deed of trust and includes the book and page of recording of each, that should be a sufficiently definite valid subordination.

It is noted that an "automatic" subordination or a separate subordination can be conditional. For example, if the subsequent deed of trust is a construction loan deed of trust, the subordination might condition the agreement to subordinate on the construction loan proceeds going into the contemplated improvements to be constructed or for related soft costs. If the condition is met, everyone's security, including the purchase money lender's, is enhanced. If such a condition exists, the construction lender will need to carefully monitor where the construction loan proceeds go.

If a title insurer is asked to insure a subsequent deed of trust as a result of the subordination, the title insurer should review the subordination. If the subordination is valid and unconditional, Schedule B-II of the loan policy, which pertains to subordinate matters, will list the subordinated deed of trust and will state "subordinated to the lien of the insured  deed of trust by subordination recorded in book [filled in], page [filled in]." If the subordination is valid and conditional, Schedule B-II's reference to the subordination will state "subordinated to the lien of the insured deed of trust by subordination recorded in book [filled in], page [filled in], subject to the conditions in the subordination agreement."

When a conditional subordination is breached, the expensive litigation which can result can be illustrated by the National Mortgage case.

National Mortgage Corporation v. American Title Insurance Co., 41 N.C. App. 613, 255 S.E. 2d 622 (1979), rev'd 299 N.C. 369, 261 S.E. 2d 844 (1980), dealt with an owner's agreeing in the lease to the lessee to subordinate the owner's fee to the lien of "any mortgages...by the Lessee to secure construction and permanent financing...for the erection, furnishing and equipping of improvements on the premises...and at the request of the Lessee [owner] will execute any...subordination agreement to effectuate the provisions of this paragraph." The actual recorded subordination agreement provided that the loan made to the lessee was for the purpose of erection certain improvements upon the owner's land.

A $125,000.00 advance from the construction lender to the borrower without the lender's taking steps to see t hat the proceeds were used for construction purposes resulted in a breach of the conditional subordination and loss of the lender's lien on  the owner's fee. See Mechanics' Lien Book, 41-17.

Regarding title insurer liability, aspects of National Mortgage, consider this quote from the Mechanic's Lien Book, 51-1:

In the lawsuit between National Mortgage and American Title the North Carolina Court of Appeals ruled in favor of the insured, stating that an exclusion which was virtually identical to paragraph 3(a) of the Exclusions From Coverage, pertaining to "defects, liens, encumbrances, adverse claims, or other matters: (a) created, suffered, assumed or agreed to by the insured claimant," did not apply. In the North Carolina Supreme Court's review of the case, the Supreme Court reversed, agreeing with the North Carolina Land Title Association's argument raised for the first time that an exclusion virtually identical to paragraph 3(d) of the Exclusions From Coverage did apply and held for American Title. Paragraph 3(d) excludes liability for "defects, liens, encumbrances, adverse claims or other matters...attaching or created subsequent to the Date of Policy."

The unfortunate thing about the National Mortgage case is that in all probability thousands of dollars in costly litigation expense could have been avoided if the policy had simply made exception to the conditional nature of the subordination. 

It should be noted that had the policy been amended by endorsement to change its Date of Policy to a date subsequent to the making of the advances, paragraph 3(d) of the Exclusions From Coverage would have been inapplicable. The insurer would have been left to his argument that paragraph 3(a) applied, a paragraph that the Court of Appeals held to be inapplicable and that the Supreme Court sidestepped.

[Citations omitted.]

 

For a case where a title insurer insured that a lender had a first lien when in fact its lien was second but the title insurer had no liability due to Exclusion From Coverage 3(a), see Schuman v. Investors Title Ins. Co., 78 N.C. App. 783, 338 S.E. 2d 611 (1986). The reasoning seemed to be that the insured lender - individual had agreed to subordinate to the bank's construction loan and even if the actual subordination agreement was not provided, the insured wound up in the same position it had agreed to, thereby triggering Exclusion From Coverage 3(a).

 

A trustee need not join in the subordination agreement absent the unusual circumstance in which the terms of the deed of trust would either require such a joinder or vest sole power or non-exclusive power in the trustee to subordinate. That is because only the beneficiary's priority position is being subordinated and title, which is vested in the trustee, is not changed. Therefore, in such a case, only the beneficiary of t he deed of  trust must execute the subordination.

 

In North Carolina, an assignment of a deed of trust may be recorded but need not be. See G.S. 47-17.2. The security, in the form of a deed of  trust, will follow the assignment of the note without a recorded assignment of the deed of trust. Therefore, before the beneficiary executes the subordination, the attorney will have to verify that the executing party is still the holder of the note.

Obviously, the subordination should be recorded. The obvious reason is that purchasers for value, lenders and lien creditors entitled to protection under the recording act (see G.S. 47-18 and G.S. 47-20) must know what priority of lien will result from any give foreclosure.

12 U.S.C. 1823(e) is discussed in the Real Estate Book, 41-17 and in G. Nelson and D. Whitman, Real Estate Finance Law 11.7 (3rd Ed). It applies to assets acquired by the FDIC and RTC. The statute provides that no agreement which tends to diminish or defeat the interest of the Corporation in any asset acquired by it under 12 U.S.C. 1823 or 12 U.S.C. 1821, either as security for a loan or by purchase or as receiver of any insured depository institution shall be valid against the Corporation unless such agreement (1) is in writing, (2) was executed by the depository institution and any person claiming an adverse interest thereunder, including the obligor, contemporaneously with the acquisition of the asset by the depository institution, (3) was approved by the board of directors of the depository institution or its loan committee, which approval shall be reflected in the minutes of said board or committee, and (4) has been, continuously, from the time of its execution, an official record of the depository institution. The application of this broad statute to a subordination is not clear or discussed in any case found. However, a title insurer will insure priority based upon an otherwise valid subordination notwithstanding this statute largely on a risk basis. This statute will be discussed in more detail in a subsequent newsletter.

[Part II of this Article, dealing with subordination aspects of condominium and planned community assessment liens and subordination clauses in leases will appear in out next newsletter. Another newsletter will deal with mechanics' liens.]

HOUSE BILL 716

In our June, 2001 newsletter, we discussed this bill pertaining to changes in the law pertaining to a personal representative's power of sale. This bill has not yet passed to the extent it effects those changes.

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