The North Carolina Court of Appeals in War Eagle, Inc., v. Belair, COA09-1516, June 15, 2010 ruled that a violation of a buffer setback is a breach of the covenant against encumbrances contained in a warranty deed and that the plaintiff's prior knowledge of the violation does not defeat a claim for recovery of damages. The trial court ruled that Plaintiff-grantee could not recover from Defendants-grantors because it had prior knowledge of the violation of a riparian buffer zone on the property.

The defendants sold a waterfront lot on the Catawba County side of Lake Norman to the plaintiffs on which they had built a foundation in beginning construction of an uncompleted home. The plaintiff executed an Offer to Purchase and Contract - Vacant Lot/Land for a purchase price of $282,500 having advised in writing of its concern with regard to the violation. At the closing, the defendants tendered a General Warranty Deed containing the following language: "The Grantor covenants with the Grantee, that Grantor is seized of the premises in fee simple, has the right to convey the same in fee simple, that title is marketable and free and clear of all encumbrances, and that Grantor will warrant and defend the title against the lawful claims of all persons whomsoever, other than the following exceptions: Ad Valorem Taxes; Any Restrictions, Easements and Rights of Way of record. The Deed was recorded in the Catawba County Registry on 26 June 2007."

The Court of Appeals observes that the North Carolina Division of Water Quality subsequently sent letters to the parties "noting a continuing violation of the riparian buffer; requesting additional information as to why the violation occurred; demanding that the removal of the foundation and existing walls and restoration of the buffer to its natural condition; and noting "additional impacts" that had been observed since the last inspection including removal of vegetation in Zone 1 of the buffer. The letter gave the parties until 29 August 2008 to correct the violation without incurring penalties."

After the deadline, the plaintiff demanded $15,510 "to cover the cost of demolishing the basement walls, haul away debris, fill and compact a hole, and the anticipated expense of planting five trees." Shortly thereafter the plaintiff brought the action. The trial court stated its conclusions of law as follows:

1. The encumbrance in question is a zoning ordinance imposed by the police power of the State of North Carolina and Catawba County, and the North Carolina Supreme Court has found that a []restriction on use which may be made of land, or on its transfer, which is imposed by statute or ordinance enacted pursuant to police power, is not an "encumbrance" within [the meaning of a] "covenant against encumbrances." Fritts v. Gerukos, 273 N.C. 116, 159 S.E.2d 536 (1968).

2. The failure of the defendants to either get the variance request granted or to demolish the foundation prior to closing did not preclude them from delivering marketable title to the plaintiff.

3. The undisputed email written by the plaintiff reveals that he had knowledge of a violation and the variance request prior to entering into an agreement to purchase the property.

4. The Court concludes after a review of the record that said buffer zone violation was an encumbrance as defined by the North Carolina Supreme Court that did not affect the defendant's ability to convey marketable title to the plaintiff. Furthermore, it was the type of encumbrance that the North Carolina Supreme Court has ruled bars plaintiff of recovery, if plaintiff had notice of the violation prior to the purchase of the property.

The trial court denied the plaintiff's Motion for Summary Judgment and granted the defendants' Summary Judgment motion.

After chastising the trial judge for making findings of fact in a Summary Judgment order that were not "uncontested facts", the Court of Appeals addressed the following issues of interest: "... whether the trial court erred in failing to recognize the existing buffer zone violation as an actionable encumbrance within the meaning of Defendant's covenant against encumbrances; and ... whether the trial court erred in concluding that Plaintiff's actual knowledge of the encumbrance defeats its claim of Defendants' breach of the covenant against encumbrances."

Defendants initially contend that this Court should dismiss Plaintiff's appeal as procedurally barred. Defendants cite Goodrow v. Martin, Inc., 6 N.C. App. 599, 170 S.E.2d 506 (1969), for the proposition that a plaintiff cannot proceed on a cause of action for breach of the covenant against encumbrances unless the complaint alleges such a breach. Here, Plaintiff did not specifically raise the issue in its complaint of the breach of the covenant against encumbrances. Defendants contend that Plaintiff should therefore be precluded from raising the issue of breach of that covenant on appeal.

The Court of Appeals notes that the trial court cited Fritts v. Gerukos, 273 N.C. 116, 159 S.E.2d 536 (1968) in its conclusions supporting summary judgment. The court observes that the North Carolina Supreme Court "explained that an ordinance such as the riparian buffer zone at issue here does not itself constitute an encumbrance within the meaning of a covenant against encumbrances:

A restriction upon the use which may be made of land, or upon its transfer, which is imposed by a statute or ordinance enacted pursuant to the police power, such as a zoning ordinance or an ordinance regulating the size of lots, fixing building lines or otherwise regulating the subdivision of an area into lots, is not an encumbrance upon the land within the meaning of a covenant against encumbrances or a contract or option to convey the land free from encumbrances, being distinguishable in this respect from restrictions imposed by a covenant in a deed. Id. at 119, 159 S.E.2d at 539."

The Court then cites the Court of Appeals decision Wilcox v. Pioneer Homes, Inc., 41 N.C. App. 140, 254 S.E.2d 214 (1979), as having drawn "a valuable distinction between an encumbrance action brought on the basis of the ordinance itself and an encumbrance action brought on the basis of an existing violation of the ordinance. Noting a split of authority among the jurisdictions that have considered the issue, this Court stated:

The majority of the jurisdictions have held that, although the existence of a public restriction on the use of real property is not an encumbrance rendering the title to the real property unmarketable, an existing violation of such an ordinance is an encumbrance within the meaning of a warranty against encumbrances. Id. at 143, 254 S.E.2d at 215.

The Wilcox Court held that the violation of the ordinance "constitute[d] an encumbrance within the meaning of the covenant against encumbrances contained in the plaintiffs' warranty deed." Id. at 143, 254 S.E.2d at 216."

"In the present case, the trial court ruled correctly, on the basis of Fritts, that the ordinance itself did not constitute an encumbrance. However, Plaintiff's encumbrance action was based on the existing violation of the ordinance, which under Wilcox did constitute an encumbrance. See id. Thus, the trial court's conclusion that the "buffer zone violation was an encumbrance . . . that did not affect the defendants' ability to convey marketable title to the plaintiff" is a non sequitur. Following Wilcox, we hold that the existing buffer zone violation constituted an actionable encumbrance within the meaning of Defendants' covenant against encumbrances."

There is a question in the correctness of the Court of Appeals citing itself for authority where the North Carolina Supreme Court has, arguably, held to the contrary. Marriott Financial Services, Inc. v. Capitol Funds, Inc., 23 N.C.App. 377, 209 S.E.2d 423 (N.C.App. 1974), the Supreme Court held with respect to the breach of a subdivision ordinance:

"Finally, the evidence discloses no breach in the covenants in Capitol's deed to Marriott. The existence of the City's subdivision control Ordinance was not an encumbrance on title, Fritts v. Gerukos, 273 N.C. 116, 159 S.E.2d 536 (1968), and failure to obtain City Council approval on a plat filed pursuant to the Ordinance did not prevent Capitol from conveying fee simple title to Marriott."

"As above noted, neither the existence of the City subdivision control Ordinance nor the failure to obtain City Council approval on a plat constituted a defect in or lien or encumbrance on the title, Fritts v. Gerukos, supra, and Marriott does not contend that any other defect, lien, or encumbrance exists. A 'marketable title' is one free from reasonable doubt in law or fact as to its validity, Pack v. Newman, 232 N.C. 397, 61 S.E.2d 90 (1950), and, again as above noted, Marriott's title was not rendered invalid by reason of the existence of the Ordinance or failure to obtain City Council approval of a plat." Marriott Financial Services, Inc. v. Capitol Funds, Inc., 23 N.C.App. 377, 209 S.E.2d 423 (N.C.App. 1974)

This position was further evidenced in Town of Nags Head v. Tillett, 314 N.C. 627, 336 S.E.2d 394 (N.C. 1985) where court refused to void deeds. "We held in Financial Services that where the statute expressly designates the offense and clearly states the punishment for its violation, "the legislative bodies dealt with the matter completely and did not intend to invalidate conveyances of real property because of failure to follow the provisions of this penal legislation." Id. at 135, 217 S.E.2d at 560."

The Supreme Court  in Town of Nags Head went on to say "Accordingly, we hold that although the town may deny a building permit to applicants whose property violates zoning ordinances, as authorized by section 3.08 of the Nags Head Code of Ordinances and by N.C.G.S. 160A-389, its enforcement of subdivision ordinances is restricted to the penal and injunctive relief of N.C.G.S. 160A-375 and section 17.10 of the code of ordinances. In addition, insofar as defendants Ryce are thwarted by the execution of such ordinances and statutes from the reasonable use of their property for residential purposes, they are entitled to rescission of the instruments of conveyance with Loy and restitution."

Thus, when the Court of Appeals, in conclusion, addressed what deemed to be the "dispositive issue of whether the trial court erred in concluding that Plaintiff's actual knowledge of the encumbrance defeats its claim of Defendants' breach of the covenant against encumbrances" and held "that the trial court erred by granting summary judgment in favor of Defendants", it might better have considered whether the remedy of rescission was available. Further the issue of the plaintiff's prior knowledge of the violation may have presented a defense to the remedy of rescission since it arguably was not an encumbrance.

If so, the court's reliance upon Investments, Inc. v. Enterprises, Ltd. 35 N.C. App. at 626, 242 S.E.2d, another Court of Appeals opinion, may have been misplaced. Where the court notes that in that case, "we held that "[e]ven the grantee's actual knowledge and record notice of the existence of an encumbrance do not constitute a defense to a grantee's action to recover damages for grantor's breach of the covenant against encumbrances." Investments, Inc., at 179. We there explained our reasoning thus:

Acceptance of this argument would render completely meaningless all of the covenants in defendants' deed. If defendants did not mean to be bound by their covenants, they should not have included them in their deed. Execution and delivery of the deed containing full covenants established the extent of their obligations thereunder. Id. at 627, 242 S.E.2d at 179. (citing Gerdes v. Shew, 4 N.C. App. 144, 150-51, 166 S.E.2d 519, 524 (1969))."

Where the trial court ruled that the buffer zone violation was "the type of encumbrance that the North Carolina Supreme Court has ruled bars plaintiff of recovery, if plaintiff had notice of the violation prior to the purchase of the property" it would seem that the trial court may have made the better ruling.

The result for real property practitioners is that we now have one set of North Carolina Supreme Court opinions that would prevent a recovery and another set of Court of Appeals opinions that would provide one. It should be noted that these matters are rarely documented in the land records and title examiners do not routinely examine zoning and subdivision issues unless they are of record in the Register of deeds or Clerk of Superior Court's offices. In as much as title insurance policies exclude losses from governmental regulation unless disclosed in the public land records, the Court of Appeals has set in motion the elements of a "Perfect Storm" of litigation on this issue and title examiners will need to be scrupulous in reporting any question concerning the same that come to their knowledge.