In our January, 1997 edition, we discussed the Court of Appeals decision in Smith v. Martin. That opinion referred to a related United States Court of Appeals case, Smith v. The United Carolina Bank, (CA-93-300, BK-91-14367-C-130 1995), an unpublished opinion which is not binding in the fourth circuit.

The following principles set out in the federal court case are quoted below for your information:

"A 1956 decision of the North Carolina Supreme Court, Monteith v. Welch, 244 N.C. 415, 94 S.E. 2d 345, indicates that the Bank, whose position is analogous to that of a subsequent innocent purchaser, is entitled to priority in this case. In Monteith, Mr. and Mrs. Monteith were the beneficiaries of a properly recorded deed of trust. Thomas Franks was named trustee. Id. at 416, 94 S.E. 2d at 346. After several years, the underlying property was sold to Mr. and Mrs. Welch. Id. At the time of the sale, the Monteiths’ deed of trust had not been cancelled. The Welches were aware of the outstanding lien; ;at closing, they gave Franks money with the understanding that he would pay the Monteiths and cancel their deed of trust. Id. at 419-20, 94 S.E. 2d at 349-50. Franks failed to carry out this plan. He cancelled the Monteiths’ deed of trust, but apparently pocketed the money. The Monteiths then sued to re-establish their security interest."

"The North Carolina Supreme Court affirmed a jury verdict in favor of the Monteiths. The court rejected the Welches’ argument that they were entitled to rely on Frank’s cancellation of the lien. Id. at 420-21, 94 S.E. 2d at 349-50. Crucial to the court’s decision was the fact that the cancellation had not yet occurred at the time the Welches bought the property. Indeed, Franks did not cancel the deed of trust until eight days after the property was conveyed to the Welches. Id. at 419, 94 S.E. 2d at 349. The court reasoned that the Welches thus had notice of the Monteiths’ senior lien and did not qualify as subsequent innocent purchasers. Id. at 420-21, 94 S.E. 2d at 349-50."

"In the course of its discussion, the court noted that the Welches could have relied on Frank’s cancellation if the cancellation occurred ‘before they purchased [the property] and [if] in fact [they] purchased [the property] relying on [the cancellation’s] validity. The burden of establishing that they purchased without notice of the unauthorized cancellation was on [the Welches].’ Id. at 420, 94 S.E. 2d at 349. 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."

"Other North Carolina authority is arguably inconsistent with this rule. See Union Cent. Life Ins. Co. v. Cates, 193 N.C. 456, 137 S.E. 324 (1927) (party aggrieved by unauthorized cancellation is entitled to priority unless it was negligent); First Fin. Sav. Bank v. Sledge, 415 S.E. 2d 206 (N.C. App. 1992) (same); see also Annotation, 35 A.L.R. 2d 948 (1954). Despite these authorities, we believe Monteith, as the state supreme court’s most recent pronouncement on the issue presented here, is controlling."

This would seem to be the law today, including when cancellation of a deed of trust is accomplished under the method in G.S. 45-37(a)(6) utilizing a certificate of satisfaction and, on occassion, an affidavit of lost note. Please see our prior newsletters and seminar materials for a discussion of G.S. 45-37(a)(6).