It is becoming increasingly common in the current state of our economy for lenders to try to work out business loans where the borrower is in default or the loan has come to term and the borrower is unable to pay the loan off or refinance in conformity with current lending requirements. Frequently, in such instances, the lender wishes to either renew the note or modify it. The question then arises as to the continued enforceability of the Deed of Trust and if enforceable, the continued priority of the debt. In Re: Foreclosure of Hall, COA10-1002, filed on March 15, 2011provides some clarification of when a note renewal will cause a deed of trust to lose priority or, worse, become unenforceable.

This case came up to the Court of Appeals when the mortgagor appealed from a trial court's order authorizing the substituted trustee to proceed with the foreclosure of the property. The mortgagor's son had executed a $550,000 note to the lender due one year later (the 2007 Note) in his capacity as the president of a construction company ("OBC"), to secure a back-up letter of credit upon which OBC's bonding company could make draws for a construction project bond. The 2007 Note was labeled "Loan Number 65257145." The mortgagor subsequently executed a North Carolina Future Advance Deed of Trust (the "Deed of Trust") that contained the following provision:

This Deed of Trust is given to secure all present and future advances made or to be made pursuant to the terms of the obligation. . . . [T]he maximum amount of present and future obligations which may be secured at any one time is $350,000.00 . . . . The period within which any and all future advances are to be made and secured hereunder is the period between the date hereof and April 18th 2008.

The Deed of Trust identified the secured obligations as:

[A] Promissory Note, issued by [the Bank] dated February 15th, 2007 in the face amount of $150,000 and modified and reduced to $80,000 on July 26th, 2007 and an Irrevocable Letter of Credit issued by [the Bank] dated April 19th, 2007 in the aggregate face amount of up to $550,000, and a Backup Line of Credit Facility dated April 19th, 2007 in the face amount of up to $500,000 executed by [the] President [of OBC.]

The Deed of Trust made no reference to securing "renewals, modifications, or extensions of the obligations listed" and stated that the secured present obligations were zero. The mortgagor then executed a Hypothecation Agreement that authorized "Matthew Hall President Outer Banks Construction Co. Inc." to hypothecate or pledge as collateral certain property of the mortgagor to secure "any present or future indebtedness, obligation or liability howsoever evidenced . . . or any extension, modification or renewal thereof, the undersigned hereby consenting to the extension or renewal . . . and waiving any notice of any such extension, modification or renewal."

When the 2007 Note matured, the bonding company had not made any draws on the letter of credit and the mortgagor's son executed a new note (the "2008 Note") labeled "Renewal of 65257145." Shortly thereafter the bonding company began making draws on the letter of credit and OBC subsequently defaulted on the 2008 Note. The foreclosure proceeding was filed and the Clerk ordered a sale. The mortgagor appealed the order to the Superior Court and at the hearing, the trial court considered the documents in evidence and the testimony of the credit administrator for the lender who testified that the 2008 Note was merely an extension of the 2007 Note required due to construction delays and that it was intended that the Deed of Trust would continue to secure the renewal. The trial court entered an order affirming the Clerk's findings of fact and authorizing the Trustee to proceed with foreclosure sale.

The mortgagor appealed the trial court's finding that the Deed of Trust secured the 2008 Note pursuant to the Hypothecation Agreement. The mortgagor contended successfully at trial that "neither the terms of the Hypothecation Agreement nor the provisions of the Deed of Trust extend her property as collateral to secure the debt incurred under the 2008 Note."

The Court of Appeals cites Putnam v. Ferguson, 130 N.C. App. 95, (1998); In re Foreclosure of Enderle, 110 N.C. App. 773, (1993) and In re Head Grading Co., Inc.,353 B.R. 122, (Bankr. E.D.N.C. 2006) for the doctrine that a deed of trust must specifically identify the obligation it secures. Reviewing the terms of the Deed of Trust, the Court determined that it explicitly secured the 2007 Note. In the present case, the Deed of Trust very specifically describes the obligation secured as including:

[A] Promissory Note, issued by [the Bank] dated February 15th, 2007 in the face amount of $150,000 and modified and reduced to $80,000 on July 26th, 2007 and an Irrevocable Letter of Credit issued by [the Bank] dated April 19th, 2007 in the aggregate face amount of up to$550,000, and a Back up Line of Credit Facility dated April 19th, 2007 in the face amount of up to $500,000 executed by … President [of OBC.] . . . (Emphasis added.)

The North Carolina Supreme Court has consistently held that a deed of trust executed as security for a debt will secure all renewals of the debt unless a different intent appears in the documents. In this opinion, the Court of Appeals cites Wachovia Nat'l Bank v. Ireland, 122 N.C. 571, (1898) for this basic doctrine as applicable in North Carolina. There, the North Carolina Supreme Court said; "The deed contains a covenant that the charge shall be binding for all renewals of the debts specified. This would be so without any agreement, unless a different intent appeared." The Court of Appeals observes that though "more than a hundred years old, this holding has never been overturned and still serves as controlling precedent in North Carolina today. See In re Blevins, 255 B.R. 680, 684 (W.D.N.C. 2000) (affirming Bankruptcy Court's holding that, under North Carolina contract law, a promissory note executed as a renewal does not cancel the original promissory note or the deed of trust securing the debt incurred under the original promissory note). Our Supreme Court has further held, "Where a note is given merely in renewal of another note and not in payment thereof, the effect is to extend the time for the payment of the debt without extinguishing or changing the character of the obligation[.]" Dyer v. Bray, 208 N.C. 248, 248, 180 S.E. 83, 83 (1935). Accordingly, a promissory note executed as a renewal only operates as an extension of time for payment and will continue to be secured by a deed of trust that secures the original debt, unless a contrary intent appears."

Here, the mortgagee contended that the 2008 Note together with the 2007 Note was secured by the Deed of Trust. The 2008 Note specifically stated that it was a renewal of loan number "65257145" which was the loan number stated in the 2007 Note. They argued that these documents indicated that the 2008 Note was issued as a renewal of the 2007 Note and thus evidenced that they were not intended to extinguish the original obligation. They contended that as a result, the Deed of Trust that secured the 2007 Note also secured the new 2008 Note. The Court of Appeals apparently did not feel that the language in the second note was sufficient to overcome the language deficiencies of the Deed of Trust and held that the terms of the Deed of Trust clearly did not reflect the intent that the debts incurred under a subsequent note such as the 2008 Note were to be also secured under the Deed of Trust. The court focused on the language they italicized in the following clause set out in the Deed of Trust and narrowly construed it:

"This Deed of Trust is given to secure all present and future advances made or to be made pursuant to the terms of the obligation. The amount of the present obligation secured hereunder is $00.00 (zero) and the maximum amount of present and future obligations which may be secured at any one time is $350,000.00 (three hundred and fifty thousand dollars).

The period within which any and all future advances are to be made and secured hereunder is the period between the date hereof and April 18th, 2008. This Deed of Trust is made pursuant to Article 7 of Chapter 45 of the North Carolina General Statutes. (Emphasis added.)"

Article 7 of Chapter 45 of the North Carolina General Statutes requires that the Deed of Trust state the period within which future obligations may be incurred. "Therefore, in anticipation of any extensions or renewals, the Bank could have secured priority for future advances or future obligations for up to fifteen years pursuant to the terms of the statute in effect at that time. However, the Deed of Trust expressly limits the time period for which future advances 'are to be made and secured hereunder' to the period expiring on 18 April 2008. As such, the Deed of Trust evinces the intent to limit the extent to which the Deed of Trust secures future advances to only those made prior to 18 April 2008." The Court also disposed of the broader renewal language in the hypothecation agreement by noting that the original pledge itself limited the date for final payment in the Deed of Trust as 18 April 2008, the same maturity date reflected on the 2007 Note. The Court opined that construed as one, the instruments reveal that mortgagor gave OBC the authority to pledge her property as security for any renewals or extensions on the obligations, but limited time during which any advances would be secured by her property to the period ending on April 18, 2008.

The mortgagor successfully argued that McNeary's Arborists v. Carley Capital Group, 103 N.C. App. 650, 406 S.E.2d 644 (1991) militates that a time limitation stated in a future advance clause in a Deed of Trust is controlling. "Under the explicit terms of [the lender's] deed of trust, the period within which [the obligor's] future obligations could be incurred expired on 3 March 1988." Id. at 652, 406 S.E.2d at 645. In the instant opinion the Court of Appeals states: "Accordingly, we agree with respondent-appellant's contention that the express time limitation for future advances contained in the terms of the Deed of Trust controls and evinces the intent of the parties that the property of respondent-appellant pledged as collateral was meant to secure only those advances made prior to 18 April 2008."

It is critical to the decision in this case that there were no advances made under the 2007 Note and, "the 2008 Note, despite being labeled a "renewal" of the 2007 Note, was not an extension of time for payment, as no debt was owed under the original 2007 Note which the Deed of Trust secured. Had the amounts been advanced under the original 2007 Note and renewed under the 2008 Note, … then the advances would have been made prior to the 18 April 2008 expiration date and would have been secured by the Deed of Trust."

The final rule applied by the court was the "'well[-]settled' principle 'that a power of sale contained in a deed of trust must be exercised in strict conformity with the terms of the instrument.' Sutton Investments, 46 N.C. App. at 659, 266 S.E.2d at 688. If the language in a separate instrument is contradictory, 'language in a deed of trust expressly limiting the exercise will govern.' Id. at 659, 266 S.E.2d at 689." Since the Deed of Trust expressly limited the pledge of security for only advances made prior to the final date and all advances made to OBC were made under the 2008 Note after the stated final date, those sums were not secured. As a result, the Court of Appeals reversed the trial court's order of foreclosure.

The Court implicitly observed that as the Bank overlooked the term limit under the Deed of Trust securing its future advances and had the responsibility of ensuring that future advances were adequately secured, the Bank should have obtained a modification of the Deed of Trust extending the time period for which future advances would be secured under the Deed of Trust.