The North Carolina Supreme Court in a per curiam decision filed on March 7, 2008 reversed and remanded Winding Ridge Homeowners Association, Inc., v. Zalman Joffe  184 N.C. App. ___, 646 S.E.2d 801 (2007), back to the North Carolina Court of Appeals. A divided panel of the Court of Appeals opined that a restrictive covenant that restricted the “use” of property to a single family residential dwelling prohibited a lease of the property to four unrelated college students. The Supreme Court stated that it “reversed for the reason stated in the dissenting opinion that the restrictive covenant is only a limitation on the type of structure that may be placed on the property and not a restriction on the type of occupancy permitted within the dwelling.”

The underlying action was commenced in 2006 when the plaintiffs filed a complaint against the defendant owners of Lot 1 in the Winding Ridge Subdivision. The action also included as defendants the five university students residing at defendants' property as tenants or subtenants at the time of the action. The plaintiffs alleged that the defendants' leasing of their residence to the tenants violated the subdivision's restrictive covenants by being in violation of Article VIII, Section 3(b) of the restrictive covenants, which provides that the lots in the subdivision “shall be used for single family residential structures.” The facts were not in dispute and the sole issue was the interpretation of the covenant and its application to the facts.

In Article VIII, titled “Use Restrictions”, the restrictive covenant at issue provides:
        Section 3. Use of Property.
        (a) Only one single family dwelling or replacement thereof shall be placed upon each lot as designated on the said plat and no such lot shall be further subdivided by future owners for the purpose of accommodating additional buildings . . . .

        (b) This property shall be used for single family residential structures and no duplex houses, apartments, trailers, tents or commercial or industrial buildings shall be erected or permitted to remain on the property provided, however, that this restriction shall not preclude the inclusion of one small light housekeeping apartment within the residential structure for occupancy by not more than two persons.

        (c) No single family dwelling shall be built, erected, altered or used unless the main body of the structure, exclusive of garages, porches, breezeways, stoops and terraces, shall contain at least 1650 square feet of finished and heated floor space in the main body of the house if the structure is a one-story building or at least 2,000 square feet for all other structures. . . .
(Emphases added).

The residence on the lot was constructed and Permitted as a single family residence and the owners subsequently leased the residence to four university students who were unrelated to one another. One of the students furnished an affidavit stating that they had been “living together in the residence as a single housekeeping unit and as a single place for culinary purposes.” That their “house [was] operated in a home-like manner. The roommates share[d] in common household chores, car pool[ed] to campus when possible, cook[ed] meals and [ate] together, car pool[ed] to eat out together, and gather[ed] for relaxation and to watch television, talk and entertain together.”

The plaintiffs sought Partial Summary Judgment and Permanent Injunction against defendants' continued violation of the subdivision's restrictive covenants. The defendant owners filed a Motion for Partial Summary Judgment arguing that the restrictive covenant merely limits the use of the lots to “single family residential structures” and does not restrict the lots to single family occupancy. The trial court entered an order granting plaintiffs' motion for partial summary judgment and permanent injunction holding that:

        5.    Article VIII of the Covenants, reasonably construed, unambiguously restricts the use of Lot 1 to single family residential use.

        6.    Based upon a reasonable construction of Article VIII in context with the rest of the Covenants, use of Lot 1 is restricted to single family residential.

        7.    The plain and obvious purpose of Article VIII is to restrict Lot 1 to single family residential use. The multiple references to “single family dwelling or replacement,” “single family residential structures” and “single family dwelling” in combination with the captions “Use Restrictions” and “Use of Property” restricts the utilization of Lot 1 to single family occupancy. This finding is also supported by the prohibition of duplex houses and apartments and the negative inference derived from the narrow exception for a “light housekeeping apartment within the residential structure for occupancy by not more than two persons.”

        8.    Giving each part of the Covenants effect according to the natural meanings of the words, including all reasonable inferences therefrom applied in such a way as to avoid defeating the plain and obvious purposes of the restriction, the Covenants were intended to restrict Lot 1 to single family residential use.

        9.    The [defendant owners] had actual and constructive notice of this use restriction when they purchased                     Lot 1.

        10.    The five student occupants are not related by blood, marriage or lawful adoption.

        11.    The five student occupants are not substantively structured as an integrated family unit.

        12.    The five student occupants are housemates who, in the course of attending college, share the cost of having a place to live as well as, on occasion, meals and fellowship. However, they are not substantively structured like a family or an integrated family unit.

        13.    The occupancy of Lot 1 by these students is a use of Lot 1 other than for single family residential purposes.

        14.    The [defendant owners], by permitting these students to occupy Lot 1, have violated the Covenants.

The defendant owners were “enjoined and restrained from using or making Lot 1 available for occupancy to any group of two or more persons not related by blood, marriage, lawful adoption, or who are not substantively structured like an integrated family unit.”

On appeal, the defendants argued that the trial court erred in concluding that the restrictive covenant prescribing that lots “shall be used for single family residential structures” is an occupancy restriction rather than a structural restriction; and that if the restrictive covenant at issue were held to be an occupancy restriction then the trial court erred in concluding that the students who occupied the premises were not substantively structured like an integrated family unit, violating the covenant.

The majority opinion succinctly sets out the traditional rules of construction for covenants of strict construction against ambiguous limitations and discerning the intention of the original parties “gathered from study and consideration of all the covenants” with the terms of the disputed  covenant “given effect according to the natural meaning of the words”.

Defendants argued that the North Carolina Supreme Court's holding in Hobby & Son v. Family Homes, 302 N.C. 64, 274 S.E.2d 174, controls the dispute. In Hobby, the subdivision residents sought to enforce the subdivision's restrictive covenants against the operator of a family care home housing mentally retarded adults in a home in the subdivision. The Hobby restrictive covenant provided that no lot “shall be used except for residential purposes, … No building shall be erected, altered, placed, or permitted to remain on any building unit other than one detached single-family dwelling …”.

The Hobby Court held that the defendants' use of the property was for residential purposes. The Court then opined that the covenant limitation as to “one detached single-family dwelling” did not also limit the use of the building to a single-family. The Supreme Court went on to add:  “While a restrictive covenant may be so clearly and unambiguously drafted that it regulates the utilization of property through a structural limitation, such was not done in the present case.
Id. at 75, 274 S.E.2d at 181-82 (citation omitted).”

 The Court of Appeals majority opined that the wording of the restrictive covenant at issue was not analogous to that in Hobby, and they instead found it more akin to the language cited in Higgins v. Builders & Finance, Inc., 20 N.C. App. 1, 10, 200 S.E.2d 397 (1973), cert. denied, 284 N.C. 616, 201 S.E.2d 689 (1974). In Higgins, another panel of the Court of Appeals held that a restrictive covenant that provided  “‘[n]o structure shall be erected, altered, placed or permitted to remain on any lot other than for use as a single family residential dwelling,’ was both a structural and usage restriction. Id. at 10, 200 S.E.2d at 404 (emphasis added).”

The court observed that the Hobby covenant did not contain a provision that the property be “used” for a “single-family dwelling,” as in Higgins and as the court suggests is the case in the covenant at issue here. The court also found it significant that “the portion of the covenant in Hobby that limited the use to ‘residential purposes’ was in a completely separate and distinct sentence from the restriction regarding a ‘single family dwelling.’ Whereas in Higgins, the restrictive covenant at issue placed the term ‘use’ within the same sentence as the requirement that there could only be a ‘single family residential dwelling.’ As we held in Higgins, a restrictive covenant, when drafted in this manner, constitutes both a structural and a usage restriction.” (citation omitted)

The Court of Appeals also determined that the trial court was correct in holding that the college students leasing the property were “not substantively structured as an integrated family unit” thus violating the restrictive covenant. The declaration at issue did not define the term “single family” anywhere. The majority observes that the Court of Appeals has held that “‘[i]n interpreting ambiguous terms in restrictive covenants, the intentions of the parties at the time the covenants were executed 'ordinarily control,' and evidence of the situation of the parties and the circumstances surrounding the transaction is admissible to determine intent.’  Angel v. Truitt, 108 N.C. App. 679, 681, 424 S.E.2d 660, 662 (1993) (quoting Stegall v. Housing Auth., 278 N.C. 95, 100, 178 S.E.2d 824, 828 (1971)). In the absence of any evidence of intent regarding the meaning of ‘single family,’ courts must interpret the term consistent with its ‘natural meaning.’ Hobby, 302 N.C. at 71, 274 S.E.2d at 179. As noted supra, our courts previously have suggested that the term ‘family’ should be construed to exclude ‘independent persons who share only the place where they sleep and take their meals’ and are not an ‘integrated unit.’ Id. at 73, 274 S.E.2d at 180; see also Smith v. Assoc. for Retarded Citizens, 75 N.C. App. 435, 440, 331 S.E.2d 324, 327 (1985).” The court then determined the evidence contained in the record, did not support the argument that the students were “substantively structured like an integrated family unit”.

Judge Geer, in the dissenting opinion, essentially agreed with the majority opinion's analysis of the proper meaning of the phrase "single family dwelling," but argued that the restrictive covenant, as drafted, is only a limitation on the type of structure that may be placed on the property and not a restriction on the type of occupancy permitted within the dwelling. She argues persuasively that Hobby and the well-established rules of construction applicable to restrictive covenants control and they require an opposite conclusion.

The dissenting opinion quotes the Hobby opinion in a succinct summation of covenant doctrine that states: “We begin our analysis of this case with a fundamental premise of the law of real property. While the intentions of the parties to restrictive covenants ordinarily control the construction of the covenants, such covenants are not favored by the law, and they will be strictly construed to the end that all ambiguities will be resolved in favor of the unrestrained use of land. The rule of strict construction is grounded in sound considerations of public policy: It is in the best interests of society that the free and unrestricted use and enjoyment of land be encouraged to its fullest extent. Even so, we pause to recognize that clearly and narrowly drawn restrictive covenants may be employed in such a way that the legitimate objectives of a development scheme may be achieved. Id. at 70-71, 274 S.E.2d at 179 (emphases added) (internal citations omitted).”

The Hobby Court construed a restrictive covenant that “included two pertinent components: (1) ‘No lot shall be used except for residential purposes,’ and (2) ‘No building shall be erected . . . other than one detached single-family dwelling . . . .’” While the first part restricted the property to residential uses, the Supreme Court rejected the contention that the second part was a restriction on the use that could be made of the residential structure.

Applying the Supreme Court’s guidance to the covenant at hand, Judge Geer asserts that there is “no meaningful distinction between this restrictive covenant and the one in Hobby. Indeed, subsection (c) is essentially identical to the provision in Hobby.”

“Each of these provisions describes only ‘the character of the structure which may be located upon a lot.’ Hobby, 302 N.C. at 75, 274 S.E.2d at 181. The subsections regulate only the type and size of the building and the number of buildings. Nowhere in these subsections is there any language specifically restricting the type of occupancy or use that may be made of the dwelling. Each of the subsections focuses exclusively on construction and other structural concepts. In short, we have only ‘a provision in a restrictive covenant as to the character of the structure,’ which Hobby holds "does not by itself constitute a restriction of the premises to a particular use.’”

The dissenting opinion then distinguishes Hobby and Higgins pointing out that the majority read a use restriction expressly set out in the Higgins covenant too broadly in the instant case. The majority, however, focuses on subsection (b)'s provision that "[t]his property shall be used for single family residential structures," suggesting that it parallels the provision upheld in Higgins v. Builders & Fin., Inc., 20 N.C. App. 1, 200 S.E.2d 397 (1973), cert. denied, 284 N.C. 616, 201 S.E.2d 689 (1974), a case decided before, however, the restrictive covenant stated: "No structure shall be erected . . . other than for use as a single family residential dwelling . . . ." Id. at 2, 200 S.E.2d at 399 (emphasis added). The two provisions are dispositively different. The covenant in this case restricts the use of the property to certain types of "structures," as did the one in Hobby, while restricted the use of the structure to a single family dwelling. The headings used in the restrictive covenant in this case do not bring this provision within Higgins because they refer only to the use of the "property," a concept equally consistent with both structural and occupancy restrictions.

Finally the dissent notes that the majority’s interpretation would create an inherent conflict in the several provisions because, “subsection (b) permits a two-person housekeeping unit with no restriction on who can live in that unit.” Judge Geer concludes by noting that “the law is clear, but the restrictive covenant is not. This Court may not restrict the use of the property when the restrictive covenant has failed to do so in a clear manner.” The North Carolina Supreme Court agreed and adopted the reasoning of the dissenting opinion in reversing the Court of Appeals decision.

What lesson does this case provide for real property practitioners? Certainly, it can be said that it demonstrates that able and knowledgeable jurists can disagree about the meaning of covenant language that has suddenly become ambiguous. Care should be taken in the drafting of covenant declarations to discern and eliminate ambiguity where possible. When adopting others’ work, read critically and questioningly. The fact that a phrase that has been used a thousand times before without being questioned or tested, does not offer any assurance that your use of that phrase will not be so tested. When asked to interpret covenants, ambiguity should be assumed.  Otherwise the interpretation would likely not be required. So, venture carefully and opine cautiously.

            Upon the advice of his golfing buddy and estate-planning attorney, Tom transferred title to all his real estate into a living trust.  A couple of years after transferring the property and setting up the trust Tom was sued by his neighbor, a new purchaser, who claimed Tom’s house violated the subdivision’s restrictive covenants.  Tom called his golfing buddy attorney and told him about being sued and was advised that if he had title insurance to file a claim with the title company and let them handle it.  Tom did just that.  A couple of weeks later he received a letter in the mail from the title company denying his claim as the defendant in the lawsuit, “Tom’s XYZ Living Trust” was not who was insured in the title policy; Tom was the insured in that policy.

            Tom engaged the services of a trial attorney to assist him with the suit.  When he told the attorney about the title company denying his claim, the attorney told him not to worry and that they would have the trust sue Tom on the warranties in his deed and force the title company to defend that way.  But when a copy of that deed was obtained from the Register of Deeds they discovered the estate-planning attorney had used a Quitclaim Deed that did not have warranties.  Tom was left without coverage under the title policy he had purchased.

            Is there anything Tom and his estate-planning attorney could have done to have prevented this from happening?  The answer will depend upon what version of the ALTA Owner’s Title Insurance Policy is being used.  For 1992 ALTA title policies where property is transferred into a living trust or any kind of trust be sure to use a Special Warranty Deed at the very least.  There really is not a reason not to use a General Warranty Deed, as the trust is the alter ego of the individual.  By using a deed with warranties the trust will be able to sue on those warranties if necessary.  Under Item 1 of Schedule A, the title policy lists a named insured.  When a claim is submitted the named insured on the policy must be the same as the party making the claim to the title company.  If the property has been transferred title coverage may still be invoked so long as an owner remains liable on the warranties of any deed he or she has given.

            Fortunately, the 2006 ALTA title policy has provided a remedy for Tom’s situation.  Under “Conditions” on the policy cover, “Section 1. Definition of Terms”, the 2006 policy provides:

    The following terms when used in this policy mean:

(d)  “Insured":  The Insured named in Schedule A.      

(i)  The term "Insured" also includes  

(D) a grantee of an Insured under a deed delivered without payment of actual valuable consideration conveying the Title

(4) if the grantee is a trustee or beneficiary of a trust created by a written instrument established by the Insured named in Schedule A for estate planning purposes.

Although title companies have transitioned to the new 2006 policy form there are a lot of the 1992 policies in existence.  When a client comes to you and requests you to draft a deed conveying insured property to a trust be sure to check whether your client’s policy is a 1992 or earlier title policy, and if it is, use a Special Warranty Deed for the transfer of title.