The case of Smith v. Martin, ____ N.C. App. ___, ___ S.E. 2d ___ (Court of Appeals No. COA-95-551 Dec. 1996), should be noted by all attorneys and paralegals.

Smith sold property to Latta. A deed of trust securing an institutional lender in the amount of $50,000.00 was recorded first and a purchase money deed of trust for $35,000.00 securing the Smiths was recorded second. Attorney Martin (subsequently a defendant) closed the transaction and was trustee on both deeds of trust. Later, Smith obtained a new deed of trust in the amount of $55,000.00 to secure an additional $20,000.00 loan to Latta and the original $35,000.00 loan. The $55,000.00 deed of trust, prepared and recorded by the defendant attorney, was intended to replace Smith’s $35,000.00 deed of trust which was marked "paid in full" but the $35,000.00 deed of trust was not cancelled by the defendant attorney. Subsequently, the defendant attorney got an affidavit of payment of the $35,000.00 from Smith and cancelled the $35,000.00 deed of trust.

In June, 1990, UCB committed to loan Latta $245,433.00 if UCB could be secured by a first lien. Third party defendant, Attorney Hassell, was hired to close the loan. He hired Attorney Baker to do the title work. Baker hired Ragan, an independent paralegal, to do the title search. Ragan found the $55,000.00 deed of trust. Ragan testified that Ms. Latta told Ragan the lien should be cancelled since the debt had been paid off. Ms. Latta denied this and said that she told Ragan the $35,000.00 deed of trust should have been cancelled at the time the $55,000.00 deed of trust was recorded. Ragan told Hassell Ragan’s recollection of the conversation and then Ragan told Martin that Ragan thought the $55,000.00 deed of trust should be cancelled. Martin consulted with Hassell, who concurred. On June 7, 1990, defendant Martin, as trustee, cancelled the $55,000.00 deed of trust without consulting Smith. Martin confirmed this in a letter to Hassell but did not inform Smith. UCB’s $245,433.00 loan was closed and its deed of trust recorded. This resulted in the payment and cancellation of the original $50,000.00 first lien deed of trust.

Smith sued defendant Martin for breach of trustee’s duty, breach of fiduciary duty, negligence and professional malpractice. In turn, Martin sued Hassell for indemnification. The Court of Appeals held that Martin breached his duty as a trustee under Smith’s deed of trust because Martin cancelled the deed of trust without contacting Smith or otherwise verifying that the $55,000.00 indebtedness had been paid, or without having express authority in the deed of trust to make the questioned cancellation, citing Annot., 57 A.L.R. 477 (1928), 55 Am. Jur. 2d Mortgages Sec. 467 (1971) and Davenport v. Vaughn, 193 N.C. 646, 137 S.E. 174 (1927) as authority for saying that Martin could not rely on the "bare representation" of a third party.

Martin contended that he was not the proximate cause of Smith’s loss because Smith signed a "Deed of Subordination." After noting that this document might not have even applied to the UCB loan in question (among other reasons, the subordination was not recorded), the court held that the deed of subordination was unenforceable as a matter of law, citing MCB Limited v. McGowan, 86 N.C. App. 607, 359 S.E. 2d 50 (1987), discussed in our article on subordination agreements in our October, 1996 newsletter. "A subordination clause must state the matters which most directly affect the security of the seller’s purchase money mortgage - the maximum amount of the proposed loan and the maximum rate of interest permitted on the future obligation." MCB Limited v. McGowan, supra.

As a result, the court ruled as follows: "We agree with this reasoning. Therefore, we hold that subordination agreements and clauses which subordinate loan obligations secured by a deed trust to future loans must, at a minimum, include terms which state the maximum amount of the future loan and the maximum rate of interest permitted on the loan. This requirement serves to protect the security interest of the holder of the prior deed of trust." The court noted that, obviously, since the subordination was silent as to these terms, there resulted much confusion as to which UCB loan the Smiths were subordinating to.

Last, there was the issue of mitigation of damages, which involved whether Smith did too much to protect his rights or not enough.

While a full discussion of the mitigation issue is beyond the scope of this article, it is worth noting that the issue was resolved against defendant Martin because Smith’s attorney "from the beginning" advised the defendant and his insurance carrier of the steps to be taken and requested that the defendant and his carrier fund the mitigation activities, take over the activities, or release Smith from the duty to mitigate.

In conclusion, the case reaffirms case law, including that impacting upon subordination agreements. Also, it is interesting to ponder whether the reasoning of the cases, which apply to deeds of trust and mortgages, will be extended to automatic subordination agreement clauses in condominium or planned unit development declarations wherein assessment liens are subordinated to certain types of mortgages and deeds of trust.

For additional reading, see E. Urban and G. Whitney, North Carolina Real Estate, Sec. 21-80 (1996 Harrison Co.).

In Cen-Pen Corp. v. Hanson, 58F. 3rd 89 (4th Cir. 1995), a Chapter 13 plan treated Cen-Pen as an unsecured creditor (entitling it to approximately 25% of its claim). The plan required each creditor to submit a proof of claim and an objection to the plan within specified time periods and the plan specified that the plan would be automatically confirmed if no such objections were received. Further, the plan stated that, to the extent that the holder of a secured claim does not file a proof of claim, the lien of the creditor shall be avoided upon entry of the order of discharge. Cen-Pen apparently did not file an objection to the plan. The plan was confirmed and all creditors submitting allowable claims were paid pursuant to the plan. Cen-Pen secured a copy of the plan which treated it as an unsecured creditor.

11 U.S.C. Section 1327 states that:

"(a) The provisions of a confirmed plan bind the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan;.

(b) Except as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor.

(c) Except as otherwise provided in the plan or in the order confirming the plan, the property vesting in the debtor under subsection (b) of this section is free and clear of any claim or interest of any creditor provided for by the plan."

The debtor contended that 11 U.S.C. Section 1327, particularly 11 U.S.C. Section 1327(c), eliminated Cen-Pen’s lien. The court disagreed, citing Dewsnup v. Timm, 502 U.S. 410 (1992) for the general rule that liens pass through bankruptcy unaffected. A discharge extinguishes only in personam claims against the debtor but generally has no effect on an in rem claim against the property of the debtor. Johnson v. Home State Bank, 501 U.S. 78 (1991) was cited by the court. The debtor must take an affirmative action to avoid a lien. No adversary proceeding under Rule 7001(2) and Rule 7004 was conducted, which the court ruled was required. Adequate notice is a prerequisite to according preclusive effect to a confirmation order under 11 U.S.C. Section 1327. In Re Linkous, 990 F. 2d 160 (4th Cir. 1993). The court cited 11 U.S.C. Section 506(d)(2) as further support of its statement that failure to file a proof of claim is not the basis of avoiding a lien and cited 11 U.S.C. Section 501 as providing for, but not requiring, filing of a proof of claim.

Listing Cen-Pen as an unsecured creditor did not suffice to avoid the lien, the court stated. The debtor argued that the plan provisions regarding the effect of failure to file a proof of claim, together with listing Cen-Pen as an unsecured creditor, "provided for" Cen-Pen’s claim sufficient to satisfy the requirements of 11 U.S.C. Section 1327(c) and vest title in the debtor free and clear of Cen-Pen’s lien. Generally, a plan "provides for" a claim or interest when it acknowledges the claim or interest and makes explicit provisions for its treatment. The court noted holdings that a plan "provides for" a lien by, for example, expressly providing for payment of an allowed secured claim and cancellation of the lien. "Several courts have held that a plan ‘provides for’ the lien held by a secured creditor only when it provides for payment to the creditor in an amount equal to its security. In Re Bradshaw, 65 B.R. 556 (Bankr. M.D.N.C. 1986)..." The debtor’s plan nowhere mentioned or otherwise acknowledged Cen-Pen’s lien and "certainly did not ‘provide for’ treatment of the liens or full payment of the underlying claim." The court stated that, since as an unsecured creditor, Cen-Pen would receive only 25% of its claim, the plan did not "provide for" Cen-Pen’s claim and its lien survived the Chapter 13 confirmation.

There was a vigorous dissent on the basis that 11 U.S.C. Section 1327 should clearly have led to an opposite result. And, one would think that, with all of the cases generated under 11 U.S.C. Section 1327, the Bankruptcy Reform Act of 1994 would have amended that section, but it did not.

In Paving Equipment of the Carolinas v. Waters, 122 N.C. App. 502 (1996), the court held that attorney’s fees and costs could not be included in a mechanics’ lien enforcement judgment under G.S. 44A-13(b).

In Marble Bank v. Commonwealth Land Title Ins. Co., 914 F. Supp. 1252 (E.D.N.C. 1996), the court held against the insured because the real property value was less than the amounts of the first and second deeds of trust which were ahead of the insured’s third lien $2,000,000.00 deed of trust, insured as a third lien. The claim was for $3,500,000.00 in liens having priority over the insured third lien. Since there was no equity over the amount of the first and second liens, there could be no loss as a result of the mechanics’ liens.

"Insured closing protection" or "insured closing service" letters are now clearly permitted by North Carolina’s insurance laws. See G.S. 58-26-1(d). Routinely, the title insurer will issue such a letter to a proposed insured lender (or other proposed insured) covering the protected party for certain specified acts or omissions of the approved attorney or group of approved attorneys named or referred to in the letter, subject to the provisions of the letter. The two major problems protected against are failure of the attorney to follow closing instructions and attorney defalcation. This is issued at no extra charge. In North Carolina, this letter is actually additional protection for the named protected party or parties, since, in North Carolina, the approved attorney might be the attorney agent of the insured, but is probably not the agent of the insurer. See G.S. 58-26-1.

It is important for all parties to see to it that clear, written, closing instructions are given to the approved attorney if the approved attorney is playing any role in the closing.

The ALTA form letter is frequently used. This letter can be amended to waive requirement for a binder or commitment. A master letter covering all of the title insurer’s approved attorneys can be issued to the lender. Subsequently, the lender can request a short confirmation letter from the title insurer confirming that an attorney or a law firm is covered by the previously issued master letter by virtue of being an approved attorney or an approved firm.

It is important to follow closing instructions since an "ICS" letter can create liability where policy liability might not exist.