As the financial and housing markets headed toward freefall in September of 2008, an enterprising homeowner named Kyung Ha Chung applied for two loans, from two lenders, to be secured by two deeds of trust against her house.  The problem was, she didn’t tell the two lenders about each other, and signed the two deeds of trust on the same day, before two different notaries.

How The Problem Arose:  Document Batches Recorded Together

As is common practice, and to avoid lines at the Recorder’s Office, the two different title companies involved delivered the trust deeds to the Recorder’s Office in a pouch of documents before the 8:00 a.m. opening time.  As is also common practice, the batch of documents were examined to ensure that they met the requirements for recording, and then all recorded with an 8:00 a.m. time stamp.  Several days later, as time allowed, the documents were indexed so as to be searchable in the grantor-grantee index, one several hours before the other.  This resulted in a situation where both of the deeds of trust had a recording timestamp of 8:00 a.m., but one was indexed before the other.

Priority Rules In California:  “Race-Notice”

The bank holding the earlier-indexed deed of trust claimed that it had priority over the later indexed document, and asked that the court confirm that fact.  In order to resolve the question, the court considered the general rules regarding the priority of deeds of trust and other liens recorded in California.  In general, an earlier-recorded document has priority over a later-recorded document, assuming no prior knowledge of earlier-recorded liens.  This is referred to as the “race-notice” theory of recordation – it is a “race” to record first, subject to not having “notice” of an earlier-recorded interest.

Applying those principles to this case, the court determined that both documents were recorded at exactly the same time – 8:00 a.m.  The court also determined that the subsequent indexing of the documents was simply an administrative process of the recorder’s office beyond the control of the recording party, and did not reflect one document being recorded before another for purposes of priority.  Because neither document had been indexed at the time that they were recorded – 8:00 a.m. –there would have been no way for either of the lenders searching the record at that moment to determine that the other document had been recorded.  Because neither lender was aware, or could have been aware through a search of the public records, of the other deed of trust, and since both were recorded at the same time, neither one had priority over the other.  Like Solomon, the court “split the baby” by determining that the deeds of trust had equal priority.

Questions Raised, And Possible Solutions

This opinion raises interesting questions.  For example:

  • If the two deeds of trust have equal priority, do they both foreclose and share the proceeds?
  • If one forecloses, is it subject to the other, so that effectively neither can foreclose the other out?
  • Perhaps more importantly, how can a lender avoid this type of fraud in the first place?  While good practice dictates that controls be put in place to avoid and detect fraud (Standard Procedures and Controls for the Title Industry Prepared by the ALTA Internal Auditing Committee), what sort of controls would work in a case like this?

Some commentators have suggested that the risk of simultaneous priority cannot be eliminated, and title insurers simply need to live with that risk.  (“Living With Tied Priority” (First Bank v East W. Bank) by Roger Bernhardt, Professor of Real Estate Law at Golden Gate University.)  However, there may be ways to at least minimize the risk.  One way may be to delay funding for two or three days to allow for a further review or “date down” of the real property record, but this is cumbersome and would not work for time sensitive transactions.  Another is a common registration system for open and pending loan orders, which would make it more difficult to perpetrate this kind of fraud. If there are other approaches the industry is using, we would like to hear about them.