The current good economy (going on almost 10 years now) has meant that North Carolina appellate decisions affecting lenders trying to collect defaulted debt have been few and far between in the last couple of years. The North Carolina Court of Appeals changed that with its March 26 decision in Gray v. Fannie Mae, an opinion that lenders will cheer for making clear that collateral estoppel applies to non-judicial foreclosure orders.
In 2006, Mary and Jack Gray got a $300,000 reverse mortgage with Wells Fargo. The collateral description covered the Grays’ primary residence, as well as another home occupied by the Grays’ relatives. After the deed of trust was recorded, the property was subdivided with a house sitting on each parcel. When the Grays died, both parcels passed to their children (plaintiffs in this action). Wells Fargo foreclosed on the property through a non-judicial foreclosure, was the winning bidder at sale, and had the property deeded to Fannie Mae.
One year after the trustee’s deed was recorded, plaintiffs sued the trustee and Fannie Mae and argued that the description of the collateral property was wrong and should only have included the Grays’ primary residence, not the home of the relatives. They asserted claims for declaratory judgment, mutual mistake, unjust enrichment, violation of the North Carolina Reverse Mortgage Act, breach of fiduciary duty, and unfair and deceptive trade practices. The trustee moved for summary judgment on the ground of collateral estoppel, which the trial court denied. The trustee then appealed and the Court of Appeals reversed, granting judgment for the trustee on all claims on the basis of collateral estoppel.
Collateral estoppel is a fancy term that can be summarized as “you don’t get two bites at the apple.” If you are party to a legal action in which an issue was already decided in a final judgment, you don’t get to challenge that same issue in a subsequent action.
So why is this important to foreclosures? Well, in a non-judicial foreclosure, the clerk of court has to find (among other things) that there is a valid debt and the debt is in default. Having a court order that the debt is “valid” and “in default” can be very helpful for a lender, particularly one who pursues a deficiency balance against borrowers or guarantors after the foreclosure is completed. It means that there are fewer defenses or affirmative claims that an obligor can raise in defending against liability on the debt.
So why is the Gray opinion relevant? As some may recall, the N.C. Supreme Court issued a decision in 2016 (In re Lucks) in which the justices held that “traditional doctrines of res judicata and collateral estoppel applicable to judicial actions do not apply” to non-judicial foreclosures. As I wrote at the time, it was unclear what effect this would have on an entered foreclosure order. The concern was that post-Lucks a foreclosure order would not stop a borrower or guarantor from raising any challenge they wanted, including a challenge to the validity of the debt or default (even if the clerk had already ruled against them on those issues).
However, lenders can breathe a big sigh of relief. The Court of Appeals in Gray read Lucks very, very narrowly and held that it only applies to situations in which the clerk of court does not enter an order authorizing the foreclosure sale to proceed (i.e., if lenders lose on foreclosure before the clerk, they are not barred from trying to foreclose again based on a new default on the debt or through a judicial foreclosure). The court specifically held that collateral estoppel does apply to an order of the clerk of court authorizing the foreclosure to proceed.
Lenders, if you are concerned about challenges to the validity of the debt or whether a default exists, you can now rest easier on that issue if you have first obtained a foreclosure order from the clerk of court. And the Gray opinion is a good reminder that broad statements in prior court opinions can often be overcome by arguing to limit that holding to the facts of the case. Showing that a little bit of Lucks is a good thing when looked at through shades of Gray [insert appropriate groans here].