By Thomas G. Wolfe
A recent opinion by the North Carolina Court of Appeals shakes things up a bit for banks or lenders that initiate foreclosure proceedings on real property in North Carolina, purchase that property at a foreclosure sale, and then seek to obtain a deficiency judgment against a guarantor of the underlying loan. Of course, this scenario is more likely to occur for creditors where the prospect of actually recovering any deficiency amount against the borrower-mortgagor is bleak, the prospect of at least a partial recovery against a guarantor looks more promising, and/or some other policy consideration is taken into account.
Turning to the court’s Feb. 17, 2015, decision in Branch Banking and Trust Company v. Smith, the North Carolina Court of Appeals was called upon to review the North Carolina law (N.C. Gen. Stat. §45-21.36) making available a statutory defense or offset to certain loan obligors in a deficiency action in which the foreclosing creditor has purchased its collateral—the real property—at a foreclosure sale.
As observed by the court, after a foreclosure sale in North Carolina, the amount of the outstanding debt is deemed to be reduced by the amount of the net proceeds realized from the sale. However, this general rule is displaced by Section 45-21.36 in situations where the foreclosing creditor itself ends up buying the real property as its collateral at the foreclosure sale.
More specifically, Section 45-21.36 provides that where the foreclosing creditor purchases the property and subsequently sues to collect the amount of deficiency, certain obligors may, as a matter of defense, demonstrate that the collateral “was fairly worth the amount of the debt.” In turn, this showing would successfully defeat the deficiency judgment against the obligor. Alternatively, the statute provides that the obligor may, by way of offset, show that the creditor’s winning foreclosure bid was “substantially less than the collateral’s true value.” Consequently, a successful showing along these lines would “offset any deficiency judgment” against the obligor.
What is particularly notable in the Branch Banking and Trust Company case is that the bank sought a deficiency judgment against the guarantors of the bank’s loan for a real estate project. Previously, the borrower-mortgagor, a limited liability company, had been dismissed from the case. Over $1.4 million of outstanding debt was due on the bank’s loan, and the bank purchased the property at the foreclosure sale for $800,000. Consequently, after the net proceeds from the foreclosure sale were applied, there was a remaining deficiency of approximately $700,000. The state trial court granted summary judgment to Branch Banking and Trust against all eight guarantors of the loan for the deficiency.
However, one of the eight guarantors, Mounib Aoun, appealed the amount of the judgment entered against him—approximately $502,310. Essentially, on appeal, Aoun contended that summary judgment in favor of the bank was inappropriate because there was an issue of fact as to whether he was entitled to the defense or offset afforded by Section 45-21.36. Among other things, the court record revealed that there was some evidence tending to show that the bank had ordered an appraisal of the property. The appraisal, apparently dated about five months prior to the foreclosure sale, reportedly indicated that the property at issue was worth over $2.1 million.
In response, Branch Banking and Trust Company argued that Aoun could not invoke the right of defense or offset made available by the North Carolina statute because, as a guarantor, Aoun did not have any “property interest” in the mortgaged property. The only party that had a property interest was the borrower-mortgagor, and it had been dismissed from the case, the bank maintained.
Moreover, the bank argued that even if Aoun conceivably could be considered to have any right to a defense or setoff under Section 45-21.36 as a guarantor, he had waived that right when he signed the guaranty agreement or waived it via the court proceedings. Ultimately, the North Carolina Court of Appeals rejected these arguments by the bank.
In reversing the judgment of the state trial court and remanding the matter, the appellate court determined that Aoun had a right as a guarantor to invoke the North Carolina statute even though the borrower-mortgagor was dismissed from the action. The appellate court determined that the loan guarantor presented sufficient evidence to create a genuine issue of material fact that the real property either was worth more than the amount of the outstanding $1.4 million loan debt, or was worth more than the $800,000 the lending bank paid to purchase the property at the foreclosure sale. The court determined that while Aoun might not be able satisfy the required evidentiary showing, he should be given the opportunity to do so.
Another interesting thing about the decision in the Branch Banking and Trust Company case is that the North Carolina Court of Appeals acknowledged that many of its prior rulings from the modern era “appear to support the position of the Bank that the G.S. 45-21.36 defense/offset is not available to a mere guarantor.” Yet, the court ruled otherwise. Why?
Part of the answer resides in the fact that the appellate court relied heavily on a 1938 decision by the North Carolina Supreme Court, stating, “We are compelled…by our Supreme Court’s holding in Virginia Trust Company v. Dunlop, 214 N.C. 196, 198 S.E. 645 (1938) to conclude that Appellant, though merely a guarantor, is entitled to the G.S. 45-21.36 defense/offset, even where the [borrower-mortgagor] has been dismissed from the action.”
The bank argued that the North Carolina Supreme Court’s 1938 opinion in Dunlop did not make a “clear and unequivocal” ruling about whether the right to a defense or offset under Section 45-21.36 was available to a guarantor. However, that argument did not prevail. The North Carolina appellate court stressed that “though Dunlop contains dicta which might seem equivocal to the modern reader, as it was written in 1938, the holdings are clear…We are bound by this holding until our Supreme Court speaks on this issue and renders a holding contrary to that in Dunlop, notwithstanding holdings by this Court which may appear to conflict with Dunlop.”
As a result, the natural question arises: How would the North Carolina Supreme Court rule today on this issue faced by the state’s appellate court?
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