U.S. Bank NA v. Pinkney

North Carolina’s Supreme Court Delineates Crucial Differences Between Power of Sale Foreclosures and Judicial Foreclosures

A non-judicial foreclosure by power of sale is the more common, stream-lined method to foreclose a deed of trust in North Carolina. To allow a sale in a non-judicial foreclosure, the court must find the existence of only six factors. One of those six findings is whether there exists a “valid debt of which the party seeking to foreclose is the holder.”N.C. Gen. Stat. §45-21.16(d) (emphasis added). To prove that it is a “holder”-- and thus entitled to foreclose “non-judicially”-- a party must have possession of the Note which must either be payable to that party or indorsed in blank. N.C. Gen. Stat. §§25-1-201(b)(21)(a) and 25-3-205(b).

A foreclosing lender’s “holder status” is arguably the most litigated issue in North Carolina non-judicial foreclosures, particularly where one party is the original payee on the Note, but another party now claims to be the holder of the Note with the right to foreclose. For example, issues of “holder status” may genuinely arise where “Bank A” is the original payee on the Note; “Bank D” to whom the Note is specifically endorsed is the party seeking to foreclose; and there is a missing link in the chain of endorsements from “Bank A” to “Bank D.”

Such were the facts in the recent North Carolina Supreme Court decision of U.S. Bank v. Pinkney. The Pinkneys executed a Note to Ford Consumer Finance (Bank A in the scenario above). Ford Consumer Finance later endorsed the Note to Credit Asset (Bank B) which “assigned” the Note to Salomon Mortgage (Bank C). Salomon Mortgage then specifically endorsed the Note to U.S. Bank (Bank D). The problem for U.S. Bank was that there was a missing endorsement on the Note from Credit Asset (Bank B) to Salomon Mortgage (Bank C). In lieu of that endorsement on the Note, there existed instead an “Assignment of Mortgage/Deed of Trust” which stated that the Note was assigned from Credit Asset to Salomon Mortgage. The missing endorsement on the Note impeded U.S. Bank’s effort to prove it was the “holder” of the Note.

Perhaps cognizant of this issue, U.S. Bank initiated a judicial foreclosure action rather than a non-judicial foreclosure. In response, the Pinkneys filed a motion to dismiss arguing that U.S. Bank could not prove that it was the “holder” of the Note because of the missing endorsement on the Note and thus the Bank’s judicial foreclosure complaint failed to state a claim. The trial court agreed and dismissed the judicial foreclosure action with prejudice. U.S. Bank appealed to the North Carolina Court of Appeals. Applying the requirements applicable to non-judicial foreclosures by power of sale, the Court of Appeals found that U.S. Bank failed to establish its status as a holder of the Note and therefore did not have the right to foreclose. The Court of Appeals therefore affirmed the trial court’s order dismissing the judicial foreclosure action. The Court of Appeals reasoned that because U.S. Bank was not the original holder of the Note, “each transfer required indorsement of the Note from one holder to the next” and the assignment (from Credit Asset to Salomon Mortgage) was an inadequate indorsement.

U.S. Bank then appealed to the North Carolina Supreme Court which, in a unanimous opinion, reversed the decision of the lower courts. The Supreme Court reasoned that “[b]ecause the Court of Appeals applied the requirements applicable to non-judicial foreclosure by power of sale, not judicial foreclosure, … the court erred and that dismissal on that basis was improper.” The Supreme Court noted the many differences between the non-judicial foreclosure by power of sale and the judicial foreclosure. For example, non-judicial foreclosure by power of sale arises under contract and is not a judicial proceeding. By contrast, judicial foreclosure is an ordinary civil action. Accordingly, the North Carolina Rules of Civil Procedure do not apply to non-judicial foreclosures; whereas they do apply to judicial foreclosures.

Relying on the notion that complaints in judicial proceedings should be construed liberally and should only be dismissed if “it appears certain that plaintiffs could prove no set of facts which would entitle them to relief under some legal theory,” the Supreme Court noted that a judicial foreclosure complaint states a claim if it alleges only a debt, default on the debt, a deed of trust securing the debt, and the plaintiff’s right to enforce the deed of trust. The Court held that U.S. Bank’s complaint pled the facts and circumstances necessary to give the Pinkneys adequate notice of the judicial foreclosure claim, and found that “[a] missing indorsement at this initial notice-pleading stage does not preclude the Bank from proceeding with its civil action.” Indeed, the Court noted that U.S. Bank, despite the fact that there was a missing endorsement which could affect its status as “holder” is nonetheless entitled to submit and prove by evidence at trial its right to foreclose in a number of other ways. For example, the Court noted that:

  • A “person entitled to enforce an instrument” under N.C.G.S. §§ 25-3-301 and 25-3-309 includes a holder and nonholder in possession;
  • A transfer of an instrument vests in the transferee any right of the transferor to enforce the instrument under N.C.G.S. § 25-3-203(b);
  • A transferee for value is provided the “enforceable right to the unqualified indorsement of the transferor” under N.C.G.S. § 25-3-203(c); and
  • A number of courts have allowed a transferee to enforce an instrument where an indorsement was missing; e.g. Norfolk Shipbuilding & Drydock Corp. v. Carlyle, 242 B.R. 881, 887 (Bankr. E.D. Va. 1999) (“[T]he absence of an endorsement does not . . . deprive a transferee of the right to enforce the instrument.”); Pierce v. DeZeeuw, 824 P.2d 97, 100 (Colo. App. 1991) (applying the indorsement exception under the predecessor of U.C.C. § 3-203(c) to an assignment), cert. denied, Colo. Sup. Ct., (Feb. 18, 1992) (unpublished); Fleming v. Caras, 170 Ga. App. 579, 580, 317 S.E.2d 600, 602 (1984) (reversing dismissal because the plaintiff was “entitled to an indorsement” under the predecessor of U.C.C. § 3-203(c)).

In sum, there are many occasions where a lender has the right to enforce a Note but cannot prove that it is the “holder” of the Note. On those occasions, the lender may be prevented from foreclosing on the real estate in a non-judicial foreclosure by power of sale. However, given the holding of U.S. Bank v. Pinkney, the lender is clearly afforded a path to foreclose judicially.

Published by Michael Stein on December 15, 2017.