Earlier this month, the North Carolina Court of Appeals rejected a challenge to a foreclosure special proceeding based on res judicata in Roberson v. Tr. Services of Carolina, LLC, No. COA17-1152. In this decision, the Court of Appeals reaffirmed the seminal 2016 Supreme Court decision, Matter of Lucks, limiting the applicability of the doctrine in the context of non-judicial foreclosure. This is the latest in a line of relatively new opinions limiting the application of the Rules of Civil Procedure and judicial doctrines in foreclosure special proceedings, which are created by statute and are distinct from judicial actions. Since this has become the law of the land, lenders, trustees, and their attorneys have continued to rebuff challenges to the assertion of the power of sale based on claim preclusion.

In North Carolina, a deed of trust granting the power of sale can be foreclosed pursuant to a statutory procedure, classified as a “special proceeding”, that in many ways is less demanding than a full judicial action1. In a foreclosure special proceeding, the Clerk of Superior Court of the county in which the property to be sold is located holds a limited hearing to determine the existence of six statutory elements2. Res judicata and collateral estoppel are related judicial doctrines that prohibit re-litigating findings already made by a court of competent jurisdiction. Rule 41 is a Rule of Civil Procedure that prescribes when a dismissal operates as an adjudication on the merits, thereby implicating res judicata.

The Lucks opinion, upon which the Court of Appeals relied in its decision this month, held that “traditional doctrines of res judicata and collateral estoppel applicable to judicial actions do not apply” to non-judicial foreclosure special proceedings. In doing so, the Supreme Court noted the “fluid nature of the debtor-creditor relationship” and recounted a few of the myriad reasons why a creditor might choose not to proceed with the hearing (e.g., CFPB holds, loss mitigation, etc.), lending practical support to the rationale of its holding. Noting that foreclosure special proceedings are conducted in an informal setting, the court explained that the role of the court hearing a non-judicial foreclosure matter is to find the existence or non-existence of the six elements required for the court to authorize a foreclosure sale, and that a refusal to authorize a sale based on the non-existence of one or more element “is not a ‘dismissal’” and does not “implicate res judicata or collateral estoppel in the traditional sense.” The court did caution that a creditor would be prohibited from bringing another foreclosure special proceeding based on the same default. The Roberson court, citing Lucks, also noted the prohibition on proceeding with non-judicial foreclosure again based on the same default. Neither opinion elaborates on the definition of “same default”, but prior opinions3 discuss that subsequent missed payments are defaults which can provide the basis for foreclosure4, so missed payments after a failed special proceeding would give rise to a new and distinct power of sale foreclosure. In any event, no version of res judicata or collateral estoppel, however restricted in application, would prevent a lender from seeking to foreclose a deed of trust by judicial action, even based on the same default.5

In Roberson, the borrowers had defaulted on a deed of trust. In the first special proceeding, the substitute trustee and lender failed to show on appeal that the lender was the holder of the underlying promissory note. The second special proceeding petered out after the borrowers appealed the clerk’s order and the substitute trustee failed to prosecute the matter in Superior Court. But the third time's a charm, as it were. The substitute trustee obtained an order from the Clerk of Court allowing a foreclosure sale, but instead of appealing the clerk’s order as the borrowers had done in the previous two foreclosure proceedings, this time they filed a separate complaint asking the Superior Court to dismiss the special proceeding, arguing that the principles of res judicata applied and that the “trial court’s dismissal with prejudice” should operate as an adjudication on the merits pursuant to Rule 41(b). Of note, their complaint failed to request injunctive relief pursuant to N.C.G.S. § 45-21.34.

In summary fashion, the Court of Appeals referred to the holding in Lucks to defeat the borrowers’ claim, restating the premise that “a lender is not prejudiced by the traditional doctrines of res judicata and collateral estoppel when a trial court denies a non-judicial foreclosure request” and noting that the borrowers had not alleged that the current default was the same as the default serving as the basis for the two prior special proceedings. The court went on to say, in dicta, that, had the borrowers raised a legally sufficient challenge, the “appropriate remedy . . . would have been to seek an injunction from the trial court precluding [the foreclosure] based on that particular default.” By requiring a separate action for challenges based on arguments that do not address any of the six statutory elements, the special proceeding remains simple and efficient, and clerks and their assistants, who are often not attorneys, are prohibited from considering collateral attacks based on extraneous law.

On its face and for most practical purposes the issue of the applicability of res judicata and collateral estoppel to non-judicial foreclosure seems settled, but some questions remain. If the Rules of Civil Procedure don’t apply and a trial court’s refusal to authorize foreclosure is not a dismissal, what is the significance of a “new default” such that it alone provides a new basis for another special proceeding? The Rogers Townsend & Thomas court gave the explanation; “the operative facts and transactions necessary to the disposition of both actions gave rise to separate and distinct claims of default, and some of the particular default claims relevant to the second action could not have been brought in the first one.” Could this be the manifestation of the courts’ hesitance to abandon res judicata and collateral estoppel altogether and thus salvage what might be seen as the purest form thereof? Or could its continued existence be a vestige of the rational gymnastics prior courts performed in order to square application of res judicata and the two-dismissal rule6 to non-judicial foreclosure? In Roberson, the challenge to the first special proceeding was based on standing, and the trial court explicitly found the existence of a default. Likewise, the Lucks opinion sprang from a challenge based on the authority of the substitute trustee to bring the proceeding. What if the challenge is based on the right to foreclose or the non-existence of the debt? Why should a new default always be the determinative event that would allow another bite at the power of sale apple? Is that not a negative implication of res judicata and Rule 41 in action? Whatever the answer may be, it’s important to bear in mind that, though another missed payment can provide a new basis on which to bring another special proceeding, certain evidentiary deficiencies simply cannot be cured in that setting, and, when that happens, the foreclosure must be achieved judicially.

The Roberson opinion is a reminder of the very limited applicability of res judicata and collateral estoppel, as well as the progress in the evolution of a practical set of rules to govern North Carolina foreclosure special proceedings that respect the essentially contractual nature of the power of sale. In just a few short years the law has gone from “Rule 41 applies, but each missed payment can provide the basis for a new foreclosure” to “the Rules of Civil Procedure don’t apply, so Rule 41 is out of the picture and res judicata doesn’t apply in the traditional sense, but a new default is still required.” The opinion also bolsters the proposition that a foreclosure special proceeding is limited in scope to the six statutory elements, and that collateral challenges to the exercise of the power of sale must come in the form of a separate action initiated by the party objecting to the foreclosure. This should comfort lenders holding debt secured by deeds of trust to North Carolina real property. If you have all your ducks, but they just weren’t in a row on your first (or second or third or fourth) attempt, try again in a month.

1For example, the Rules of Civil Procedure do not generally apply unless specifically incorporated into the statutory scheme. See Lucks at 226, 505. This effectively eschews discovery and the availability of certain motions and results in a faster, more efficient foreclosure process. Judicial foreclosure, however, remains an option.
2 (i) valid debt of which the party seeking to foreclose is the holder, (ii) default, (iii) right to foreclose under the instrument, (iv) notice to those entitled to such . . . , (v) that the underlying mortgage debt is not a home loan as defined [by statute], or if the loan is a home loan . . . , that the pre-foreclosure notice [required by statute was sent and that prescribed time periods have elapsed], and (vi) that the sale is not barred by [a party’s servicemember status]. N.C.G.S. 45-21.16(d).
3 E.g. In re Herndon, 245 N.C.App. 83 (2016), Lifestore Bank v. Mingo Tribal Preservation Trust et al. 235 N.C.App. 573 (2014).
4 Herndon at 93-4 (“lender’s election to accelerate payment on a note did not necessarily place future payments at such issue such that the lender was barred from filing subsequent foreclosure actions based upon subsequent defaults, or periods of default, on the same note.”) quoting In re Rogers Townsend & Thomas, PC, 241 N.C.App. 247 (2015, vacated on unrelated grounds by Matter of Rogers Townsend & Thomas, PC, 369 N.C. 221).
5 See, e.g., Lucks at 223, 503.
6 Prior to Lucks, the applicability of the Rules of Civil Procedure was considerably murkier. Lifestore, Rogers Townsend & Thomas, and Herndon used new default as the rationale as to why two voluntary dismissals do not amount to a dismissal with prejudice pursuant to Rule 41(a) and res judicata, seemingly allowing practicality to guide their legal reasoning to the necessary result, i.e. preserving the power of sale.

Published on May 16, 2018.