For years, the typical post-default strategy of secured lenders has been to foreclose the collateral through the power-of-sale contained in the deed of trust, credit the foreclosure proceeds to the outstanding loan balance, and then sue the borrower and guarantors for any remaining deficiency balance.  

A question that regularly arose in these deficiency actions was whether or not the guarantors could raise the defense found in N.C.G.S. § 45-21.36, which in essence allows a defense and offset to any deficiency balance due to the foreclosed property being fairly worth the amount of the outstanding debt (even though the winning foreclosure bid was insufficient to pay off the outstanding loan). The common interpretation of the statute based upon the wording thereof was that this defense was available to the property owner (generally, the borrower) but not to the guarantors. Last week, in High Point Bank and Trust Company v. Highmark Properties, LLC, et al., the North Carolina Supreme Court turned that interpretation on its head in holding that not only does the statute apply to borrowers and guarantors but also that it cannot be drafted around nor subjected to waiver language in any loan or security documents.  

The logical result of this ruling is that many, if not most, post-foreclosure deficiency actions will now result in this defense being raised by the guarantors thereby creating an issue of fact to be tried by the judge or jury. And while the burden of proof is initially on the guarantor to prove this defense, the North Carolina Court of Appeals recently held in United Community Bank v. Wolfe, et al., that all the guarantor needs to do to establish his case is to provide testimony from the property owner that the property owner believed the property was fairly worth the amount of debt at the time of the foreclosure sale, thereby creating an issue of fact such that the court will likely refuse to grant summary judgment in favor of the lender.  

While these cases are clearly a win for debtors, there are strategies lenders can use to avoid finding themselves at trial on a deficiency action. Most notably, on the back end, lenders should consider obtaining judgment prior to foreclosure – thereby effectively cutting off the defense because the defense is triggered only in a case to recover a post-foreclosure deficiency; lenders may also want to consider pursuing judicial foreclosure in some instances since the statute in question only applies to cases involving a power-of-sale foreclosure. Neither of these options may be prudent in every situation, but it is worth discussing the new state of the law and resulting options with counsel prior to deciding on a post-default strategy.

While that was certainly bad news for lenders, the North Carolina Supreme Court gave lenders a bit of good news last week. In Ussery v. Branch Banking and Trust Company, the court held that waiver language in BB&T’s note modification agreements can be sufficient to waive offsets and defenses borrowers might otherwise try to raise against the bank. In Ussery, the borrower brought an action against the lender for its alleged failure to provide a certain type of government-backed loan six years prior. However, subsequent to learning this certain type of loan was not available, the borrower obtained a commercial loan from BB&T that was extended six times by the execution of note modification agreements, each of which included waivers of all offsets and defenses.  Furthermore, through these modification agreements, the borrower repeatedly reaffirmed his obligations under the commercial loan. The court held that the “undisputed facts . . . show that plaintiff chose to obtain a new commercial loan after learning no government-backed loan was available, and he repeatedly reaffirmed his obligations under the commercial loan and expressly waived any offsets and defenses to the loan against the bank.”

The take-away from all three of these recent cases is that the state of law in North Carolina with respect to borrowers, guarantors and lenders is ever-changing and it is important for lenders not only to stay on the top of the law but also to look at the facts of each post-default case, consult with counsel, and make an informed decision regarding how to best move forward – whether that be through the traditional route of foreclosure through the power-of-sale provision followed by filing suit on the deficiency or whether it may be more prudent to file suit first and then pursue foreclosure, file suit and pursue foreclosure simultaneously, or perhaps to pursue foreclosure through the judicial foreclosure process rather than through the power-of-sale provisions found in the deed of trust.