District Split is Ripe for California Supreme Court Review
Mortgage Shotgunning
The real estate fraud known as mortgage shotgunning or slamming occurs when real property is refinanced with multiple lenders within a short period of time, such that each lender lacks knowledge of the other lenders. The prior lender and homeowner, working in cahoots, then abscond with the multiple payments on the same property.
The fraud is difficult to detect because of the delay between recording a trust deed and the ability of title searchers to discover that trust deed.
After falling victim to this fraud, the lenders find themselves in a dispute over which lender has a fully-secured first-priority interest in the property. All other lenders will be left with a less-secure, and potentially worthless, interest.
As explained herein, the Fourth District (Riverside) and Second District (Los Angeles) of the California Court of Appeal have come to opposite conclusions when forced to decide priority of competing trust deeds recorded within a short period of time by good faith purchasers (encumbrancers) without notice of the other trust deed.
The Race-Notice Recording System
The conflict resulting from this alarming trend of mortgage shotgunning is decided in California (and many other states) by the Race-Notice Rule, which allows a purchaser or lender to obtain priority to a real property interest by:
- Acquiring the interest as a bona fide encumbrancer (i.e. lender) or purchaser for valuable consideration with neither actual knowledge nor constructive notice of a previously-created interest; and
- “First duly record[ing]” the interest, i.e., recording before the previously-created interest is recorded.
(Cal. Civ. Code, §§ 1107, 1213 & 1214.)
Some lenders have litigated when a document is “duly recorded” under this statutory scheme, asserting that a recorded document does not provide notice to third parties until it is indexed by the county recorder, perhaps several days later.
Simultaneously Recorded Trust Deeds Are Equal in Priority
Two cases have concluded that simultaneously recorded trust deeds are equal in priority, regardless of the time of indexing or any other fact.
In 2011, the California Court of Appeal in First Bank v. East West Bank (2011) 199 Cal. App. 4th 1309, published an opinion addressing two lenders that dropped off their deeds before the county recorder’s office opened, causing both to be stamped as if they were recorded at 8 a.m. the same morning. One party claimed that its interest was indexed first, thus giving its interest first priority. The court rejected this argument, stating that it “would disrupt the statutory scheme to make priority turn on the random act of indexing . . . .” Instead, both parties were deemed to be of equal priority.
In 2012, the California Court of Appeal in Baer v. Douglas (Mar. 19, 2012) No. D057811, 2012 Cal. App. Unpub. LEXIS 2091 (unpublished), “agree[d] with the holding and reasoning in First Bank, supra, 199 Cal.App.4th 1309 and conclude[d] that neither the sequence of the instrument recording numbers stamped by the recorder on the parties’ simultaneously recorded trust deeds, nor the sequence of the page numbers where the trust deeds appear in the official records, determines the relative lien priority of each trust deed.”
These cases highlight the unwillingness of courts to disrupt the Race-Notice Rule that the first duly recorded interest maintains priority, even when the two trust deeds are both recorded “first.”
Districts Are Split as to Priority Among Trust Deeds Recorded at Different Times by Good Faith Purchasers Without Notice
Two unpublished cases have come to opposite results when addressing the question of which trust deed has priority when both are recorded without actual or constructive notice at the time of recording. That is, as between innocent lenders, who wins?
Simental: First Recorded Wins
In 2010, the California Court of Appeal in Riverside in the case of Simental v. Inyo-Mono Title Co. Profit-Sharing Plan (Jun. 14, 2010) No. E048891, 2010 Cal.App. Unpub. LEXIS 4414 (unpublished), addressed two bona fide purchasers (encumbrancers) that paid value for what they thought would be the first trust deed on a parcel of real property. The later-recording party argued that it had no constructive notice of the first-recorded trust deed because it had not been indexed by the county recorder by the time the later-recording party recorded its interest. The Simental court rejected this argument, finding that “the question is not whether [the later-recording party] had constructive notice” of the first-recorded trust deed. Instead, the court found that, in addition to being a bona fide purchasers, the real property “interests were also required to be ‘first duly recorded'” pursuant to Civil Code sections 1107 and 1214.
Bank of East Asia: Second Recorded Wins
However, in 2013, the California Court of Appeal in Los Angeles came to the opposite conclusion in Bank of East Asia U.S.A. N.A. v. Javaherian (2013) 2013 Cal. App. Unpub. LEXIS 422, 2-3 (unpublished).
In this case:
The [Javaherian] deed of trust was recorded in the recorder’s office on March 2, 2005. The Bank’s deed of trust was recorded in the recorder’s office on March 3, 2005. The [Javaherian] deed of trust was indexed in the recorder’s office records on March 5, 2005, and the Bank’s deed of trust was indexed on March 7, 2005.
Based on these facts, “[t]he Bank contend[ed] that its deed of trust has priority over the [Javaherian] deed of trust, because the Bank had no actual or constructive notice of the [Javaherian] deed of trust [recorded on March 2, 2005,] when it received and recorded its deed of trust” on March 3, 2005.
After quoting First Bank extensively, the Court of Appeal reasoned that “[a]lthough the [Javaherian] deed was recorded first, it failed to provide subsequent purchasers and encumbrancers with constructive notice until it was indexed. Therefore, when the Bank’s deed of trust was duly recorded, the Bank was not charged with constructive notice of the prior deed of trust and the Bank’s interest is not subject to the [Javaherian] deed of trust.”
The reasoning of the Court of Appeal is illuminated by its conclusion that “[b]etween the two innocent parties in this case, Javaherian was in the best position to protect her interest by promptly recording the [Javaherian] deed of trust and verifying that it had been properly indexed.”
However, there is no statute or case law providing for such a balancing test between two innocent lenders, nor is there any test as to which party is in the best position to protect its interest by prompting recording and/or verifying the indexing of its trust deed. Either party could have done so.
Even if Javaherian had undergone such an effort, it would not have changed the result in this case. For example, if Javaherian had verified that her trust deed was indexed on March 5 or 6, 2005, Javaherian would have had no notice of the Bank’s trust deed recorded on March 3, 2005. This is because the Bank’s trust deed was not indexed until March 7, 2005.
This case seems to repeal by implication the Race-Note statutes.
In light of the district split, the California Supreme Court should address this issue to provide clarity for courts, attorneys, lenders and title insurers.
Lesson: Record Promptly
The lesson in these cases is clear: lenders, escrow officers and title companies should promptly record their interests to protect the lender’s priority. Moreover, lenders and title officers may be wise to conduct another title search several days after recording, before funding the loan (if possible), to determine if any earlier-recorded documents have been indexed.
Moreover, the Bank of East Asia case, discussed above, suggests that yet another title search should be conducted several days after the operative trust deed has been indexed to determine if a competing trust deed was later-recorded.
Parties should proceed with caution given that the rules of real estate may have harsh consequences, even for victims of fraud.
Scott Talkov‘s practice in California real estate law has included mortgage shotgunning litigation.
