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Calif. App. Court (1st Dist) Holds Assignee May Sue Title Company for Erroneous Release

The Court of Appeal of California, First District, recently held that an assignee of the original beneficiary of a deed of trust, as the current holder of an obligation, has the right under California Civil Code § 2941(b)(6) to prove damages against the title company that allegedly recorded a release of the deed of trust in error.

A copy of the opinion in SMS Financial XXIII, LLC v. Cornerstone Title Company is available at:  Link to Opinion.

In 2004, a bank made a business loan to an investment company.  The loan was guaranteed by the investment company’s principals (“guarantors”) and secured by a second deed of trust on the real property the guarantors owned.

In 2011, the bank assigned the note and deed of trust to the plaintiff.  The plaintiff, the investment company, and the guarantors later executed a forbearance agreement reciting that the loan was in default and agreed that the plaintiff would not exercise its right under the note, guaranty and deed of trust as long as the investment company made payments according to a schedule set forth in the agreement.

The investment company failed to make the required payment.  In 2014, the plaintiff began to initiate foreclosure when it learned that in 2007, without the knowledge of the bank, the defendant title company had executed and recorded a release of the obligation secured by the deed of trust. The release stated that it was prepared under the provisions of California Civil Code § 2941(b)(3).

The plaintiff alleged that the title company had no authority to prepare and record the release, and that contrary to the language in the release, the obligation secured by the deed of trust had not been paid, satisfied, or discharged.

The plaintiff sued the investment company, the guarantors and the title company, seeking payment of the loan and a declaration that the release was void.  As an alternative, in the event the release was determined to be valid, in its fourth cause of action the plaintiff sought damages for the title company’s negligence in executing and recording the release without complying with the provisions of California Civil Code § 2941(b)(3).

The plaintiff argued that as the successor to the bank, who was the original beneficiary of the deed of trust, it was entitled to damages, including attorney’s fees, under California Civil Code § 2941(b)(6).

The title company demurred to the fourth cause of action, and argued that the plaintiff failed to allege that the tort claims included in the cause of action were assigned to the plaintiff with the loan and deed of trust.

The trial court agreed and issued an order sustaining the title company’s demurrer without leave to amend, and dismissed the title company from the case.

On appeal, the plaintiff argued that the trial court erred in sustaining the title company’s demurrer to the damages claim and dismissing the title company from the case.

Specifically, the plaintiff alleged that the title company prepared and recorded the release, which represented that the obligation secured by the deed of trust was paid in full and that the release was deemed the equivalent of a reconveyance under California Civil Code § 2941(b)(3).  Also, the plaintiff alleged that the title company was negligent in preparing the release without authorization from any person having the authority to authorize the release.

The plaintiff argued that these allegations stated a cause of action for damages under California Civil Code § 2941(b)(6).

As you may recall, California Civil Code § 2941(b)(3) sets forth the procedure by which a title insurance company may prepare and record a release of a mortgage obligation:

(3)  If a full reconveyance has not been executed and recorded pursuant to either paragraph (1) or paragraph (2) within 75 calendar days of satisfaction of the obligation, then a title insurance company may prepare and record a release of the obligation. However, at least 10 days prior to the issuance and recording of a full release pursuant to this paragraph, the title insurance company shall mail by first-class mail with postage prepaid, the intention to release the obligation to the trustee, trustor, and beneficiary of record, or their successor in interest of record, at the last known address.

(A)  The release shall set forth:

(i)  The name of the beneficiary.

(ii)  The name of the trustor.

(iii)  The recording reference to the deed of trust.

(iv)  A recital that the obligation secured by the deed of trust has been paid in full.

(v)  The date and amount of payment.

(B)  The release issued pursuant to this subdivision shall be entitled to recordation and, when recorded, shall be deemed to be the equivalent of a reconveyance of a deed of trust. See California Civil Code § 2941(b)(3).

Additionally, section 2941 provides that a title insurance company that prepares or records a release under Civil Code § 2941(b)(3) is “liable to any party for damages, including attorney’s fees, which any person may sustain by reason of the issuance and recording of the release.”  California Civil Code § 2941(b)(6).

Noting the broad language of the statute, the Appellate Court concluded that the plaintiff alleged facts sufficient to state a claim against the bank, as the beneficiary of the deed of trust.  And, the plaintiff alleged that the obligation secured by the deed of trust was released in error by the title company, which in the Appellate Court’s view, presented a dispute as to whether the release was valid and whether the plaintiff will have lost security for the loan and will therefore have been damaged.

Accepting these allegations as true for purposes of the demurrer, the Appellate Court held that the plaintiff’s allegations stated a claim for damages under California Civil Code § 2941(b)(6), and therefore the trial court erred in sustaining the title company’s demurrer to the plaintiff’s cause of action for damages.

The title company argued that there was nothing in the statute to suggest that the bank, which held the loan and deed of trust at the time the title company filed the release, had any claim against the title company under section 2941, and therefore the bank had no claim to assign to the plaintiff with the note and deed of trust.

The title company also argued that, even assuming that section 2941 gave rights to the bank, it would be “unconscionable” if the bank could sue the title company for damages sustained by the release, and then assign the loan and deed of trust to the plaintiff, which could in turn sue the title company for damages it suffered by the release, and then assign the loan and deed of trust to some third party which could also sue the title company for damages it sustained by reason of the release.

The Appellate Court rejected these arguments.  First, the title company offered no authority to support its positions, which was contrary to the explicitly statutory language.  The Court noted that section 2941(b)(6) imposed broad liability on any title company that issues and records a release under Civil Code § 2941(b)(3).  And, under Civil Code § 2941(b)(6), the plaintiff, as the holder of an obligation, had the right to prove damages against the title company that recorded a release of that obligation.

The title company relied on the Appellate Court’s ruling in Heritage Pacific Financial, LLC v. Monroy (2013) 215 Cal. App. 4th 972, to argue that as a matter of law, the assignment of the bank’s contractual rights to the plaintiff did not include the assignment of the bank’s tort claim against the title company under section 2941.

As you may recall, Heritage Pacific concerned a promissory note that a borrower executed with a mortgage company.  Id., at 980.  The plaintiff in Heritage acquired the note from the mortgage company and then determined that the borrower had made false representations in her original loan application.  Id., at 982.  The plaintiff in Heritage sued the borrower based on representations she made in the original loan application with the mortgage company.  Id.  The trial court in Heritage sustained the borrower’s demurrer, and the Appellate Court affirmed, concluding that the transfer of the promissory note to Heritage gave Heritage contractual rights, but not fraud rights, which were as a matter of law not incidental to the transfer of the promissory note.  Id., at 991.

However, the Appellate Court explained that it reached this conclusion based on the legal principal set forth in National Reserve Co. of America v. Metropolitan Trust Co. of California (1941) 17 Cal. 2d 827 — that is, if the accrued cause of action can be asserted by the assignor independent of ownership of the contract, and if that cause of action is not essential to continued enforcement of the contract, then the cause of action did not pass under the assignment as incidental to the contract unless the assignment specifically or impliedly designated the cause of action.

In Heritage Pacific, the Appellate Court found that the language of the assignment did not specifically or impliedly designate tort claims.  The fraud claims that Heritage alleged against the borrower would pass under the assignment as incidental to the note if they could not be asserted by the mortgage company apart from the promissory note, or if they were essential to the enforcement of the contract.  However, the Appellate Court held that the fraud claims failed on both counts because they could be asserted by the mortgage company independently of its continued ownership of the promissory note, and they were not essential to the enforcement of the promissory note.

Relying on Heritage Pacific, the title company argued that the section 2941 claim was not assigned to the plaintiff with the deed of trust because the language of the assignment did not specifically or impliedly designate tort claims, because the bank could assert a claim against the title company under section 2941 independent of its ownership of the deed of trust, and because the section 2941 claim was not essential to the enforcement of the deed of trust.

The Appellate Court distinguished Heritage Pacific, where it considered whether a lender’s pre-existing fraud claims, arising from misrepresentations made to the lender in a loan application, were incidental to the transfer of the loan, and concluded that as a matter of law they were not.

In contrast, the issue in this case is not whether the bank’s pre-existing tort claim against the title company was transferred from the bank to the plaintiff with the assignment of the note and deed of trust.  By virtue of holding the deed of trust by assignment from the bank, the plaintiff had its own potential claim against the title company under California Civil Code §  2941(b)(6), regardless of any claims that the bank may have been or may still be able to assert.

In sum, the Appellate Court concluded that under California Civil Code § 2941(b)(6), the plaintiff, as the holder of an obligation had the right to prove damages against the title company that recorded a release of the obligation.

Accordingly, the Appellate Court reversed the trial court’s order sustaining the demurrer and dismissing the title company from the case.

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