Mortgage Shotgunning and the Priority of Trust Deeds

• Publication year: 2014
• Author: By Scott Talkov

Mortgage Shotgunning and the Priority of Trust Deeds

By Scott Talkov

©2014 All Rights Reserved.

I. MORTGAGE SHOTGUNNING FRAUD

The real estate fraud known as "mortgage shotgunning" or "mortgage slamming" occurs when a homeowner obtains multiple loans secured by the same home in order to receive loan proceeds that, in combination, greatly exceed the value of the real property.¹ The homeowner commits fraud by failing to inform each lender that s/he has obtained multiple loans secured by the same property. The homeowner² then absconds with the proceeds of the multiple loans on the same property.³

This species of real estate fraud, declared to be an "alarming trend" in 2009,⁴ is difficult to detect because of the delay between the trust deed recordation date and the date on which the recorded trust deed is available for discovery by title searchers. Each lender is thereby led to believe that it will have a fully-secured, first-priority trust deed. Indeed, defrauding parties generally use multiple title insurers, notaries, escrow companies and lenders to reduce the chance of fraud detection before the defrauding party can abscond with the funds.

After falling victim to this fraud, lenders find themselves in a dispute over which lender has a fully-secured, first-priority interest in the subject property. Those without a first-priority lien hold a less-secure, potentially worthless interest in the real property.⁵

The resulting litigation between victimized lenders (often funded by their respective title insurers) has been decided differently in California's Fourth District Court of Appeal (Riverside) and Second District Court of Appeal (Los Angeles). Each district has reached opposite conclusions as to the priority of competing trust deeds recorded by victims of mortgage shotgunning. This district split raises fundamental questions about California's race-notice recording system. In these cases, good faith purchasers (encumbrancers) without notice of an existing trust deed, have recorded their trust deeds shortly after the recordation of an immediately preceding trust deed. Each case also involved a claim that the date on which the county recorder indexes the trust deed changes the priority of those interests from the assumed priority under the race-notice system. However, the two courts reached opposite conclusions, creating a district split that should be reconciled by the California Supreme Court.

II. THE RACE-NOTICE RECORDING SYSTEM

The recording priority of trust deeds in California (and many other states) is governed by the state's race-notice recording statutes, which allow a lender or purchaser to obtain an interest in real property that has priority over another interest in the same real property by:

(a) Acquiring the interest as a bona fide encumbrancer (i.e., lender) or purchaser for valuable consideration, meaning that s/he pays consideration in exchange for an equity or fee interest in certain real property, while possessing neither actual knowledge nor constructive notice of a previously created interest in that property; and
(b) "First duly record[ing]" the interest, meaning that the lender or purchaser records the granting instrument before any competing interest in the property is recorded.⁶

In California, these rules were codified long ago in 1872. Specifically, Civil Code section 1213 states that recorded documents provide constructive notice to third parties, thereby preventing anyone with a subsequently recorded interest from wresting title to the property from the holder of current title without paying value for that interest.

Central to the disputes in mortgage shotgunning litigation, Civil Code section 1107 provides that "[e]very grant of an estate in real property is conclusive against the grantor, also against every one subsequently claiming under him, except a purchaser or incumbrancer who in good faith and for a valuable consideration acquires a title or lien by an instrument that is first duly recorded."

Another pivotal statute in these disputes is Civil Code section 1214. This statute reads in relevant part, "[e]very conveyance of real property . . . is void as against any subsequent purchaser or mortgagee of the same property . . . in good faith and for a valuable consideration, whose conveyance is first duly recorded."⁷ The essence of Civil Code section 1214 lies at the heart of mortgage shotgunning litigation. It "renders an unrecorded conveyance void as to subsequent bona fide purchasers who record their title first."⁸

When lenders record their secured interests in real property and fund a loan with hundreds of thousands of dollars (or more) in consideration, only to later find that their interests may be worthless, litigation frequently ensues. In such litigation, lenders with a "duly recorded" deed of trust often assert that a recorded document does not provide notice to third parties until it is indexed by the county recorder, perhaps several days after recordation. This argument tests the very purpose of the race-notice recording system.

III. SIMULTANEOUSLY RECORDED TRUST DEEDS ARE EQUAL IN PRIORITY

The California Court of Appeal has been called upon twice in recent years to determine the priority of simultaneously recorded trust deeds.⁹ Although neither case mentions "mortgage shotgunning," the fact that they involve bona fide encumbrancers disputing the priority of their lien rights in the same real property suggests that that this form of mortgage fraud gave rise to the disputes.

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In 2011, the California Second District Court of Appeal in Los Angeles issued a published opinion in First Bank v. East West Bank in which lenders with loans secured by the same residential real property dropped off their trust deeds at the Los Angeles County Registrar-Recorder/County Clerk before it opened, causing both trust deeds to be file stamped as if they were recorded at 8:00 A.M. the same morning.¹⁰ One lender claimed that its trust deed was first in priority because its deed had been indexed first.¹¹ The court rejected this argument, finding that it "would disrupt the statutory scheme to make priority turn on the random act of indexing," a process that allows the county recorder to find instruments in its computerized database.¹² Instead, the court deemed the lenders to hold interests of equal priority in the subject property. This decision drew considerable attention among mortgage attorneys, including Golden Gate University Professor of Law Roger Bernhardt, who wrote an article advising lenders on how to deal with tied priority.¹³

In 2012, the California Fourth District Court of Appeal in San Diego authored an unpublished opinion in Baer v. Douglas.¹⁴ In Baer, two trust deeds were time and date stamped as though they were recorded at the same moment in time. One lender contended that its lower recording number indicated an earlier priority, and should break the tie. The court rejected this argument, finding that neither the sequence of the 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, determined the relative lien priority of each trust deed. Instead, the court upheld the holding and reasoning in First Bank, that the time of recordation is the only relevant factor in determining priority.¹⁵ In other words, indexing plays no role in the court's analysis.

These cases highlight the unwillingness of courts to disrupt the conclusion dictated by the race-notice system, that the first, duly recorded interest maintains priority over others, even when two trust deeds are both...