Johnson v. Schultz

• Decision Date: 15 April 2010
• Docket Number: No. 75A09.,75A09.
• Citation: 691 S.E.2d 701
• Court: North Carolina Supreme Court
• Parties: William Wood JOHNSON and wife, Suzanne Wayne Johnson v. Timothy P. SCHULTZ and wife, Shelley D. Schultz, Donald A. Parker, Jerry Halbrook, Trustee, and State Farm Bank, F.S.B.

691 S.E.2d 701

William Wood JOHNSON and wife, Suzanne Wayne Johnson v. Timothy P. SCHULTZ and wife, Shelley D. Schultz, Donald A. Parker, Jerry Halbrook, Trustee, and State Farm Bank, F.S.B.

No. 75A09.

Supreme Court of North Carolina.

April 15, 2010.

COPYRIGHT MATERIAL OMITTED

Woodruff, Reece & Fortner, by Gordon C. Woodruff and Mary McCullers Reece, Smithfield, for plaintiff-appellees.

Pendergrass Law Firm, PLLC, by James K. Pendergrass, Jr., Raleigh, for defendant-appellants Timothy and Shelley Schultz, Jerry Halbrook, and State Farm Bank, F.S.B.

Katherine Jean, Counsel, and David R. Johnson, Deputy Counsel, Raleigh, for North Carolina State Bar, amicus curiae.

Horack Talley Pharr & Lowndes, P.A., by Robert B. McNeill and Phillip E. Lewis, Charlotte, for North Carolina Land Title Association, amicus curiae.

MARTIN, Justice.

This appeal presents the question of how North Carolina law allocates the risk of loss between a buyer and a seller when the closing attorney in a residential real estate transaction embezzles the sales proceeds. We conclude that in most residential closings buyers possess practical advantages over sellers in terms of protecting themselves from attorney misconduct. Therefore, under principles of equity recognized by this Court as early as 1875, buyers must bear the risk of such losses.

The facts of the instant appeal arise from a real estate transaction involving William and Suzanne Johnson (sellers or plaintiffs) and Timothy and Shelley Schultz (buyers). On 17 November 2005, buyers contracted to purchase sellers' home in Benson, North Carolina for $277,500. Buyers hired attorney Donald Parker to represent them during the closing process. On behalf of buyers, Parker searched the title to the property, obtained title insurance, prepared and recorded a power of attorney, prepared the closing documents, and conducted the closing. Sellers were familiar with Parker from past dealings and paid him $125 to prepare a deed to the property. On 3 January 2006, the parties closed the transaction at Parker's law office.

To help pay for the property, buyers financed $200,320.24 from State Farm Bank (the Bank). On the day of closing, the Bank wired this money to Parker's trust account. Buyers paid the remaining balance from their personal funds. On 3 January 2006 at 4:46 p.m., Parker recorded the general warranty deed and the deed of trust. Thereafter, Parker tendered sellers a check drawn from his trust account for the net proceeds of the sale. When sellers attempted to cash Parker's check in May 2006, it was returned to them marked "NSF" for non-sufficient funds. The State Bar's subsequent investigation revealed that Parker had embezzled the closing proceeds on 4 January 2006.

On 13 July 2006, sellers filed a complaint against buyers, Parker, Jerry Halbrook as trustee under the deed of trust, and the Bank (defendants). Sellers filed an amended complaint against defendants on 20 July 2007 asking the trial court to set aside the conveyance of property and revert fee title back to sellers. In the alternative, sellers requested $277,500 in monetary damages. All defendants except for Parker—who admitted all allegations in the complaint—moved for summary judgment. The trial court ultimately concluded that sellers must bear the risk of loss since they were entitled to the sales proceeds at the time of the embezzlement. The trial court granted defendants' summary judgment motion, and sellers appealed.

The Court of Appeals, in a divided opinion, reversed the trial court's grant of summary judgment in favor of defendants. Johnson v. Schultz, ___ N.C.App. ___, 671 S.E.2d 559 (2009). The Court of Appeals concluded that placing the risk of loss on buyers is "not only more consistent with how residential real estate transactions are generally closed in this state, but also produces a more equitable result." Id. at ___, 671 S.E.2d at 566. Since the trial court did not consider whether Parker acted as sellers' attorney—a disputed issue of fact—the Court of Appeals remanded the case with instructions for the trial court to consider this issue to determine if sellers must share in the loss. Id. at ___, 671 S.E.2d at 570.

Before turning to the merits of this appeal, we briefly address two preliminary issues. First, we observe that the parties utilized the settlement method rather than the escrow method at closing. All three judges at the Court of Appeals agreed on this point, and the majority opinion describes both closing methods in detail. Id. at ___, 671 S.E.2d at 563-64. Second, because the parties did not engage in an escrow closing, the entitlement rule applied in GE Capital Mortgage Services, Inc. v. Avent, 114 N.C.App. 430, 442 S.E.2d 98 (1994), is not applicable to the present case. The entitlement rule provides an equitable framework for placing losses during escrow transactions on "the party who was entitled to the property at the time of the ... embezzlement." Id. at 432, 442 S.E.2d at 100. Avent applied the entitlement rule to an escrow method closing, id., and we decline to extend it to settlement method closings.

Having resolved these preliminary issues, we now turn to principles of equity that have been applied under North Carolina jurisprudence to allocate losses between innocent parties. The court in Avent stated that its application of the entitlement rule was "consistent with the equitable principle that where one of two persons must suffer loss by the fraud or misconduct of a third person, he who first reposes the confidence or by his negligent conduct made it possible for the loss to occur, must bear the loss." 114 N.C.App. at 435, 442 S.E.2d at 101 (internal quotation marks omitted) (quoting Zimmerman v. Hogg & Allen, P.A., 286 N.C. 24, 30, 209 S.E.2d 795, 799 (1974) (alterations in original) (citations omitted)). Thus, while the entitlement rule is limited to escrow closings, there are no similar restrictions on the broader equitable principle underlying the Avent decision.

As early as 1875, this Court declared that "no principle of equity is better established than that where one of two innocent persons must suffer by the acts of a third, he who has enabled such third person to occasion the loss, must sustain it." State ex rel. Barnes v. Lewis, 73 N.C. 138, 144 (1875). This equitable maxim is not unique to this jurisdiction and is a foundational principle of American common law. See, e.g., Eliason v. Wilborn, 281 U.S. 457, 462, 50 S.Ct. 382, 383, 74 L.Ed. 962, 967 (1930) ("As between two innocent persons, one of whom must suffer the consequence of a breach of trust, the one who made it possible by his act of confidence must bear the loss."); 1 William Lawrence Clark & Henry H. Skyles, A Treatise on the Law of Agency § 493, at 1070 (1905) ("Where one or two innocent persons must suffer from the agent's wrongful act, it is just and reasonable that the principal, who has put it in the agent's power to commit such wrong, should bear the loss, rather than the innocent third person." (citations omitted)); 2 John Norton Pomeroy, Equity Jurisprudence § 363, at 9 (Spencer W. Symons ed., 5th ed. 1941) ("`He who trusts most must lose most.'" (citations omitted)).

A principal is typically only responsible "to third parties for injuries resulting from the fraud of his agent committed during the existence of the agency and within the scope of the agent's actual or apparent authority from the principal." Norburn v. Mackie, 262 N.C. 16, 23, 136 S.E.2d 279, 284 (1964) (citations omitted). In the present case there is no evidence that Parker acted within the scope of his actual or apparent authority when he embezzled the sales proceeds.

Even where the law of agency does not apply, however, equitable principles continue to operate. See Goode v. Hawkins, 17 N.C. 317, 319, 17 N.C. 393, 396-97 (1833) ("No one can in equity be permitted to set up a benefit derived through the fraud of another, although he may not have had a personal agency in the imposition." (citation omitted)). Thus, while agency law does not require the principal to absorb losses caused by actions outside the agent's authority, equity may nonetheless place these losses on the party "who first reposed the confidence, or by his negligent conduct made it possible for the loss to occur." Wilmington & Weldon R.R., Co. v. Kitchin, 91 N.C. 39, 44 (1884) (citing, inter alia, Barnes, 73 N.C. 138).

To determine which party reposed confidence in Parker, we must consider the customary procedures for closing real estate transactions in North Carolina. Although both parties in a residential real estate closing are free to hire their own attorney, "the most common practice is for the closing attorney to represent the purchaser and lender while performing limited functions for the seller (such as the preparation of the deed)." Patrick K. Hetrick, Larry A. Outlaw & Patricia A. Moylan, N.C. Real Estate Comm'n, North Carolina Real Estate Manual 508 (2008-2009 ed.) (italics omitted) hereinafter North Carolina Real Estate Manual. In fact, the State Bar instructs that the closing attorney "may prepare the deed as an accommodation to the needs of her client, the buyer, without becoming the lawyer for Seller." N.C. St. B. Formal Ethics Op. 10 (July 14, 2005), reprinted in North Carolina State Bar Lawyer's Handbook 2008, at 317 (2008) hereinafter Ethics Opinion. Moreover, the buyer's attorney usually "handles or coordinates the closing, prepares the closing statement(s), and disburses funds." North Carolina Real Estate Manual 509.

Because of these customary procedures for residential real estate closings, buyers have recourse to actionable legal claims not available to sellers. By embezzling the funds provided for the purchase of sellers' home, Parker breached fiduciary duties he undertook on behalf of buyers. Buyers also maintain the possibility of recovering a portion of their loss from the Client Security Fund of the North Carolina State Bar (CS...