We all are aware of the turmoil in the financial industry through which our country has lived over the past eight or so years. Banks and other lenders have gone out of business, been taken over by other entities and vast numbers of loan documents have been shifted around. In addition borrowers have experienced great financial distress sometimes resulting in defaults on their loans. And private lenders have been active in financing deals, especially to borrowers who purchase the lenders’ own property.

It sometimes happens that a borrower defaults on a loan that is secured by a deed of trust and the lender does not take action for a substantial period of time to enforce the lender’s rights. Normally if there is a recorded encumbrance on the title to real estate the date of the encumbrance is shown on a preliminary title commitment but the due date of the promissory note secured by the deed of trust is not usually shown. Sometimes the actual recorded deed of trust will state the due date of the promissory note. If more than six years have elapsed between the date of the recorded deed of trust and the date an investor examines the situation it is possible that the promissory note is stale.

A stale promissory note cannot be enforced, and that means that any deed of trust that purports to secure the obligation of the stale promissory note cannot be enforced either. The law says that the record owner of real property is entitled to have a judgment quieting title against the lien of any such deed of trust that purports to secure the obligation of a stale promissory note.

A few years ago a case was decided in which a private lender made a loan secured by a deed of trust on real property in connection with a sale of that property by the lender. The promissory note was due in two years, and after the default by the borrower the property was transferred to a trust as to which the lender was the trustee. The trust later borrowed against the property and gave another deed of trust to a different lender, and when the second note was defaulted the lender on that note foreclosed and took title at the trustee’s sale. The trustee successor to the original lender threatened, twelve years after the default on the original promissory note, to foreclose the original first deed of trust.

The lender who had foreclosed on the second deed of trust sued to quiet title based on the staleness of the first promissory note. The court upheld the second lender’s right to have the first deed of trust extinguished due to the stale promissory note.

The entity that had sought to foreclose the first deed of trust claimed in defending that deed of trust that the due date of the promissory note had been extended over the years by mutual agreements, but none of these agreements was in writing. The court held that the statute of frauds prevented any of these claimed extensions of the promissory note from avoiding the effect of the statute of limitations.

This fact pattern is not a common one, to be sure. It may occur more often in private lending than in institutional lending, but as noted at the outset of the article, things have gotten lost in the shuffle of paperwork associated with transferring assets and obligations between banks. It is still something to think about when investing in property that is encumbered, especially if the deed of trust shows that it was granted to a private lender and is more than six years old. In addition an investor could look to see if the original deed of trust was made to an entity such as Countrywide which has gone out of business and been taken over by regulators or other entities. It may be worth an investor’s time if any of these indicators is present to do a little digging to find out details about the status of the promissory note. The preceding is intended for education and should not be considered legal advice.