When the attorney closing a residential real estate transaction steals the closing proceeds, does the buyer or the seller bear the loss?
The holding of the 2-1 majority today in the North Carolina Court of Appeals decision in Johnson v. Schultz is that in the typical transaction the loss will fall on the party whose lawyer absconded with the funds, at least in the absence of fault.
In North Carolina, that’s in most cases going to be the buyer, who typically selects the closing attorney. The holding of Judge Robert C. Hunter, concurred in by Judge Martin, was as follows:
we conclude that where, as here: (1) one attorney is used to handle a residential real estate closing, (2) the attorney misappropriates the remaining balance of the purchase price owed to the seller, and (3) the risk of loss must be allocated to one or more parties, courts should first consider the existence of fault. However, if fault does not exist and the risk must be allocated between essentially “innocent” parties, courts should then consider which parties had an attorney-client relationship with the wrongdoing attorney and impose the risk of loss on those parties. Where multiple parties to the transaction have an attorney-client relationship with the offending attorney, the risk of loss should be shared among them.
The Court rejected the approach taken by the trial court, which had followed what is known as the "entitlement rule." Under that rule, the loss fell on the seller, who was the party entitled to the funds in the hands of the attorney. The theory of the entitlement rule is that that the holder of an escrow is the agent for the party for whom the funds are being held. An earlier Court of Appeals decision, GE Capital Mortgage Services v. Avent, 114 N.C. APP. 430, 442 S.E.2d 98 (1994), had followed the entitlement rule in a case involving an escrow held following a residential closing, but it was distinguished by today’s decision.
Judge Wynn dissented, and took a completely different approach. He would have placed the risk of loss on the seller, because the seller had opted to take its proceeds in the form of a check drawn on the closing attorney’s trust account, as opposed to the cash payment specified in the standard 2005 NCBA contract form. The majority reasoned that requiring sellers to walk away from the closing with cash "would significantly disrupt the way real estate transactions are traditionally closed in North Carolina."
The opinion contains a detailed discussion of how residential real estate transactions are closed in North Carolina. Those generally involve the "settlement closing" method, but sometimes involve what’s called an "escrow closing." The case also defines what an "escrow" is, for the first time in a reported North Carolina appellate opinion, and discusses obscure types of escrows like a "set-aside escrow" and a "deed and money escrow." (You’ll have to read the opinion if you want to know more about these things).
In the Johnson case, the closing attorney, now disbarred, had made off with more than $250,000 in closing proceeds owed to the seller. The case was apparently a big deal in the residential real estate closing world. The North Carolina State Bar weighed in with an amicus brief on behalf of the seller, which was countered by an amicus brief by the North Carolina Land Title Association for the buyer.
It’s now on to the Supreme Court. And even then, the case may not be over. That’s because the buyer claimed that the attorney had been acting for the seller as well, and the Court of Appeals held that the case needed to be remanded for resolution of this issue.