Shifting the Loss from a Forged Instrument:  Protection for Innocent Real Estate Purchasers and Mortgage Lenders Under The Doctrine of Equitable Estoppel

Under California law, a deed that purports to convey title (ownership) or any other interest in real property, such as an easement, is completely void if the conveyancing party’s signature on the deed is forged. The same holds true for a mortgage (called a “deed of trust” in California) where the borrower’s signature is forged. That means that a forged deed or mortgage is invalid from the get-go, and is ineffective to transfer any interest in real property to another, even when the intended recipient is innocent, pays fair market value, and has no knowledge or reason to suspect that the signature of the conveyancing party is a forgery.

Does the law recognize any exceptions to this harsh rule for an innocent purchaser or lender who discovers after the fact that the owner’s signature was forged? While the right to relief is dependent on analyzing the facts in each case, under certain circumstances the innocent purchaser or lender may find relief under a legal doctrine called equitable estoppel.

California Civil Code Section 3543 states broadly that, “Where one of two innocent persons must suffer by the act of a third, he, by whose negligence it happened, must be the sufferer.” This statute rests on the general principle that when one of two innocent persons must suffer a loss, the loss must be borne by the one whose conduct, acts or omissions brought about the injury. While an owner of real property cannot truly be divested of his or her title by a forged deed or mortgage, he or she may be equitably estopped by their conduct from denying its validity. Stated differently, the doctrine of equitable estoppel under Civil Code Section 3543 operates on the principle that the party who knows it is a victim of wrongdoing is in a better position to prevent further loss to other victims.

California courts have historically applied Civil Code Section 3543 in a variety of factual situations where the issue of real property ownership was in dispute.

In the 1941 case of Merry vs. Garibaldi, the owner of a parcel whose name was forged on a promissory note and mortgage by her son-in-law who then fraudulently absconded with the loan money remained silent after learning that her signature had been forged on both instruments. Her silence over time prevented the defrauded lenders from learning about the fraud in time for them to file a lawsuit that might have enabled them to recover the money from the owner’s son-in-law who committed the fraud because the statute of limitations had expired. The court decided that the property owner was equitably estopped, or prohibited from denying that the forged note and mortgage on her property were valid, and the lenders were entitled to enforce their rights under the mortgage. According to the court, as between the victims of the fraud in that situation – the homeowner whose signature had been forged and the couple who made the loan – the notions of equity and justice should not compel the lenders to bear the loss.

Another case from 1942 called Meadows v. Hampton Live Stock Com. Co., applied Civil Code Section 3543 with regard to title to cattle rather than real estate, but the principle was the same. The owner of the cattle received two checks from a cattle auctioneer that were both dishonored by the bank, yet he stood by idly while the auction company auctioned off and sold the cattle to third parties. The court found that the owner of the cattle watched as the cattle were being unloaded and knew that they would be offered for sale to others, and he thereby “entrusted the [auction company] with the indicia of ownership.” The court went on in its published opinion to hold that the owner of property who clothes another with the apparent title to it, or the power of disposition of it, is estopped from afterwards asserting his title against an innocent third party purchaser who has thereby been induced to deal with the apparent owner.

In the more recent case of Wurzl v. Holloway from 1996, the Court of Appeal applied Civil Code Section 3543 in favor of another mortgage lender who received a forged note and mortgage in a factual scenario that the court described as one of “misplaced confidence” by the property owner in an unlicensed escrow operation.

In order to invoke equitable estoppel generally or Civil Code section 3543 in particular, it must be established that the party to bear the loss was, at a minimum, negligent in allowing the other victim to be defrauded by the forgery. Civil Code section 3543 expressly requires a finding of negligence on the part of the property owner, specifying that “he, by whose negligence it happened, must be the sufferer.” A myriad of cases have required a finding of negligence on the part of the property owner before applying Civil Code Section 3543 to protect the interests of the other victim. In the absence of negligence on the part of the property owner, the courts have held that the third party victim must bear the loss, as the Court of Appeal recently determined in the case of WFG v. Wells Fargo that was published in June of this year. In that case, the court held that a homeowner has no duty to monitor and correct the public records, specifically the grantor-grantee index in the county where his or her property lies in order to ensure that no one has recorded a forged deed to the property, purporting to convey title to another party. The simple failure of a property owner to discover the existence of a fraudulent deed that is recorded in the chain of title for their property, without evidence of more culpable conduct on the part of the owner, is insufficient to establish the negligence that is necessary for a third party victim of such fraud to bring a successful claim for relief against the true property owner under Civil Code Section 3543.

Whether an innocent purchaser of real property who has received a deed, or an innocent lender who has received a mortgage on which the property owner’s signature was forged has a claim for relief against the property owner under Civil Code Section 3543 is a complicated issue that requires a detailed analysis of the facts. However, in situations where the property owner is negligent in allowing the party who forged the instrument(s) to defraud an innocent third party with the forged instrument, the innocent third party may have grounds to bring an action in court to equitably estop – or bar – the true property owner from denying that the third party has acquired valid title to, or a mortgage lien on, the property.