Title Insurance Client Alert - Court of Appeals of Virginia Affirms Circuit Court Order Declaring a Deed of Trust Void

Yesterday, in Loan Funder LLC, Series 715 v. Farm Life, LLC, Record No. 0784-24-4 (Ct. App. Va. Jan. 20, 2026), the Court of Appeals of Virginia issued a significant decision affirming an order entered by the Circuit Court of Loudoun County quieting title to certain real property owned by Farm Life, LLC (“Farm Life”) and declaring void a deed of trust purporting to encumber the property.

This case involves a deed of trust which served as security for a loan taken out by one of Farm Life’s managers to fund a personal business venture without the knowledge or consent of Farm Life’s other managers and members. The lender, Loan Funder, appealed the Circuit Court ruling, arguing that the court misinterpreted the rules in Code § 13.1-1021.1(B) and (C) regarding unauthorized real property transfers by LLC managers.

BACKGROUND:

When Farm Life, LLC was organized in April 2013, its original operating agreement provided that it would be governed by a board of five managers and have seven members, including all five managers. Each member owned a one-seventh share of the company.

One provision of Farm Life’s operating agreement stated that certain “extraordinary matters” could not be taken except by the vote of members “holding at least 51% of the outstanding Percentage Interests entitled to vote.” Among these matters was the act of “sell[ing] or transfer[ing] all or substantially all of the Company assets other than in the ordinary course of business.”

Farm Life owned nearly 100 acres of real property in Hamilton, Virginia. Farm Life’s real property and the structures thereon constituted Farm Life’s only substantial assets. Farm Life’s business involved renting out its real property for various purposes. Farm Life never held itself out as engaged in any business other than the use of its own real property.

Zhongwei Lu (“Lu”), an attorney licensed in New York, was both a member and a manager of Farm Life. On January 7, 2016, Lu applied for a $1.567 million loan with RCN Capital (“RCN”). On the loan application, Lu listed himself as the loan applicant and stated that the purpose of the loan was “[i]nvestment in Blue Coast Bakery.” Lu listed Farm Life’s Hamilton property as the property available as collateral for the loan and noted Farm Life’s ownership of the property.

Lu applied for the loan without informing the other members or managers of Farm Life and without obtaining their permission. Lu did not inform Farm Life’s members and managers of his actions until he had placed a deed of trust on Farm Life’s real property, received the loan proceeds, sent money to fund the bakery project, and placed Farm Life in default on the loan.

RCN classified Farm Life, not Lu, as the loan applicant. Pursuant to RCN’s practices, Lu was not permitted to be a sole guarantor for the loan and was required to obtain the consent of other Farm Life members, because he was not the majority owner of the borrower entity. Lu attempted to subvert RCN’s requirements—and the majority-vote requirements within Farm Life’s own operating agreement—by furnishing documents that falsely indicated that he possessed a majority ownership share of Farm Life.

On January 7 or 8, 2016, Lu submitted a purported operating agreement “amendment” dated December 10, 2015. The document stated that on that day, pursuant to a telephonic meeting, “the ownership of all outstanding memberships” in the company “have been distributed and are now owned by Zhongwei Lu,” giving Lu a 54% ownership in the company. Lu acknowledged at trial, no such meeting ever occurred, and Lu was never transferred a majority ownership share of Farm Life.

RCN’s counsel immediately noticed issues with the document. The document contained mathematical errors. Additionally, the document was signed only by Lu and by no other LLC members or managers. RCN’s counsel concluded that Lu’s amendment was “ineffective” and that, unless the other members of Farm Life were to “get legitimately bought out, they will all need to guarantee the loan.”

After being informed that RCN had rejected his amendment, Lu procured a new amendment to the operating agreement. The new purported amendment corrected mathematical errors, contained signatures that were purportedly by all of Farm Life’s members, including members located in China, and provided a purported explanation for the transfers. The loan broker (314 Capital Partners) and RCN’s counsel accepted this document as satisfactory. Later, RCN agreed to edit the loan term sheet such that only Lu was required to guarantee the loan.

At trial, Lu invoked his Fifth Amendment right against self-incrimination when asked whether he signed the names of Farm Life’s members on this purported amendment. However, Lu also admitted that he was never actually made a majority-in-interest member of Farm Life. Two Farm Life managers whose purported signatures appear on the document testified that they did not sign, or were not aware of, any amendment to the operating agreement.

Lu signed a commitment letter with RCN on January 27, 2016. On the commitment letter, Lu listed Farm Life as the borrower, and wrote, falsely, that he was signing as the “Majority in Interest Member.” Lu, individually, was listed as a guarantor.

During the loan process, RCN produced a “term sheet” that noted, “Borrower is pulling cash out of subject property in order to invest in his bakery business.” Lu testified that neither RCN nor Loan Funder, the entity that eventually took over the loan, ever asked Lu whether Farm Life was in the bakery business.

RCN’s representative testified that “not much” investigation into Blue Coast Bakery was ever performed by RCN. He testified that RCN, as an asset-based lender, focused its inquiry on “the collateral itself.” The representative testified that RCN attempted to account for the risk of fraud on this type of loan in part by charging higher interest rates.

After RCN received an attorney opinion letter attesting to the loan’s validity, Lu signed the loan agreement, promissory note, and deed of trust in February 2016. Loan Funder soon took on the role of lender on Farm Life’s loan and conducted its own independent review and underwriting.

The first loan payment came due in March 2017. In June 2017, Lu wrote to Farm Life to inform them that he had taken out the loan without Farm Life’s consent, used the property as collateral, and that Farm Life was now in default on the loan. Farm Life subsequently moved to remove Lu as a manager.

In July 2018, Farm Life brought this suit against several parties, including RCN and Loan Funder. Its third amended complaint was filed in March 2020. In one count, Farm Life asked the trial court to quiet title to its real property and to void the deed of trust, as well as certain other loan documents.

On March 12, 2024, the trial court ruled that title to the property would be quieted in favor of Farm Life. In support of this ruling, the trial court found:

Lu lacked actual authority to take out the loan.
Because a Florida bakery was not related to the purpose of Farm Life’s business, Lu was not “even apparently carrying on in the ordinary course of Farm Life’s business, or the business of the kind carried on by Farm Life” when he encumbered the property.
Under Code § 13.1-1021.1(B), Farm Life was not bound by Lu’s actions in signing the deed of trust, and that the deed of trust was therefore void.
The promissory note could not be voided by the quiet title action.

The trial court entered its final order on April 12, 2024.

APPEAL:

On appeal, Loan Funder argues:

The trial court erred when it held that Farm Life was not bound by the deed of trust.
The trial court erred in applying Code § 13.1-1021.1(B) rather than Code § 13.1-1021.1(C) to the facts of this case.
The trial court’s error was not harmless because under Code § 13.1-1021.1(C), the deed of trust was conclusive in its favor.

The Court of Appeals agreed with Loan Funder that the trial court erred in applying Code § 13.1-1021.1(B) rather than Code § 13.1-1021.1(C). However, the Court of Appeals also held that the trial court’s error was harmless to the outcome in this case. Pursuant to the trial court’s findings and the record, the deed of trust was invalid under Code § 13.1-1021.1(C).

ANALYSIS:

In the Court of Appeals’ opinion, the Court supported the affirmation of final order rendered by the trial court based on the following:

Code § 13.1-1021.1(C), not Code § 13.1-1021.1(B), governs the deed of trust.
Subsection C applies when a manager signs a deed of trust encumbering the LLC’s property.
Inquiry does not end with holding that the trial court erred.
In every case, this Court must assess whether an error was harmless before reversing the judgment of a trial court.
The trial court explained that Lu lacked actual authority to encumber the LLC’s property with a deed of trust in order to fund a personal bakery project “unrelated to any of Farm Life’s business.” This finding is binding on this Court, as Loan Funder did not assign error to it. This finding is supported by the provisions of Farm Life’s authentic operating agreement. The operating agreement said that no transaction transferring all or substantially all of the LLC’s assets outside of the ordinary course of business could be performed without the consent of members owning over half of the company. Lu only owned one seventh of the company and the transaction involved transferring the LLC’s only substantial asset outside the ordinary course of business.
Farm Life’s work bore no relation to the bakery business or the state of Florida. The record shows that Lu, in his attempt to prove his authority to act, provided Loan Funder with at least one document that was evidently flawed and legally ineffective.
The term “knowledge” in Code § 13.1-1021.1(C) should be read to mean “constructive knowledge” as that term is understood in the relevant Virginia common law.
The common law rule directly on point is the doctrine of apparent authority. “The general rule is that as between the principal and agent and third persons, the mutual rights and liabilities are governed by the apparent scope of the agent’s authority.”
An agent’s apparent authority is limited to the authority that a reasonable person under the circumstances of a particular case would believe the agent possessed.
In applying the rules of statutory construction, the Court held that “knowledge,” as used in Code § 13.1-1021.1(C), should be read to mean “constructive knowledge” as that term is used in Virginia’s common law of apparent authority.
Under the common law of apparent authority, a third party is generally barred from citing its reliance on an agent’s appearance of authority when the agent has evidently diverged from the ordinary purposes and activities of his or her business.
While an everyday person cannot be expected to gain an understanding of the contours of a seller’s business, it is generally reasonable for a sophisticated corporate entity to gain at least a basic understanding thereof.
In Virginia, “[o]ne who deals with an agent does so at his own peril and has the duty of ascertaining the agent’s authority.”
Not all claims of authority by an agent can suffice to confer apparent authority upon himself. Virginia case law indicates that an agent’s acts establishing apparent authority must be traceable to actions of the principal; the principal must represent the agent as authorized to perform an action or must permit the agent to do so.

FINDINGS:

The stark, apparent divide between Farm Life’s day-to-day activities and the purpose for which Lu sought to encumber its real property precluded Loan Funder from relying on Lu’s appearance of authority without further inquiry. Loan Funder, aware that an LLC manager was seeking to obtain a loan to perform business bearing no relation to the principal’s type of business or geographic location, was on notice that they were not dealing with an ordinary LLC manager and was responsible for dealing with him as such.
To the extent to which Loan Funder could have remained wholly unaware of Lu’s divergence from Farm Life’s ordinary course of business and instead focused solely on the value of the collateral, such a sophisticated corporate entity was not permitted to do so.
Several aspects of Lu’s actions outside of his divergence from Farm Life’s ordinary business should have further cast doubt on Lu’s ability to act on its behalf. In interacting with Lu at its own risk, Loan Funder, a sophisticated party, faced an agent who (1) appeared to be operating outside the ordinary scope of his principal’s business, (2) was attempting to transfer his principal’s real property, its only substantial asset, (3) initially provided an operating agreement showing his lack of authority to perform the relevant transaction alone, and (4) attempted to counteract the effect of that operating agreement with an error‑ridden document with obvious legal deficiencies. Given this combination of circumstances, a reasonably prudent sophisticated corporate lender would not have been justified in believing, without further inquiry, that Lu was authorized to take out the deed of trust on Farm Life’s behalf.
Lu’s claims of authority in no way represented the will or the permission of his principal, as is required to create apparent authority. Farm Life never represented Lu as the LLC’s majority owner and never permitted him to represent himself as such.
Acknowledgement that Loan Funder faced a difficult situation in this case in that Lu apparently attempted to assuage the lender’s concerns through the use of forgery. An agent’s criminal acts and forgeries, however, generally do not bind the principal.

In sum, the Court of Appeals held as follows: The trial court erred by relying on Code § 13.1-1021.1(B) instead of Code § 13.1-1021.1(C). However, this error was harmless to the outcome of the case because the trial court’s findings and the evidence in the record compel the conclusion that Farm Life was not bound by the relevant deed of trust under the standards set forth in Code § 13.1-1021.1(C), read to preserve the common law of apparent authority. Therefore, the judgment of the trial court was affirmed.