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Tuesday, November 16, 2010

Update: Mortgage Foreclosure and Missing Notes


    This blog post’s discussion of the law has been updated in a subsequent post on this blog.  See “Mortgage Foreclosures, Missing Promissory Notes, and the Uniform Commercial Code: A New Article,” February 11, 2013, at



This post, concerning missing promissory notes in mortgage foreclosures, about which I've written in the past (see "Related Posts," below), is in three parts. Part One is for my usual blog readers, and tells the story of my recent frantic trip to Boston to lecture on this topic, which has me reliving a nightmare. Part Two is for readers seeking general guidance on the necessity of a promissory note before foreclosure is possible. Part Three is a technical legal explanation of the law for lawyers involved in the legal battles concerning these missing notes.

Part One: Sliding into the Lectern Like a Base Runner at Home Plate

Since 2009 I've given a number of lectures on the missing promissory note in mortgage foreclosures, and the most recent was at 4 p.m. last Thursday in Boston at the annual meeting of the National Consumer Law Center (NCLC), which ran Thursday through Sunday, and contained numerous programs on a variety of consumer law subjects. Mortgage foreclosures are a hot topic these days, of course, and I was told ahead of time that my one hour lecture was already very popular with consumer lawyers signing up for the different sessions.

When I dream and have nightmares, they're almost always the same dull kind of thing: I can't get there from here, or I'm unprepared for class, or I can't find the room I'm supposed to teach in, or similar terrors about loss of control. Very uninteresting dreams, but, control freak that I am, horrors that have me waking in a panic. So it's always doubly troubling when they come true, as in this trip to Boston.

On Wednesday, November 10, the day before I was to leave, I was sitting at my computer in the late morning reading emails when a notice appeared on my screen that a virus had been detected and I should click on the warning box to see more about this threat. Without thinking (sigh), I did so, only to welcome the virus into my computer, which promptly crashed and remained crashed until the following Monday (yesterday) when I was able to retrieve it from the shop. I've since learned that such evil notices are called "scareware," and the people who create them and destroy other people's computers should be given the old Roman punishment of being sewed into a sack with an adder, a cat, and a chicken, and then cast into the sea (I'm not usually in favor of capital punishment, but in this case I'd carry out the sentence myself while smiling). For me the computer crash meant not only the loss of my notes on the speech I was to give the next day, but also non-access to the materials I'd already sent to Boston that were being duplicated and handed out to attendees at the conference. Everybody there would have more notes on my lecture than I did. All I had was my memory of what I'd said in past talks.

That was annoying, but not quite a catastrophe. I'm an accomplished speaker, an expert on this topic, filled with new thoughts and information, and good at impromptu situations where the spotlight hits me and I'm expected to be entertaining and informative. Moreover, since my flight plans had me arriving in Boston at noon, I could get to the Park Plaza Hotel in plenty of time to pick up the conference materials containing the eight pages I'd sent, and review and mark them up enough to guide me through my talk.

The woman who runs my life, Barbara (see the post of that title, May 5, 2010) had called me a few weeks before about the reservations she was making for me, and informed me there was a very expensive direct flight from Columbus, where I live, to Boston, and a much cheaper airfare for a flight that required me to change planes in Philadelphia. Not wanting to saddle the NCLC with a huge reimbursement, I told her to route me through Philadelphia. She assured me that if I left Columbus on US Airways at 8:30 a.m. that Thursday morning, I would be in Boston by noon. "Book the flights," I told her, and she did. A week before the speech, The Wall Street Journal contacted me and asked if I would be willing to grant their reporter an interview right before my presentation at 2 p.m. at the Park Plaza Hotel (she would take a train from New York City to meet me there). Pleased at being asked and at the chance to spread my message about promissory notes, I agreed readily. Then I heard from friends in Boston, Rhode Island, and New York who wanted to hear my talk and asked if I could get them into the room. I arranged that, and agreed to meet them at my hotel room at 3 p.m., with the idea we would go down to the ballroom where I was to speak and, after my talk, go to supper together. It was a busy schedule, but not overly so.

I'm not a morning person, so it was with great personal sacrifice I rose that Thursday at 6 a.m., grabbed my overnight bag, drove myself to the airport, checked in and received my two boarding passes, and made it through the security screening a little after 7 a.m. With plenty of time before my 8:30 departure, I stopped at a coffee shop in the concourse and sipped a cup while reading the morning paper. A little before 8 a.m. I wandered down to my departure gate, and that's when the nightmare started. The gate was barren: no attendants, no passengers, no departure times on the screen at the podium. My early morning dullness fled at once, replaced by rising panic. What was wrong?

It turned out that what was wrong was an error Barbara had made (which almost never happens). The reservations she'd booked did have me leaving Columbus at 8:30 and arriving in Boston at twelve, but they were for p.m. and not a.m.!  Suddenly I had no reservations at all that would get me to my destination in time to do all the things I'd scheduled. Jaw-dropped, I pictured a ballroom filled with consumer lawyers staring blankly at an a vacant lectern on an empty stage.

Thanks to the diligent work of a wonderful woman at US Airways (and the payment of an extra fee of $300!), I was able to snag a ride on a plane to Washington, D.C., which then passed me on to a flight to Boston, arriving a little after 1 p.m. My Nigerian cabdriver assured me he could get me to the Park Plaza before 2 p.m., and, by golly and bless him, he did it (I gave him a large tip). I slid into the hotel just before two, registered and pocketed my room key, and as I entered the room the phone was ringing. It was the reporter from The Wall Street Journal asking if I could meet her at the coffee shop next door to the hotel. Since I hadn't eaten that day, I was pleased to be able to do grab a sandwich while explaining to her how promissory notes worked in mortgage transactions. Then, as I left her and entered the hotel, I scooted up to the registration desk and snagged a copy of the materials handed out to all the attendees. I took it back to my room, where my friends promptly showed up and, of course, wanted to talk. I had a quick visit with them and then, explaining my circumstances, sent them down to the ballroom at 3:40, giving me a little time to scan the materials and make notes on what I needed to say.

I came into the crowded ballroom (between 200 and 300 lawyers were present, including numerous former students, as I later learned), and climbed to the stage exactly at 4 p.m. I shook hands with the moderator, who commented that I looked frazzled. "Worried about your speech?" he asked, concerned. I gave a little laugh. "Oh, no," I told him as he walked to the lectern to introduce me, "the speech will be fun—it was getting here that's frazzled me!"

The presentation went very well. I walked the attendees through the Uniform Commercial Code rules on promissory notes, brought them up to date with recent developments and thoughts, and received applause three times during the speech, most loudly when I said the fraudsters who were submitting false paperwork to the courts and cheating their investors should be prosecuted and thrown in jail. As always in these sessions, I learned a lot from the audience when I took questions. One of them about waiver of the right of presentment, stumped me, though I now have some ideas on how to handle that difficulty, see below.

After the talk, my friends and I repaired first to a bar (where I had a martini, and I needed it) and then to a wonderful supper. Life was good again. The "can I get there in time?" nightmare was over, and the return trip on Friday was uneventful.

Part Two: General Guidance to Foreclosure and Missing Notes

As I've explained in the posts listed at the very end, the law is clear in all fifty states: unless the foreclosing bank has possession of the original promissory note the home owner signed at the closing, no foreclosure is possible. Why not? Because without that note, the bank is an inappropriate entity to do the foreclosure (in legal terms, the bank "lacks standing"). The law clearly says that only a "person entitled to enforce" the promissory note may do so, and that term is defined as someone in possession of the note or who has a logical explanation as to why it cannot be produced. A copy of the note will not suffice. There might be one hundred copies of the note, but that wouldn't permit one hundred different foreclosures. As one lawyer attending my talk said to me afterwards, "The banks say a copy of the note should be enough, but you can bet they wouldn't take a copy of a check!" In any foreclosure action, the home owner should demand to see the original note. If it is not produced, no judge should permit the foreclosure to go forward. In that situation, the foreclosing bank should sit down with the home owner and work out some sort of compromise acceptable to both.

Part Three: The Legal Rules Concerning Missing Promissory Notes

This segment is for lawyers and is quite technical. It is a rewritten version of the materials that I used in Boston at the NCLC conference in November, 2010.



                                             A Discussion by Douglas Whaley
                                                 Professor of Law Emeritus
                                                 The Ohio State University

The Problem:

A mortgagor is having trouble making payments and wants to work out a new payment schedule, but has trouble finding out who is the entity currently holding the mortgage (payments are sent to a mortgage servicing company, which has been non-helpful). Finally the mortgagor gets a notice from the current holder of the mortgage (an assignee), threatening foreclosure unless all missed payments are made and late fees paid as well. The mortgagor can’t do this, so the assignee files suit to foreclose. One problem with this lawsuit is that while the plaintiff can prove the mortgage was assigned to it (there is a central registration system—MERS, see below—so this part is sometimes easy), but does not possess the original promissory note, which no one seems to be able to find. The assignee (perhaps, but not always) does have a copy of the original promissory note, which it attaches to the complaint in a judicial foreclosure action.

Why doesn’t the current assignee of the mortgage have the promissory note? Well, there are many possibilities. In the feeding frenzy that was the mortgage business of the last decade, things were done fast and furiously. Mistakenly believing that the mortgage assignment was all that was necessary, the assignee of the mortgage did not always see to it that the promissory was transferred and so it may be still in the possession of the original mortgage/payee, or, failing that, no one is sure exactly where the note is at the moment (perhaps it was bundled with hundreds or thousands of other notes when the mortgage packages were securitized, but locating that bundle or the using personnel to search through it and retrieve the relevant note is either impossible or not cost efficient). However, the current plaintiff can prove the validity of the assignment of the mortgage to itself, and surely some minor detail like the current location of the promissory note is irrelevant; otherwise the mortgagor could get away with not paying the mortgage debt, and being safe also from foreclosure! The heavens would fall.

The Issue:

Should the holder of the mortgage be able to foreclose when it does not have possession of the promissory note?

The Answer:

Absolutely not. Article 3 of the Uniform Commercial Code (see below) could not be clearer. Only the “person entitled to enforce” the promissory note can sue on it, and that person must either have possession or prove the note has been lost or stolen. But, alas, the courts often get this wrong, most recently in the appalling decision of Bank of New York v. Dobbs, 2009 WL 2894601 (Ohio App. 2009) (The court ignored the UCC and cited to the Restatement of Property (Mortgages) §5.4 for the proposition that an assignment of the mortgage is presumed to be also an intention to assign the note. Of course it is, but intentions are not the same thing as actually doing it—witness my annual New Year Eve vow to exercise and lose weight). Other Ohio courts have reached the correct result: U.S. Bank N.A. v. Marcino, (2009) 181 Ohio App.3d 328. The federal courts have proved sensitive to all this; see, e.g., In re Foreclosure Cases, 2007 WL 3232430 (N.D.Ohio 2007); In re Vargus, 396 B.R. 511 (Bkry. C. D. Cal. 2008) (there are a number of similar cases).


The relevant UCC sections, which we will explore one by one in the text following them, are:

§ 3-412. Obligation of Issuer of Note or Cashier's Check.

The issuer of a note . . . is obliged to pay the instrument (i) according to its terms at the time it was issued . . . . The obligation is owed to a person entitled to enforce the instrument . . . .
[Emphasis added.]

§ 3-301. Person Entitled to Enforce Instrument.

"Person entitled to enforce" an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3-309 or 3-418(d) . . . .


This section replaces former Section 3-301 that stated the rights of a holder. The rights stated in former Section 3-301 to transfer, negotiate, enforce, or discharge an instrument are stated in other sections of Article 3. In revised Article 3, Section 3-301 defines "person entitled to enforce" an instrument. The definition recognizes that enforcement is not limited to holders. The quoted phrase includes a person enforcing a lost or stolen instrument. Section 3-309. It also includes a person in possession of an instrument who is not a holder. A nonholder in possession of an instrument includes a person that acquired rights of a holder by subrogation or under Section 3-203(a). It also includes any other person who under applicable law is a successor to the holder or otherwise acquires the holder's rights. It also includes both a remitter that has received an instrument from the issuer but has not yet transferred or negotiated the instrument to another person and also any other person who under applicable law is a successor to the holder or otherwise acquires the holder's rights.
[Emphasis added.]

§3-203. Transfer of Instrument; Rights Acquired by Transfer. [THIS IS THE "SHELTER RULE"]
* * *
(b) Transfer of an instrument, whether or not the transfer is a negotiation, vests in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, but the transferee cannot acquire rights of a holder in due course by a transfer, directly or indirectly, from a holder in due course if the transferee engaged in fraud or illegality affecting the instrument.


2. Subsection (b) states that transfer vests in the transferee any right of the transferor to enforce the instrument "including any right as a holder in due course." If the transferee is not a holder because the transferor did not indorse, the transferee is nevertheless a person entitled to enforce the instrument under Section 3-301 if the transferor was a holder at the time of transfer. Although the transferee is not a holder, under subsection (b) the transferee obtained the rights of the transferor as holder. Because the transferee's rights are derivative of the transferor's rights, those rights must be proved. Because the transferee is not a holder, there is no presumption under Section 3-308 that the transferee, by producing the instrument, is entitled to payment. The instrument, by its terms, is not payable to the transferee and the transferee must account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it. Proof of a transfer to the transferee by a holder is proof that the transferee has acquired the rights of a holder. At that point the transferee is entitled to the presumption under Section 3-308. . . .
[Emphasis added.]

§ 3-204. Indorsement.
(a) "Indorsement" means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument. . . . For the purpose of determining whether a signature is made on an instrument, a paper affixed to the instrument is a part of the instrument.
[Emphasis added—such a paper was called an “allonge” at common law and by the Official Comment to this section. See allonge discussion below.]

§ 3-308. Proof of Signatures and Status as Holder in Due Course.
* * *
(b) If the validity of signatures is admitted or proved and there is compliance with subsection (a), a plaintiff producing the instrument is entitled to payment if the plaintiff proves entitlement to enforce the instrument under Section 3-301 . . . .


2. Subsection (b) restates former Section 3-307(2) and (3). Once signatures are proved or admitted a holder, by mere production of the instrument, proves "entitlement to enforce the instrument" because under Section 3-301 a holder is a person entitled to enforce the instrument. Any other person in possession of an instrument may recover only if that person has the rights of a holder. Section 3-301. That person must prove a transfer giving that person such rights under Section 3-203(b) or that such rights were obtained by subrogation or succession.
[Emphasis added.]

§ 3-309. Enforcement of Lost, Destroyed, or Stolen Instrument.
(a) A person not in possession of an instrument is entitled to enforce the instrument if (i) the person was in possession of the instrument and entitled to enforce it when loss of possession occurred, (ii) the loss of possession was not the result of a transfer by the person or a lawful seizure, and (iii) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process.
(b) A person seeking enforcement of an instrument under subsection (a) must prove the terms of the instrument and the person's right to enforce the instrument. . . .
[Emphasis added.]

§ 3-601. Discharge and Effect of Discharge.
(a) The obligation of a party to pay the instrument is discharged as stated in this Article or by an act or agreement with the party which would discharge an obligation to pay money under a simple contract.

§ 3-602. Payment.
Subject to subsection (e), an instrument is paid to the extent payment is made by or on behalf of a party obliged to pay the instrument, and to a person entitled to enforce the instrument.

How this all fits together:

A. The Difference Between the Note and the Mortgage

It is a common law maxim that “security follows the debt”; Noland v. Wells Fargo Bank, N.A., 395 B.R. 33 (Bankr. S.D. Ohio 2008); Manufacturers and Traders Trust Co. v. Figueroa, 2003 WL 21007266, 34 Conn. L. Rptr. 452 (Conn. Super. 2003). This means the mortgage (the “security”) travels along with the promissory note (the “debt”). Thus whoever has the promissory note is the only entity that can enforce the mortgage. The mortgage itself is not a debt; it merely reflects a security interest in collateral.

There has been an attack on this concept recently in a way that might aid homeowners.  In U.S. Bank v. Ibanez, handed down on January 7, 2011, the Massachusetts Supreme Judicial Court ruled that a mortgage cannot be assigned in blank (a common practice in the securitization of mortgages), so that the holder of a blank mortgage assignment was not the proper entity to foreclose.  “We have long held that a conveyance of real property, such as a mortgage, that does not name the assignee conveys nothing and is void,” the court said.  When the assignee argued that it held the promissory note, which automatically gave it the appropriate ownership interest in the mortgage ("security follows the debt"), the court disagreed, saying that a more formal assignment of the mortgage was necessary for a clear real estate title.  “In Massachusetts, where a note has been assigned but there is no written assignment of the mortgage underlying the note, the assignment of the note does not carry with it the assignment of the mortgage.” The court then added that a holder of the note could file a lawsuit to obtain the mortgage.  Without a properly assigned mortgage the mortgage holder remains unchanged, which is why the banks lacked the power to foreclose.  The court refused to apply its decision only to future cases, thus creating a legal mess in Massachusetts that could undo foreclosures held years ago.  Bank stocks fell instantly.  The case is U.S. Bank v. Ibanez, 458 Mass. 637, 2011 WL 38071 (Mass. 2011); see also  Interestingly, in Utah some homeowners have been successful in bringing quiet title actions to strip off the mortgage where no entity can prove a valid chain of assignments of the mortgage.  Doing that would rid the property of the mortgage lien and permit subsequent sale, though it would not excuse the mortgagor's liability on the promissory note should it finally surface in the hands of a PETE. See  The Massachusetts Supreme Judicial Court did not consider the effect of UCC §9-203(g), discussed below at "Article 9 Complications," which clearly states that possession of the promissory note automatically creates a security interest in the mortgage even without a formal assignment of same.  Why didn't the court discuss this very relevant statute?  My guess is that no one (not the parties, not the law clerks, not the judges) came across it in preparing the case or the decision (so here the UCC law professor emits a sad sigh).

The obligation giving rise to the mortgage is reified in the promissory note, and only the current possessor of the promissory note can bring suit thereon (regardless of who is the assignee of the mortgage). An assignee of the mortgage who does not have the promissory note is not allowed to foreclose on the mortgage (see extensive discussion in the Connecticut decision cited above, and in In re Foreclosure Cases, 2007 WL 3232430 (N.D.Ohio 2007); In re Vargus, 396 B.R. 511 (Bankr. C. D. Cal. 2008)). Nor will a mere copy of the note suffice. Anyone could make a copy, but that doesn’t create a right to sue. The actual note must be produced. Note that the Official Comments above all refer to possession of the instrument as necessary to its enforcement.

When it comes to actions brought on a promissory note, the Uniform Commercial Code is clear. The maker/issuer of the note (the mortgagor) who wishes to be discharged from liability on the note can only make payment to a "person entitled to enforce” the instrument (“PETE” for short hereafter); §3-312. PETE is defined in §3-301 as the "holder" of the instrument (one who takes through a series of valid indorsements—a “negotiation”) or someone having the rights of a "holder" under §3-203(b)'s shelter rule, both discussed below.

B. “Negotiation”

A proper negotiation of the note creates “holder” status in the transferee, and makes the transferee a PETE. The two terms complement each other: a “holder” takes through a valid “negotiation,” and a valid “negotiation” leads to “holder” status. How is this done? There are two ways: a blank indorsement or a special indorsement by the original payee of the note.

With a blank indorsement (one that doesn’t name a new payee) the payee simply signs its name on the back of the instrument. If an instrument has been thus indorsed by the payee, anyone (and I mean anyone) acquiring the note thereafter is a PETE, and all the arguments below will not carry the day. Once a blank indorsement has been placed on the note by the payee, all later parties in possession of the note qualify as “holders,” and therefore are PETEs.

If the payee’s indorsement on the back of the note names a new payee (“pay to X Company”), that is called a “special indorsement.” Now only the newly nominated payee can be a “holder” (a status postponed until the new payee acquires the note—you have to hold to be a holder). The special indorsee, wishing to negotiate the note to a new owner, may now sign in blank, creating a bearer instrument, or may make another special indorsement over to the new owner.

Only if there is a valid chain of such indorsements has a negotiation taken place, thus creating “holder” status in the current possessor of the note and making that person a PETE. If there are problems with the negotiation (the original payee’s name is missing, for example), the person suing on the instrument will have to rely on the “shelter rule” to become a PETE (see discussion of the shelter rule below).

C. The Allonge

Sometimes the indorsement is not made on the promissory note itself, but on a separate piece of paper, called an “allonge,” and formally defined as a piece of paper attached to the original note for purposes of indorsement. An allonge (which has an interesting history, traceable to the days in which instruments circulated for long periods before being presented for payment) must be “affixed to the instrument” per §3-204(a)’s last sentence (see above). It is not enough that there is a separate piece of paper which documents the transfer unless that piece of paper is “affixed” to the note; see Adams v. Madison Realty & Dev., Inc., 853 F.2d 163, 6 U.C.C. Rep. Serv. 2d 732 (3d Cir. 1988) (mere folding of the alleged allonge around the note insufficient—$19.5 million involved). What does “affixed” mean? The common law required gluing. Would a paper clip do the trick? A staple? See Lamson v. Commercial Credit Corp., 187 Colo. 382, 531 P.2d 966, 16 U.C.C. Rep. Serv. 756 (1975) (“Stapling is the modern equivalent of gluing or pasting. Certainly as a physical matter it is just as easy to cut by scissors a document pasted or glued to another as it is to detach the two by unstapling”). Thus a contractual agreement by which the payee on the note transfers an interest in the note, but never signs it, cannot qualify as an allonge (it is not affixed to the note), and no proper negotiation of the note has occurred. If the indorsement by the original mortgagee/payee on the note is not written on the note itself, there must be an allonge or the note has not been properly negotiated, and the current holder of that note is not a PETE (since there is no proper negotiation chain).

D. The Shelter Rule

It has always been a basic rule in commercial law that the sale of anything vests in the buyer whatever rights the seller had in the object sold. Phrased another way, the buyer takes shelter in the rights of the seller. Even legal rights can pass in this way, including “holder” status. Say, for example, that the payee fails to indorse the note (so no “negotiation” takes place) but instead sells the note to a new owner. The new owner is not a “holder” (since there has not been an indorsement by the payee), but the new owner takes shelter in the holder status of its buyer, and thus is a PETE according to both §§3-301 (defining PETE) and 3-203 (the shelter rule). In this case, the burden of proving proper ownership is on the person in possession of the instrument, and until that is done no liability on the note arises (since the maker of the note's obligation to pay it under §3-412, see above, only runs to a PETE). The shelter rule even acts to pass on the original holder’s rights completely down the chain as long as the current possessor of the note can prove the validity of all previous transfers in between.

The shelter rule can be hugely useful to the foreclosing entity.  Say that the orginal payee on the note was First Bank, which never indorsed the note at all.  The note was then transferred into the hands of Second Bank, which is the plaintiff in the current foreclosure action.  Second Bank, using the shelter rule, is a PETE as long as it proves the chain of ownership in the note, obtaining the "holder" status of First Bank even without proper indorsements on the note or an allonge.

E. Lost Notes

If the note has been lost, §3-309 still places the burden of proving a right to payment on the person claiming the right to enforce the lost instrument. Nothing is presumed. The plaintiff must show the validity of each transfer of the instrument from the original payee to the current plaintiff, and explain how and why the note cannot be produced. If the original note might still be out there in circulation, the courts should not grant relief under this section.  The original version of §3-309 required proof that the note was lost when in the possesion of the current party, but nine states have adopted the 2002 version of §3-309, which dispenses with that requirement.

The last sentence in §3-309 (see above) does allow the court to rule in favor of the entity claiming under a lost note if there is a bond or other security posted to protect the payor from the risk of double payment to a later party producing the note.

F. Payment by the Maker

If the maker of the note pays a "person not entitled to enforce," he/she is not discharged from liability on the note, and faces the prospect of having to pay the true owner when that person surfaces with proof of ownership of the note (see §§3-601 and 3-602 above). Courts must take special care not to expose the maker to such double liability.


Ten years or so ago the bank that made the mortgage loan and took back the original promissory note kept both. It filed the mortgage in the local real property records so as to announce its lien interest to the world, and if the promissory was not paid as it matured the bank declared a default and foreclosed on the property. But when the financial shenanigans of the last decade occurred many lenders sold the promissory note and mortgage to institutional banks which put them into trusts with other mortgages ("securitization"), sold rights in said trust in the form of bonds ("collateral debt obligations"), and the actual individual mortgages were serviced by a separate company (which collected the monies and declared defaults when they were not forthcoming). All of this created a problem for keeping track of who owned the mortgage rights (as seen above, more attention should also have been paid to who possessed the promissory note). If the real property mortgage lienholder had to be changed every time the mortgage switched hands that would be awkward and expensive. Filing fees in real property record offices average $35 every time a new document is filed.

The solution was the creation of a straw-man holding company called Mortgage Electronic Registration Systems [MERS]. MERS makes no loans, collects no payments, though it does sometimes foreclose on properties (through local counsel). Instead it is simply a record-keeper that allows its name to be used as the assignee of the mortgage deed from the original lender, so that MERS holds the lien interest on the real property. While MERS has legal title to the property, it does not pretend to have an equitable interest. At its headquarters in Reston, Va., MERS (where it has only 50 full time employees, but deputizes thousands of temporary local agents whenever needed) keeps track of who is the true current assignee of the mortgage as the securitization process moves the ownership from one entity to another. Meanwhile the homeowner, who has never heard of MERS, is making payment to the mortgage servicer (who forwards them to whomever MERS says is the current assignee of the mortgage). If the payments stop, the servicer will so inform the current assignee who will then either order MERS to foreclose or will take an assignment of the mortgage interest from MERS so that it can foreclose in its own name. Amazingly, MERS Corporation holds title to roughly half of the home mortgages in the country, some 60 million of them!

While the mortgage is now listed in MERS’s name, it is a mere place-holder for the various subsequent assignments of the mortgage.  However, the MERS procedure changes none of the above analysis of the Uniform Commercial Code’s rules about the promissory note. Indeed, MERS’s own website clearly states that the law promissory notes must still be complied with even if there is a proper registration of the mortgage assignee’s interest with MERS. MERS is merely telling the world who is entitled to the collateral, but it creates no right to sue to enforce the mortgage. Only a “person entitled to enforce” the note may do that.

Things would have gone better for MERS if it had done its job more thoroughly, but in the speed and volume that was necessitated by the boom/bust ecomony, it became sloppy, its records often confused, and eventually courts started blowing the whistle.  There are decisions reaching all possible results, but recently many courts (and particularly bankruptcy ones) are questioning whether MERS has standing to foreclose on any of the mortgages it holds.  The Supreme Court of Arkansas has even ruled that since it makes no loans MERS cannot be the mortgagee on a deed filed in the Arkansas property records; see Mortgage Elec. Registration System, Inc. v. Southwest Homes of Arkansas, 2009 Ark. 152, 301 S.W.3d 1 (2009); but Michigan disagrees, allowing MERS to foreclose, see Residential Funding Co. v. Saurman, 204 N.W.2d 183 (Mich. 2011).  In one Utah trial court decision a judge ruled that MERS couldn't prove up its records and granted the home owner's petition to quiet title and remove the MERS deed from the records.  No one could find the promissory note (on which further liability depends), so that home owner is a major beneficiary of the MERS mess.

Interestingly, MERS itself issued a statement on November 11, 2010, that it is only a record holder and is in no way a guarantor of any information given to it by those who subscribe to its services. In effect, MERS's records are merely hearsay as to what transfers have occurred. Thus in proving up a proper chain of mortgage assignments for the foreclosing assignee of the mortgage, the MERS records should not be admissible in evidence!

MERS has been much under attack lately.  In early February, 2012 the New York Attorney General filed suit against the major banks charging that their use of MERS was an "end run" around the property recording system, which was designed so that the identity of the true mortgagee would be a public record.  In 2012 Merscorp, Inc., which operates MERS, was sued by the Delaware Attorney General who alleged it initiated foreclosures for which "the authority has not been fully determined and may not be legitimate."

H. Questions for the mortgagor’s attorney to consider:

1. Has the promissory note been dishonored (that is, has “default” occurred)?

All foreclosure statutes, whether permitting self-help or requiring the involvement of a court, forbid foreclosure unless the underlying debt is in default. That means that the maker of the promissory note must have failed to make the payments required by the note itself, and thus the note has been dishonored.

Under UCC §3-502(a)(3) a promissory note is dishonored when the maker does not pay it when the note first becomes payable. By itself it does not create a right of physical presentment of the note, but §3-501 does create such a right if the maker so demands. Section 3-501(a) defines “presentment” as a demand to pay the instrument made by a “person entitled to enforce an instrument” [the PETE], and under subsection (b)(2) adds that “Upon demand of the person to whom presentment is made, the person making presentment must (1) exhibit the instrument” [emphasis added]. Until there is such a presentment, §3-310(b) (the so-called “merger” rule) provides that “the obligation is suspended to the same extent the obligation would be discharged if an amount of money equal to the amount of the instrument were taken, and the following rules apply: * * * (2) In the case of a note, suspension of the obligation continues until dishonor of the note or until it is paid.” [The “until it is paid” language refers to the situation where the note is never presented for payment because the maker makes all the required payments and is therefore never in default.] If the obligation is "suspended" it cannot be the basis of a lawsuit until that suspension ends.

Many promissory note have a standard clause waiving the right of presentment, and that would be effective to obviate the effect of a demand under §3-501. However, the debt itself is owed to a PETE (see §3-412), and only that person can show that the debt was not paid when due, thus creating a dishonor and severing the note from the under obligation, so as to permit foreclosure. A PETE must have physical possession of the note, as explained above. Both the Official Comments to §§3-502 and to 3-310 make it clear that a dishonor can only occur if the person who wishes to sue is a "holder," i.e., someone in possession of the instrument [see Official Comment 3 to §3-502, "This [section] allows holders to collect notes in ways that make commercial sense without having to be concerned about a formal presentment on a given day" (emphasis added), and Official Comment 3 to §3-310: "If the check or note is dishonored, the [other party] may sue on either the dishonored instrument or [the underlying contract] if [that person is in] possession of the dishonored instrument and is the person entitled to enforce it."].

            It has always been a basic rule of negotiable instruments law that once a promissory not is given for an underlying obligation (like the mortgage contract), the underlying obligation is merged into the note and is suspended while the note is still outstanding.  Discharge on the note would (due to the rule that the two are merged) result in discharge of the underlying obligation.  This makes sense: paying the note would also pay the obligation.  Because of the merger rule, the underlying obligation is not available as a separate cause of action until the note is dishonored.

            This merger rules, with its suspension of the underlying obligation until dishonor of the note, is codified in §3-310(b) of the UCC: 

(b) Unless otherwise agreed and except as provided in subsection (a), if a note or an uncertified check is taken for an obligation, the obligation is suspended to the same extent the obligation would be discharged if an amount of money equal to the amount of the instrument were taken, and the following rules apply: 

                                    *   *   * 

(2) In the case of a note, suspension of the obligation continues until dishonor of the note or until it is paid. Payment of the note results in discharge of the obligation to the extent of the payment.
Thus until the note is dishonored there can be no default on the underlying obligation (the mortgage contract).  All foreclosure statutes, whether permitting self-help or requiring the involvement of a court, forbid foreclosure unless the underlying debt is in "default." That means that the maker of the promissory note must have failed to make the payments required by the note itself, and thus the note has been dishonored.  Under UCC §3-502(a)(3) a promissory note is dishonored when the maker does not pay it when the note first becomes payable.

Putting this altogether, were I a mortgagor’s attorney, on getting notice of the intent to foreclose, I would demand that my client be presented with the original promissory note. Failing that the mortgagor is not in default since he/she has not dishonored the note. Until that happens, §3-310 above suspends the entire mortgage obligation. The contractual obligation to pay has merged into the note, and until the note is dishonored it's unavailable as a separate cause of action. If the foreclosing bank says that the original promissory note had a clause waiving the right of presentment, I would demand to see the note as proof of that assertion.

There are some California cases stating that production of the original promissory note is not required in California since it is not mentioned in the comprehensive California statute detailing foreclosure procedure in this non-judicial foreclosure state (there are California decisions to the contrary, see below). I looked up the California foreclosure statute. Cal.Civ.Code § 2924(a) clearly states that the power of foreclosure is "to be exercised after a breach of the obligation for which that mortgage or transfer is a security." If no dishonor of the note has occurred then there has not yet been such a breach, and the California statute would not permit foreclosure. In any event, the California statutes do not allow the wrong party to foreclose, so someone attempting to do so must establish PETE status (thus having standing to sue), and that, as we've seen, requires possession of the note.  There are California bankrupcty decisions so saying; see In re Doble, 2011 WL 1465559 (Bankr. S.D. Cal. 2011).  For decisions from other states requiring that the plaintiff be the owner of the note at the time of a non-judicial foreclosure sale, see Burgett v. MERS, 2010 WL 4282105 (D. Ore. 2010); In re Adams, 693 S.E.2d 705 (N.C. App. 2010); In re Bailey, 437 B.R. 721 (Bankr. D. Mass. 2010).

If the client wants to pay the mortgage debt, but is leery of paying the wrong entity, he/she should pay the debt into an escrow account and advise the putative assignee of the mortgage that the amount deposited will be available on production of the promissory note or the signing of an indemnity agreement. Such a deposit would be the equivalent of tender of the amount due, so as to avoid late charges; see §3-603 and "Tender of Payment Under UCC §3-604: A Forgotten Defense?," 39 Ohio St. L. J. 833 (1978). The amount could also be paid into court in an interpleader action in appropriate circumstances.

2. Is the promissory note technically negotiable?

This is a thorny issue. First of all, as the debtor’s attorney, don’t raise the issue yourself. Why not? Because if the note is not technically “negotiable” under the rigid rules of UCC 3-104 then arguably the Uniform Commercial Code does not apply, and all of the statutory provisions examined above are not the law. The other side may think of this and want to argue it (on the other hand, most attorneys would rather slaughter hogs than think about the elements of negotiability), so what do you say if it comes up?

There have been serious scholarly arguments that most mortgage notes are not technically negotiable. [See Neil Cohen, "The Calamitous Law of Notes," 68 Ohio St. L.J. 161 (2007); Ronald J. Mann, Searching for Negotiability in Payment and Credit Systems, 44 UCLA L. Rev. 951, 962-85 (1997).] The typical issue concerns what is called the “courier without luggage” requirement: the note must not contain promises or obligations (with certain exceptions) other than a bald promise to pay the debt to the order of a named person or bearer [UCC §§3-104(a)(3), 3-106]. Pennsylvania’s Chief Justice John Gibson once said that a negotiable instrument must be a “courier without luggage.” Overton v. Tyler, 3 Pa. 346, 347 (1846). This oft-repeated description means that the instrument must not be burdened with anything other than the simple and clean unconditional promise or order; it cannot be made to truck around other legal obligations. If the maker of a note adds any additional promises to it, the note becomes non-negotiable because the prospective holder is then given notice that the note is or may be conditioned on the performance of the other promise. Section 3-104(a)(3) specifies the few additional items that may be mentioned in an instrument without destroying its negotiable character. See also §3-106. Since most mortgage notes are cluttered with extraneous promises by the maker, these are not “negotiable instruments” as that term is defined in the UCC.

In the article mentioned above, Professor Ronald Mann argues that a promise in the typical mortgage note provides that on electing to make a prepayment, the maker of the note must give a written notice to that effect to the holder of the note. Is this an extraneous promise forbidden in a “negotiable” note? He argues it is, but that seems wrong to me. UCC §3-106(b) allows a references to another document for rights as to prepayment, and while that is not exactly what is happening here, it is an indication that the Code drafters were unconcerned with prepayment issues when it came to negotiability (the reason being that prepayment aids the maker, so the rules should be construed to protect that bias). Further, what is the harm by so minor a promise, that it should strip away the protection of the only uniform treatment of the law from what all parties intended to be a promissory note? Official Comment 2 to §3-104 states that a major test on whether the parties intended to create a negotiable instrument is the inclusion vel non of “order or bearer” language in the note. Since the typical note is payable to the “order” of a named payee, that should settle it that the parties did intend for the UCC to apply to their transaction. The same Official Comment goes on to provide that where the parties intended to create a negotiable instrument but made some minor misstep, Article 3 could be applied by analogy (since it is the current best thinking of how instruments should be legally governed—amended most recently in 2002).  So far the courts have not agreed with Professor Mann that such promises destroy negotiability. See HSBC Bank USA, Nat. Ass'n v. Gouda, 2010 WL 5128666, 73 UCC Rep.Serv.2d 226 (N.J.Super. 2010); In re Edwards, 2011 WL 6754073 (Bkrtcy.E.D.Wis. 2011).

Finally, if all else fails, the common law in all states clearly required possession of a promissory note before foreclosure could proceed, though that's going to take some library research to prove up state by state.

3. Other issues:

Of course foreclosure lawsuits have other problems the mortgagor’s attorney should explore.

a.  Assignment Proof.  The assignment itself may have difficulties with a chain of title, and that should be investigated with vigor.  The leading case requiring a clear chain of title in assignments is U.S. Bank v. Ibanez, 458 Mass. 637, 2011 WL 38071 (Mass. 2011); see also  I discuss the case above in the segment on "Security Follows the Debt."

b.  Business Records:  Assignees are required to prove up the business records that are the basis of the assignment, and such evidence is an exception to the hearsay rule only where the person proffering the business records can testify to their authenticity.  Assignees to whom such records are transferred in the ordinary course of business do not have the requisite personal knowledge of the records creation and preservation, and hence cannot so testify to their validity.  This rule of evidence can be a major stumbling block to foreclosure actions and other collection efforts.  See Asset Acceptance v. Lodge, 2010 WL 3759538 (Mo. App. 2010); Chase Bank USA v. Herskovits, 2010 N.Y. Misc. Lexis 2818 (Civ. Ct. 2010); DNS Equity Group, Inc. v. Lavallee, 907 N.Y.S.2d 436 (Dist. Ct. 2010); Palisades Collection, L.L.C. v. Kalal, 781 N.W.2d 503 (Wis. App. 2010); Riddle v. Unifund CCR Partners, 298 S.W.3d 780 (Tax. Civ. App. 2009); Unifund CCR Partners v. Bonfigil, 2010 Vt. Super. Lexis 24 (2010); but see Simien v. Unifund CCR Partners, 321 S.W.3d 235 (Tex. Civ. App. 2010).

c. Article 9 Complications. Various provisions in Article 9 of the Uniform Commercial Code provide that the creation of a security interest (that is, ownership rights) in a promissory note that is being sold (as opposed to being used as collateral) does not require the buyer of the note to take possession of the note if the sale is made pursuant to an agreement reflected in a writing or other record [see §§9-203(b), 9-309(3)]. Some commentators seem to think that this gets rid of the need to possess the note for foreclosure purposes. It doesn't, and confuses apples with oranges. The Article 9 rules have nothing to do with the home owner who is the maker of the promissory note, but apply only to regulate rights between later parties claiming ownership in the note as it passes from one hand to another. The Article 9 rules were written so that the note can be sold by contracts without being physically moved around (thus allowing the note to be warehoused somewhere). Section 9-203(g) further provides that whoever has a perfected interest in the note automatically has a perfected interest in the underlying mortgage ("security follows the debt"). But Article 9 says nothing about who is entitled to enforce the note when it comes due, which is left to Article 3; thus the plaintiff in the foreclosure must still prove it is a PETE,as that term is defined in Article 3. Moreover, even if §9-203(g) works its magic to transfer the mortgage interest to the possessor of the note, that does not mean that foreclosure can be had without satisfying the court (in judicial foreclosures) that the state foreclosure laws requiring a clear chain of mortgage assignments have been met. In non-judicial foreclosure state, UCC §9-607(b) provides that "if necessary to enable a secured party [including the buyer of a mortgage note] to exercise the right of [its transferor] to enforce a mortgage non-judicially," the secured party may record in the office in which the mortgage is recorded (i) a copy of the security agreement transferring an interest in the note to the secured party and (ii) the secured party’s sworn affidavit in recordable form stating that default has occurred and that the secured party is entitled to enforce the mortgage non-judicially. For a complete discussion of these issues, see the UCC's Permanent Editorial Board's official explanation:

d.  Robo-Signers and Notaries.  Affidavits of those filing foreclosure actions that the debts have been reviewed and verified must, of course, be true.  In the foreclosure mills these swearings are often pro forma and, due to the volume involved, frankly impossible, being done by humans acting like robots.  Where this can be proven, the lawsuit should be dismissed, and, indeed, massive publicity over this practice led to the suspension of many foreclosures nationwide in 2010.  Notary stamps are required on assignments in many states or the assignment is invalid, and if the evidence demonstrates the stamp was added much later, that is fraud [see]. Indeed there is out and out fraud in many foreclosures as phony documents are created, signatures forged, false affidavits of lost instruments sworn to, and newly “discovered” allonges solve negotiation difficulties. If the lawsuit was filed by someone who didn’t have standing and the attorney who filed it should have known that, he/she should be reported to the bar association, and the misfiling should also be called to the judge’s attention as a reason to dismiss. This is also criminal conduct, of course, and should be prosecuted, including as a defendant any attorney participating in deception of the court. 

Recently the Florida courts have become disgusted by improper documentation and have insisted upon it, causing major foreclosures to be abandoned and the courts to strip the properties from their mortgages (!): see

On April 6, 2011, the Ohio Supreme Court dismissed a complaint filed by lawyers against three trial court judges who recently began requiring lawyers to personally verify the authenticity of all documents used in foreclosures.  The judges have refused to grant summary or default judgments without such certification, though a trial can still go forward.  The attorneys are not happy.

e.  Fraud.  Outside of the UCC, consider filing a lawsuit charging fraud (misrepresentation of a material fact made with knowledge of its falsity or a reckless disregard of its truth, on which there was justifiable reliance causing damages) if it’s indeed present in your case and you can prove it. Fraud is the civil action for lying, an ugly thing to charge someone with, creating great headlines for the media. If you can prove fraud has been at work, well, that's good news. The common law maxim is that “fraud vitiates all transactions,” so that nothing can hide fraud. Those guilty of fraud cannot sue on the contract, which is now void for illegality (as that word is used in the law of contracts: void as a matter of public policy), and punitive damages, including attorney’s fees are also a possibility. Nor is unjust enrichment a possibility since guilty parties to an illegal contract lose all rights to sue on any theory—they are truly “outlaws” in the literal meaning of that term.

I. Conclusion:

The UCC rules are not just fusty technicalities. They reflect common sense: you can't sue or foreclose unless you can prove you are entitled to sue or foreclose. What could be more basic in our law than that idea? I tell the Legal Aid lawyers who call me that if the trial judge hates the UCC and wants to duck all of this, remind him/her that it is the statutory law of this jurisdiction (indeed, all jurisdictions in the USA have identical UCC provisions to those quoted above). And, in fact, the common law is no different from the UCC [see the Restatement of Property (Mortgages) §5.4 and its Comments], so dodging the UCC does not help the plaintiff trying to foreclose without having possession of the note.  Bankruptcy judges have been particularly sensitive to missing notes, holding that without them a creditor cannot file a valid proof of claim; see In re Kemp, 2010 WL 4777625 (Bankr. D. N.J. 2010).

The truth is that the current lending mess was sloppily run for years, with greed as the fuel, and no one paid any attention to details, and increasingly complex transactions led to the loss of a paper trail. But now the orgy has ended with major hangovers for the participants who paid no attention to the basic rules. The borrowers (who also have had to battle this problem at their end, when they can't figure out who is the proper party to negotiate with over repayment issues or settlement discussions), have done nothing wrong. They do owe the debt and the house is still the collateral, so they are not off the hook at all. But the courts won't let someone foreclose just because that someone thinks they are the right entity to do it, or really, really, really wants to foreclose. They have to prove they are a PETE by clear evidence. Wishing that they had that evidence is not enough. Indeed, as discussed above, if the buyer pays the wrong person, he/she still owes the debt; UCC §3-602. If the current plaintiff cannot prove valid ownership, the only remedy left for the plaintiff is to pass liability back to the entity from which the obligation was purchased, and so on until we find a person who really is entitled to enforce. The common law, see Restatement of Contracts (Second) §333(b), creates a warranty from the assignor to the assignee that the obligation assigned exists and is subject to no defenses, and this is the remedy the disappointed assignee should seek if it is not a PETE. If the chain of transactions cannot be undone (the records are lost, a major player has ceased to exist, or whatever), well, life is hard. You shouldn’t buy assets unless your seller can prove good title to them. If the mortgagee’s assignee wins the lawsuit but doesn’t have proper documentation, any subsequent sale of the property foreclosed upon is going to be problematic (and that should be pointed out to judges before they rule).

On the other hand, judicial expediency towards allowing the foreclosure can lead to closed ears when the UCC and its ironclad rules are mentioned. In an email exchange about all this with Richard Holt, a research fellow at a think tank on the overwhelming judicial issues of the financial crisis (and the person who persuaded MERS to issue the letter mentioned above), he commented:

The foreclosure complaints rarely reach a level of any sophistication which even remotely begins to even consider the UCC. Most are resolved in rocket dockets where there is not even a defense. Hundreds of thousands, perhaps more than a million, of foreclosures have been obtained that way. . . . In many of these cases the hearing goes like this:

Judge to the Defendant's counsel: What do you have to say to the Plaintiff's pleadings?
Defendant's counsel: The Plaintiff does not have standing.
Judge to the Plaintiff's counsel: What do have to say to the Defendant's assertion?
Plaintiff's counsel: We have a copy of the assigned mortgage.
Judge: Good enough for me, summary judgment to the Plaintiff.
Defendant's counsel: Well, my client cannot afford an appeal so that’s it then.

Final Thoughts:

And you thought all that technical stuff in the Commercial Paper course (yawn) was unimportant! So did the lawyers who allowed their clients to purchase these pseudo-obligations. I’ve taught Commercial Paper for over four decades and mostly focused on checks, where there has always been much litigation. Promissory notes weren’t as sexy as checks are because the legal issues surrounding notes are mostly settled and uncontested by lawsuits. But of a sudden my phone/email messages are filled with attorneys on both side of the missing promissory note foreclosure issue (frequently, but not always, former students) asking for guidance, and the humble promissory note has at last become a hot topic.

Many homeowners are caught in a trap whereby one part of the foreclosing bank is engaged in working out an agreement to save the property, while the other is sending out a foreclosure notice. Basic rules of contract and estoppel can lead a court of equity to refuse foreclosure in these situations; see PHH Mortgage Corp. v. Barker, 190 Ohio App.3d 71, 940 N.E.2d 662 (2010).  The true solution to the mortgage mess that results from missing notes, inadequate documentation of mortgage assignment, confusion at the bank, and robo-signing of required affidavits, is for the foreclosing banks to put their money into creating a negotiation program that takes troubled transactions and works them out by mutual agreement with the home owner, so that the title can be cleared and the property resold. These negotiations might include a voluntary waiver of the home owner's rights in return for forgiveness of the mortgage debt, or renegotiated payments on the mortgage, or whatever the parties can construct as a compromise. With all of the above defenses on the table, the home owner has some leverage to make the bank listen to his/her concerns and not just steamroller over them in the rush to foreclose.

[To contact me send an email to or call (614) 791-8660.]
Related Posts:
“How I Became a Law Professor,” January 27, 2010
 “The Socratic Dialogue in Law School,” January 31, 2010
“Clickers,” March 17, 2010
“The Summer Bar Review Tours,” June 15, 2010
“The Sexy Promissory Note,” August 17, 2010
"Mortgage Foreclosures: The Disaster of Unintended Consequences," October 27, 2010
"Women in My Law School Classroom," January 8, 2011
"I Threaten To Sure Apple Over an iPad Cover," April 8, 2011
"The Payment-In-Full Check: A Powerful Legal Maneuver," April 11, 2011
"Adventures in the Law School Classroom," September 10, 2011
"What Non-Lawyers Should Know About Warranties," October 11, 2011
"How To Write and Effective Legal Threat Letter," October 19,2011


  1. Great Post! It's very nice to read this info from someone that actually knows what they are talking about.
    REO Properties Florida

  2. This was awesome! Thank you for the post. This is the best article on UCC and Notes that I have read and I have been reading articles and studying UCC 3 since 2009. Thank you.


  3. If I asked for copies of my original mortgage and note, and the bank claiming to own my loan sends me copies from my registry of deeds, should I accept that as proof? I have the typical WAMU/FDIC/CHASE situation that has now been sold in a huge block of non-performing loans to LSF9 Participation Trust (a hedge fund), who is now foreclosing on me. I am in N.H., so I have a 10 day injunction to file an objection to the auction, set a hearing date, and hopefully make both LSF9 and Chase prove they have the right to my home. Please give me your thoughts.

  4. I can't give specific legal advice, sorry. The bank has to have the original to foreclose, but they have to prove that to the judge, not you, or to the foreclosing entity if a non-judicial foreclosure. If the copy appears to be properly indorsed and the maker of the note has no reason to suspect the wrong entity is foreclosing if would usually be very hard to stop the auction for that reason alone.