For the last few years I have been crossing the country giving lectures on what I now call the "Golden Rule of Mortgage Foreclosures," which is that such foreclosures cannot proceed without production of the original promissory note signed at the closing. A symposium at Western State University Law School last year at which I gave the keynote address turned into a law review article on point, and that law review article is reprinted below in full. The correct citation for the printed version is 39 W. St. U. L. Rev. 313 (2012). As subsequent developments occur I will add them in red to the original article below. Any corrections or suggestions may be sent to me at email@example.com.
Essentially a "holder" is someone who possesses a negotiable instrument payable to his/her order or properly negotiated to the later taker by a proper chain of indorsements. This result is reached by the definition of "holder" in §1-201(b)(21):
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 endorsement or a special endorsement by the original payee of the note.
Sometimes the endorsement is not made on the promissory note, but on a separate piece of paper, called an “allonge,” which is formally defined as a piece of paper attached to the original note for purposes of endorsement. An allonge has an interesting history, traceable to the days in which instruments circulated for long periods before being presented for payment. Consider, for example, the early period in
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(b) (the shelter rule itself). In this case, the burden of proving proper possession is on the person in holding 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.
If the note has been lost, §3-309 of the UCC allows for the re-creation of lost or destroyed notes. It states:
As stated in the first paragraph of this article, the Golden Rule of Mortgage Foreclosure: the Uniform Commercial Code forbids foreclosure of the mortgage unless the creditor possesses the properly-negotiated original promissory note. If this can’t be done the foreclosure must
stop. The maker who signs a promissory note is only liable per §3-412 to a "person entitled to enforce" (PETE) the note, a term described in §3-301 so that only someone in possession of a validly negotiated note qualifies. As we saw above, defects in negotiation frequently defeat the ability to be a PETE, and therefore stop the foreclosure from being successful. Let's now turn to the possession requirement, which is emphasized over and over in §3-301's definition of PETE and its accompanying Official Comment.
Nor will a mere copy of the note suffice. There could be 100 copies of the original note, but that would not create a right of foreclosure in 100 plaintiffs. To the bank's argument that a copy of the promissory note should be enough, ask any banker if he/she would be willing to accept a copy of check.
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. Thus the attorney for the foreclosing entity may think of this and want to argue it (on the other hand, most attorneys would rather slaughter hogs than contemplate the elements of negotiability), so what happens if it does comes up?
In the article mentioned in footnote 23, 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). So far the courts have not agreed that such promises destroy negotiability.
Finally, if all else fails and the note is deemed nonnegotiable, then the common law would apply, and the common law routinely 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.
The common law was clear that the mortgage contract and the mortgage deed are mere "security" for the payment of the promissory note (the "debt"). It is a common law maxim that “security follows the debt.” This means the mortgage travels along with the promissory note, and that the note is the important item, not the mortgage itself. Thus whoever has the promissory note is the only entity that can enforce the mortgage. The courts are more or less unanimous on this. The United States Supreme Court established the basic rule early in the 1873 case of Carpenter v. Longan: "The note and mortgage are inseparable; the former as essential, the latter as an incident. An assignment of the note carries the mortgage with it, while an assignment of the latter alone is a nullity. . . . The mortgage can have no separate existence. When the note is paid the mortgage expires. It cannot survive for a moment the debt which the note represents. This dependent and incidental relation is the controlling consideration . . . ." A purported assignment of a mortgage to a bank is not proof of a transfer of a promissory note secured by the mortgage, since the mortgage follows the note but not vice versa.
[In Eaton v. Fed. Nat'l Mort. Ass'n, 462 Mass. 569, 969 N.E.2d 1118 (2012), the Massachusetts Supreme Judicial Court backed away from Ibanez, clearly holding that the mortgage follows the note (and not vice versa), and that only the holder of the promissory note (or the agent thereof) is the proper entity to foreclose. The court managed to do this with only a curt nod to the rules of the Uniform Commercial Code. Massachusetts has now enacted a statute dealing with foreclosures that gives various redemption rights. In particular M.G.L.A. 244 § 35C requires the creditor foreclosing to be the holder of the mortgage note and further that all statements made to either state or federal courts in foreclosure proceedings shall be true. The statute also requires that all mortgage assignments be recorded. For a detailed comment on the current Massachusetts situation see Christopher Cifrino, Comment, Now UCC Me, Now You Don’t: The Massachusetts Supreme Judicial Court Ignores the UCC in Requiring Unity of Note and Mortgage for Foreclosure in Eaton v. Fannie Mae, 54 B.C. L. Rev. E. Supp. 99 (2013), http://lawdigitalcommons.bc.edu/bclr/vol54/iss6/9.]
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.
666 F.3d 1255 (10th Cir. 2012); Bank of America v. Kabba, 276 P.3d 1006 (Okla. 2012); 450 B.R. at 914; In re Foreclosure Cases, 2007 WL 3232430 (N.D.Ohio Oct. 31, 2007); In re Vargus, 396 B.R. 511 (Bankr. C. D. Cal. 2008); Norwood v. Chase Home Finance LLC, 2011 WL 197874 (W.D.Tex. Jan. 19, 2011); 194 Ohio App.3d at 644; Manufacturers and Traders Trust Co. v. Figueroa, 2003 WL 21007266 (Conn. Super. April 22, 2003); 711 S.E.2d at 165; 27 A.3d at 1087 ("It is neither irrational nor wasteful to expect a foreclosing party to actually be in possession of its claimed interest in the note, and to have the proper supporting documentation in hand when filing suit.").
(“The assignment of a debt secured by mortgage carries with it the security.”)
In 2012, the Ohio Supreme Court held that a party who does not possess a properly indorsed promissory note at the time the foreclosure proceeding is begun lacks standing, and is not the real party in interest, and that these defects cannot be cured by transfers and indorsements made after the complaint has been filed; see Federal Home Loan Mortg. Corp. v. Schwartzwald,
134 Ohio St.3d 13, 979 N.E.2d 1214 (2012). Although some courts have been in confusion as to this, both the Official Comment to §3-301 and the cases make it clear that the holder of the note need not also be the owner of the underlying obligation (i.e., the mortgagee or the mortgagee’s assignee); see Bank of America, N.A. v. Inda, 48 Kan.App.2d 658, 303 P.3d 696 (2013). Thus, a servicer in possession of the note, acting as an agent of the owner of the note, can qualify as a PETE and therefore prosecute the foreclosure action; see J.E. Robert Co., Inc. v. Signature Properties, LLC, 309 Conn. 307, 71 A.3d 492 (2013). See also Bank of New York v. Romero, 320 P.3d 1 (N.M. 2014); and Bank of America v. Kabba, 276 P.3d 1006 (Okla. 2012).
 2007 WL 3232430 at *n. 3, 3.
337. See also Bank of New York v. Romero, 302 P.3d 1 (N.M. 2014).
“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
"Mortgage Foreclosures: The Disaster of Unintended Consequences," October 27, 2010
"Women in My Law School Classroom," January 8, 2011
"The Exploding Alarm Clock," February 19, 2011
"One More Story From Law School," February 27, 2011
"I Threaten To Sure Apple Over an iPad Cover," April 8, 2011;
"Bob Whaley Goes to Law School," June 3, 2011
"The Payment-In-Full Check: A Powerful Legal Maneuver," April 11, 2011; http://douglaswhaley.blogspot.com/2011/04/payment-in-full-check-powerful-legal.html
"Adventures in the Law School Classroom," September 10, 2011
"What Non-Lawyers Should Know About Warranties," October 11, 2011;
"How To Write an Effective Legal Threat Letter," October 19, 2011; http://douglaswhaley.blogspot.com/2011/10/how-to-write-effective-legal-threat.html
"Funny Law Professors," January 15, 2012
“How To Win Arguments and Change Someone’s Mind,” August 5, 2012;
“How To Take a Law School Exam,” November 30, 2012”
"Detroit's Bankruptcy and the Law," July 24, 2013
"Legal Terms You Should Know,” September 13, 2013;
“How To Respond to a Legal Threat.” March 29, 201;http://douglaswhaley.blogspot.com/2014/03/how-to-respond-to-legal-threat.html
“Clicking on 'I Agree': Sticking Your Head in the Lion's Mouth?” September 27, 2014;