.
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
dglswhaley@aol.com.
-------------------------------------
Mortgage Foreclosures, Promissory
Notes, and the Uniform Commercial Code
As is true
of many things in life the Uniform Commercial Code’s statutes concerning the
role of promissory notes in a mortgage foreclosure are both simple and at the
same time complicated. The purpose of this article is to draw out the matter in
detail, but let’s begin with the simple (and basic) rule first. Indeed let’s
call it 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.
Of course
there are exceptions and situations in which problems with the note can be
addressed and cleared up, and those will be explored as we progress. The
difficulty is that all too often the Golden Rule of Mortgage Foreclosure is
simply ignored and the foreclosure goes ahead as if the rule were not the
statutory law of every jurisdiction in the
United States.
[2]
Why is
that? The answer is almost too sad to explain. The problem is that the Uniform
Commercial Code is generally unpopular in general, and particularly when it
comes to the law of negotiable instruments (checks and promissory notes)
contained in Article Three of the Code. Most lawyers were not trained in this
law when in law school (The course on the subject, whether called “Commercial
Paper” or “Payment Law,” is frequently dubbed a “real snoozer” and skipped in
favor or more exotic subjects), and so the only exposure to the topic attorneys
have occurs, if at all, in bar prep studies (where coverage is spotty at best).
Thus many foreclosures occur without it occurring to anyone that the UCC has
any bearing on the issue.
Judges are
frequently similarly unlearned when the matter arises, and loath to hear more.
If the defendant’s attorney announces that the Uniform Commercial Code requires
the production of the original promissory note, the judge may react by saying
something like, “You mean to tell me that some technicality of negotiable
instruments law lets someone who’s failed to pay the mortgage get away with it
if the promissory note can’t be found, and that I have to slow down my overly
crowded docket in the hundreds of foreclosure cases I’ve got pending to hear
about this nonsense?” It’s a wonder the judge doesn’t add, “If you say one more
word about Article Three of the UCC you’ll be in contempt of court!”
But the law
is the law. If the judge doesn’t like what the state statute says that is no
excuse for ignoring it. If the statute reaches a bad result then the
legislature should repeal the statute, and until that occurs the courts must
follow it. As it happens there are good and sufficient rules for Article
Three’s mandates, as we shall see below.
Let's begin
with what a mortgage actually is.
Properly defined it is a consensual lien placed by the home owner
(called the "mortgagor") on the real estate being financed in order
secure the debt incurred by the loan in favor of the lender/mortgagee.
The debt is created by the signing of a
promissory note (which is governed by Article Three of the Uniform Commercial
Code); the home owner will be the maker/issuer of the promissory note and the
lending institution will be payee on the note. There is a common law maxim that
"security follows the debt." This means that it is presumed that
whoever is the current holder of the promissory note (the "debt") is
entitled to enforce the mortgage lien (the "security"). The mortgage
is reified as a mortgage deed which the lender should file in the local real
property records so that the mortgage properly binds the property not only
against the mortgagor but also the rest of the world (this process is called
"perfection" of the lien).
[3]
What
happens to the promissory note? In the good old days, the twentieth century, it
was kept down at the bank so that when the time for payment arrived the bank
could present it to the mortgagor when due, and, if it wasn't paid, the
mortgagee could then use legal process (or in some states self-help) to
foreclose on the mortgage lien. But during the feeding frenzy that the real
estate mortgage community indulged in for the last decade, more bizarre things
happened. The mortgages themselves were no longer kept at the originating bank,
nor were the notes. Instead they were bundled together with many others and
sold as a package to an investment banking firm, which put them in a trust and
sold stock in the trust to investors (a process called “securitization”). The
bankers all knew the importance of the mortgage, and supposedly kept records as
to the identity of the entities to whom the mortgage was assigned. But they
were damn careless about the promissory notes, some of which were properly
transferred whenever the mortgage was, some of which were kept at the
originating bank, some of which were deliberately destroyed (a really stupid
thing to do), and some of which disappeared into the black hole of the
financial collapse, never to be seen again.
[See http://deadlyclear.wordpress.com/2012/03/15/securitized-distrust/]
In recent
years the combination of subprime lending, securitization of mortgage loans, a
housing market that first boomed then busted, rapacious predators who worked
hard to take for themselves the equity people had built up in their homes, and
foreclosure mills that operated with neither proper paperwork, nor attention to
the rules of law, much less common decency, led to an explosion of laws and
legal actions designed to deal with these matters.
The
collapse of the housing market in 2008 was a direct consequence of these greedy
and unwise business practices. Gullible consumers were encouraged to take out
mortgages they could not afford on property that turned out to be worth far
less than the mortgage indebtedness. Minority communities were particularly
hard hit, often targeted by shady lenders because people of color are more
likely to store their wealth in home equity in many USA communities. Things
went fine until real property stopped appreciating in value and its worth
dropped to alarmingly low levels, with a recession that engulfed the country
and, indeed, the world. Not just subprime borrowers were affected; the
recession reduced the value of almost all property, and perfectly responsible
mortgagors (many of whom were also laid off from their jobs) began to struggle
to make payments and avoid foreclosure.
According to one monitoring agency, a record number of homes received
foreclosure filings in 2010 (over 2.9 million).
[4]
Ten years
or so ago the bank that made the mortgage loan filed the mortgage deed in the
local real property records so as to perfect its interest in the realty. But
when the mortgages themselves began to be assigned, changing the real property
records at the time of each transfer would be both expensive and awkward. 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) supposedly keeps track of who is the true current
assignee of the mortgage as the securitization process moves the ownership from
one entity to another.
[5] Meanwhile
the homeowner, who has never heard of MERS, is making payments 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!
[6]
Article 3
of the Uniform Commercial Code could not be clearer when it comes to the issue
of mortgage note foreclosure. When someone signs a promissory note as its maker
("issuer"), he/she automatically incurs the obligation in UCC §3-412
that the instrument will be paid to a "person entitled to enforce"
the note.
[7] "Person
entitled to enforce"—hereinafter abbreviated to "PETE"—is in
turn defined in §3-301:
"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) . .
. .
Three
primary entities are involved in this definition that have to do with missing
promissory notes: (1) a "holder" of the note, (3) a "non-holder
in possession who has the rights of a holder, and (3) someone who recreates a
lost note under §3-309.
[8] Let's
take them one by one.
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):
(21) “Holder” means:
(A)
the person in possession of a negotiable instrument that is payable either to
bearer or
to an identified person that
is the person in possession . . . .
and by §3-203:
(a) “Negotiation” means a transfer
of possession, whether voluntary or involuntary, of an
instrument by a person other than the issuer to a person who thereby
becomes its holder.
(b)
Except for negotiation by a remitter, if an instrument is payable to an
identified
person, negotiation
requires transfer of possession of the instrument and its endorsement
by the holder. If an instrument is
payable to bearer, it may be negotiated by transfer of
possession alone.
The rules
of negotiation follow next.
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.
With a
blank endorsement (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 explored below will not carry the day. Once a blank
endorsement has been placed on the note by the payee, all later parties in
possession of the note qualify as “holders,” and therefore are PETEs.
[9]
If the
payee’s endorsement on the back of the note names a new payee (“pay to X
Company”), that's called a “special endorsement.” 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 endorsee, wishing to
negotiate the note to a new owner, may now sign in blank, creating a bearer
instrument, or may make another special endorsement over to the new owner. Only
if there is a valid chain of such endorsements has a negotiation taken place,
thus creating “holder” status in the current possessor of the note and making
that person a PETE. With the exception mentioned next, the endorsements have to
be written on the instrument itself (traditionally on the back).
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.
[10] 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
United
States history before it was even a
country.
People living in the
Americas
frequently had their banks back in
Great Britain. If they drew up
drafts ("check") on these banks and gave them to another American,
that person was unlikely to immediately send it across the
Atlantic
to the mother country. Instead, the payee would simply indorse it over to one
of the payee's creditors, who would do the same. In those days drafts would
circulate, more or less like money, for extended periods of time. But the
drafts quickly ran out of room on which to place endorsements, so a separate
piece of paper, called an "allonge" was glued to the original draft
and the new endorsements were placed on the allonge. There are cases from Great
Britain where the allonge had over a hundred endorsements before finally being
presented to the drawee for payment.
[11]
The Uniform
Commercial Code still allows the use of an allonge, and given the large number
of transfers that some mortgage promissory notes have had in the last few
years, there are many new cases dealing with the allonge. These cases
frequently reveal problems with negotiation that give the current holder of the
instrument difficulties in trying to establish "holder” status. For
example, the allonge must be “affixed to the instrument” per §3-204(a)’s last
sentence. 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.
[12] What
does “affixed” mean? The common law required gluing. Would a paper clip do the
trick? A staple?
[13]
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 endorsement
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).
Another
difficulty with allonges that has bothered a number of courts occurs in the
following fact pattern. The promissory note apparently has a valid endorsement
of the payee's name either on the back of the note or on the accompanying
allonge, but the evidence shows that when the note was transferred to the
current possessor that signature was not then on the note.
Instead it is clear that the current
possessor, realizing the problem, went back to the payee and had it indorse the
note over to the current possessor, thus clearing up the negotiation issue. But
some courts have disallowed such a late negotiation by the original payee on
the theory that by the time the payee's signature was added to the note, the
payee no longer had an "ownership" interest in the note and thus no
title to convey, which supposedly invalidates the late endorsement.
[14] This is simply wrong, and is a
misunderstanding of the difference between ownership and the rules of
negotiation. The Code never requires the person making an endorsement to have
an ownership interest in the note
[15]
(though of course the payee normally does have such an interest), but simply
that he/she is the named payee, and the Code clearly allows for correction of a
missing endorsement. Section 3-203(c) provides for it specifically:
(c) Unless otherwise agreed, if an instrument is transferred
for value and the transferee does not become a holder because of lack of
indorsement by the transferor, the transferee has a specifically enforceable
right to the unqualified indorsement of the transferor, but negotiation of the
instrument does not occur until the indorsement is made.
And Official Comment 3 explains: "The question may
arise if the transferee has paid in advance and the indorsement is omitted
fraudulently or through oversight. . . .
Subsection (c) provides that there is no negotiation of the instrument
until the indorsement by the transferor is made. Until that time the transferee
does not become a holder . . . ."
If the allonge is not in order, or there are
other problems with the negotiation of the note (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, and so let's turn to that 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(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.
The shelter
rule can be hugely useful to the foreclosing entity. Say that the original 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 transfers of the note, obtaining the
"holder" status of First Bank even without proper indorsements on the
note or an allonge. The courts have had no problem reaching this result.
[16]
If the note
has been lost, §3-309 of the UCC allows for the re-creation of lost or
destroyed notes. It states:
(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. If
that proof is made, Section 3-308 applies to the case as if the person seeking
enforcement had produced the instrument. The court may not enter judgment in
favor of the person seeking enforcement unless it finds that the person
required to pay the instrument is adequately protected against loss that might
occur by reason of a claim by another person to enforce the instrument.
Adequate protection may be provided by any reasonable means.
[17]
Note that
(b) 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.
[18] 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.
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.
[19] 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.
An assignee
of the mortgage who does not have the promissory note is not allowed to
foreclose on the mortgage
[20]
Without the note, the foreclosing entity does not have "standing" to
sue (and/or—a civil procedure distinction that is not my forte—is not the
"real party in interest").
[21] As United States District
Judge Christopher Boyko explained throwing out a number of mortgage foreclosure
cases, attempts to slide past the jurisdictional issue that arises from filing
without the necessary paperwork is unacceptable:
Plaintiff's, “Judge, you just don't
understand how things work,” argument reveals a condescending mindset and
quasi-monopolistic system where financial institutions have traditionally
controlled, and still control, the foreclosure process. Typically, the
homeowner who finds himself/herself in financial straits, fails to make the
required mortgage payments and faces a foreclosure suit, is not interested in
testing state or federal jurisdictional requirements, either pro se or
through counsel. Their focus is either, “how do I save my home,” or “if I have
to give it up, I'll simply leave and find somewhere else to live.”
In the meantime, the financial
institutions or successors/assignees rush to foreclose, obtain a default
judgment and then sit on the deed, avoiding responsibility for maintaining the
property while reaping the financial benefits of interest running on a judgment.
The financial institutions know the law charges the one with title (still the
homeowner) with maintaining the property.
There is no doubt every decision
made by a financial institution in the foreclosure process is driven by money. And
the legal work which flows from winning the financial institution's favor is
highly lucrative. There is nothing improper or wrong with financial
institutions or law firms making a profit-to the contrary, they should be
rewarded for sound business and legal practices. However, unchallenged by
underfinanced opponents, the institutions worry less about jurisdictional
requirements and more about maximizing returns. Unlike the focus of financial
institutions, the federal courts must act as gatekeepers, assuring that only those
who meet diversity and standing requirements are allowed to pass through.
Counsel for the institutions are not without legal argument to support their
position, but their arguments fall woefully short of justifying their premature
filings, and utterly fail to satisfy their standing and jurisdictional burdens.
The institutions seem to adopt the attitude that since they have been doing
this for so long, unchallenged, this practice equates with legal compliance.
Finally put to the test, their weak legal arguments compel the Court to stop
them at the gate.
The Court will illustrate in simple
terms its decision: “Fluidity of the market”---“X” dollars, “contractual
arrangements between institutions and counsel”---“X” dollars, “purchasing
mortgages in bulk and securitizing”---“X” dollars, “rush to file, slow to
record after judgment”---“X” dollars, “the jurisdictional integrity of United
States District Court”---“Priceless.”
[22]
Nor will a
mere
copy of the note suffice.
[23]
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.
There are
good practical reasons for the possession requirement. 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).
[24] Courts
must take special care not to expose the maker to such double liability.
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?
There have
been serious scholarly arguments that most mortgage notes are not technically
negotiable.
[25] 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.
[26] Pennsylvania’s Chief
Justice John Gibson once said that a negotiable instrument must be a “courier
without luggage.”
[27]
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.
[28] Since most mortgage notes
are cluttered with extraneous promises by the maker, the contention is at these
notes are not “negotiable instruments” as that term is defined in the UCC.
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.
[29]
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). Courts have been
receptive to this analogy argument.
[30
Destroying
the negotiability of the promissory note is not always a good thing for the
foreclosing entity. If the note is not negotiable, then there can no holder in
due course of that note who will take free of defenses to the note.
Such a status is reserved only for negotiable
instruments. A non-negotiable instrument is merely a contract, and like all
contracts it travels with its defenses whenever assigned from one entity to
another.
[31] There
is no such thing as a holder in due course of a non-negotiable instrument. This
is important to foreclosing entities where the homeowner has defenses to
payment that can be asserted in contract actions, but which are not assertable
against a holder in due course.
[32] Say,
for example, that the homeowner was tricked by fraud into signing the mortgage
due to extravagant lies told by the lender (which often happened, particularly
in the sub-prime market).
[33] Such
a defense would not be good against a holder in due course, who could foreclose
and take the home free of the fraud allegation. This is happening over and
over.
[34]
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.
[35]
Faced with
these daunting UCC provisions, but not possessing the original promissory note,
some entities foreclosing have turned to the mortgage contract itself, and
tried to use the failure of the home owner to make the payments required by
that contract as a ground for the foreclosure. "We can prove that the
mortgage was assigned to us, so we'll use it as the grounds for foreclosure,"
is their mantra. Let's explore why that possibility won't work.
When the
purchaser of real property attends the closing and signs paper after paper the
three primary legal documents that are involved in a later foreclosure are (1)
the promissory note by which the new homeowner, called the maker of the note,
promises to pay the lender (the payee) the amount being borrowed to finance the
mortgage, (2) the mortgage contract which promises the same thing and has a large
number of additional contractual obligations and duties, and (3) the mortgage
deed which transfers title to the real estate involved from the homeowner
(“mortgagor”) to the lending institution (‘mortgagee”). The lender keeps the
note and the mortgage contract, and files the mortgage deed in the real
property records so as to create a lien on the property which must be satisfied
before the property could later be transferred to someone else.
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.”
[36] 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.
[37] The
United States Supreme Court established the basic rule early in the 1873 case
of
Carpenter v. Longan:
[38]
"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.
[39]
Indeed,
Article 9 of the Uniform Commercial Code codifies this idea.
Section 9-203(g) 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.
[40] For a complete discussion
of these issues, see the UCC's Permanent Editorial Board's official
explanation: http://www.ali.org/00021333/
PEB%20Report%20-%20November%202011.pdf
There has
been an attack on this concept recently in a way that might aid homeowners. In
U.S. Bank v. Ibanez,
[41]
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
Massachusetts Supreme Judicial Court did not consider the effect of UCC
§9-203(g), 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).
[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.
It has
always been a basic rule of negotiable instruments law that once a promissory
note 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.
[42]
However, as
discussed above, the promissory note itself is owed to a PETE, and only that
person can show that the debt was not paid when due, thus creating a
"dishonor" and severing the note from the underlying mortgage
obligation, so as to permit foreclosure under the latter theory. 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.
Official Comment 3 to §3-502 states "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," and Official Comment 3 to §3-310 explains:
"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" (emphasis added).
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 and that the note was is the hands of a PETE when failure to
pay the note occurred.
[43]
Failing that the mortgagor is not in default since he/she has not dishonored
the note. Until that happens, §3-310
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.
Thus if the
entity trying to foreclose cannot produce the promissory note, it cannot prove
that payment was not made to the PETE, meaning that no "dishonor" of
the note has occurred under 3-502, and thus the underlying mortgage obligation
is still merged into the note.
There are
some federal cases supposedly applying California law which state 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
[44]
(there are federal California decisions to the contrary
[45]). 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. The obligation in the statute is either
the obligation of the maker of the promissory note (UCC §3-412), which
obligation only runs to a PETE, or the mortgage obligation which is suspended
as a cause of action per §3-310 until dishonor of the note in the hands of the
PETE.
Either way there is no
"breach of the obligation for which the mortgage or transfer is a security"
without the original promissory note being involved.
[46]
Arizona has
a similar dismal history with this issue, where once again some federal courts
have misconstrued Arizona's foreclosure statute so as to permit foreclosure
without production of the promissory note.
[47] The Arizona Supreme Court has recently
adopted this line of reasoning. In the
Hogan
v. Washington Mutual Bank, 277 P.3d. 781 (Ariz. 2012), the Arizona Supreme
Court held that the Arizona statute allowing non-judicial foreclosure of a deed
of trust does not require the foreclosing entity to “show the note.”
The decision contains one mistake after
another in the court’s reading of the Uniform Commercial Code.
The court separates the note from the
mortgage, in violation of the “security follows the debt” rules carefully
codified in Article 9, and then casually states that the Uniform Commercial
Code does not apply to real property liens.
The latter statement is just plain wrong.
Article 3 of the Code on Negotiable
Instruments applies to all notes, including those generated by the creation of
a mortgage lien,
[48] and
Article 9 then applies the “security follows the debt” rules to such notes.
[49] The Arizona Supreme Court pays no attention
at all to the merger rule of §3-310, which would prevent any foreclosure on the
mortgage debt until the note itself has been dishonored.
The court offered a policy reason for its
decision: “Requiring the beneficiary to prove ownership of a note to defaulting
trustors before instituting non-judicial foreclosure proceedings might again
make the “mortgage foreclosure process ... time-consuming and expensive,” . . .
and re-inject litigation, with its attendant cost and delay, into the
process.”
That may be true, but it does
not justify ignoring statutes enacted by the Arizona legislature that clearly
call for a different result. Arizona Revised Statutes §33-807 permits a
foreclosure sale "after a breach or default in performance of the contract
or contracts, for which the trust property is conveyed as security, or a breach
or default of the trust deed."
As
above, no such breach or default can exist until there is a failure to pay the
promissory note in the hands of a PETE.
[50]
There are
substantial equities in favor of the foreclosing party, and judges should work
hard to preserve these equities. The
debtor did take out the mortgage and sign the promissory note promising to pay
off the mortgage amount, and, on failing to do so, must surrender the real
property that is the security for this debt.
Further, the foreclosing entity has paid good money for the right to
foreclose, and this investment must be protected. The bank that is foreclosing may protest that
if some technicality (i.e., the rules that are explained in this article)
forbids foreclosure the homeowner might escape from having to pay anyone the
mortgage debt, but still retain possession of the mortgaged property.
Of course
these equities presume that the foreclosing entity really is the owner of the
debt and can prove it according the standard rules of law, and that the debt
truly is in default.
At the symposium
presentations that resulted in this issue of the law review, one of the
attorneys in the audience came to the microphone with a horror story about a
client who had missed some payments but then, faced with foreclosure, worked
out a repayment agreement with the current holder of the mortgage, never missed
a payment, but was considerably surprised one day to have the doorbell ring and
be faced with the "new owner" of his property which had been
purchased at a California non-judicial sale of which the current owner was
unaware.
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.
[51]
If a court
rules that the bank can’t foreclose, does that mean that the home owner gets
away without paying the mortgage? Not quite. The mortgage deed is still filed
in the real property records, and unless it’s removed the property can never
be sold, not even if the home owner dies and the heirs want to dump it. The
home remains collateral for the debt, and that won’t go away until the
mortgagee agrees to remove it from the records.
Thus the homeowner has an interest in working things out with the entity
threatening to foreclose.
If the
foreclosing bank cannot prove valid ownership and hence is forbidden the
possibility of foreclosure, the only remedy left for the bank 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
creates a warranty from the assignor to the assignee that the obligation
assigned exists and is subject to no defenses,
[52] 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 and sometimes you purchase a
worthless asset. You certainly shouldn’t buy something unless your seller can
prove good title.
If the
foreclosing bank wins the lawsuit but doesn’t have proper documentation, any
subsequent sale of the property
foreclosed upon is going to be problematic and risky for the new purchaser (and
this should be pointed out to judges before they rule). Issues like this
present new difficulties.
Consider title
insurance companies. At all real estate closings the buyer has to pay for such
insurance, but it’s not common for title insurance companies to actually have
to pay off; the title normally is flawless. But if judges start invalidating
foreclosures and ruling that the house belongs to the original owner, buyers of
foreclosure homes are going to be filing claims. Title insurance companies
might have to pay out millions, leading them to raise rates, cut down policies,
layoff employees, or declare bankruptcy. Certainly no respectable title
insurance company is going to issue a policy for the resale of a
foreclosed-upon home where there are legal issues about missing notes or
improper documentation in the foreclosure proceeding, and, without title
insurance available, what will the foreclosing bank do with an unsalable property?
[53]
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. The amount could also be paid into court in an interpleader
action in appropriate circumstances.
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 entity to make sure it has the
proper documentation before it files
the foreclosure, and to have contacted the debtor before foreclosing to see if
(a) the debt is really in default, (b) there are no defenses to foreclosure
(such as an existing workout arrangement), (c) the debtor can pay the debt without
the necessity of foreclosure), or (d) some option to foreclosing exists. The banks are overwhelmed by the ownership of
worthless homes on which they have foreclosed.
In truth it would be smarter 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. Judges faced with foreclosing entities that
do not have the original promissory note should at least use the mechanism for
lost notes described above and require the foreclosing entity to post bond
protecting the homeowner form later claimants to the property who do possess
the original note.
There are
tons of unintended consequences from the current procedures. If you are a respectable bank official caught
up in all this, how many new mortgages would you be willing to make to people
who are not already well off? Then,
without readily available mortgage loans, what will happen to the whole idea of
home ownership? Or the ability to move
to take a job in another town? Or the
economy? Or the American Dream of a
better life than one’s parents? If you
are a consumer considering buying a new home, think again. Doing so can be
asking for trouble even if you can afford to pay cash—will the neighborhood
self-destruct? Could you sell it if you
want to? How good is the title on this
new property?
For
troublesome transactions (the paperwork is a mess, the note is missing, the
home owner alleges he/she has defenses) it’s time to sit everybody around a
table and work out a satisfactory solution through negotiation. Judges might
well order this. All involved need a
resolution that will end in a resumption of the payments, or an agreed-upon
foreclosure with indemnities to the home owner against future troubles (say
from the real owner of the original promissory note), or some contractual
arrangement that ends up with a salable property in the local community.
This
article has not gotten into a host of other issues affecting mortgage
foreclosures, and those matters must be dealt with elsewhere.
Here is a brief list of some legal
difficulties:
proof the assignment of
the mortgage,
[54]
robo-signing and foreclosure mills,
[55] proof of business records
establishing the right to foreclose,
[56] and fraud.
[57] The footnotes give some guidance to these
difficulties, which have little or nothing to do with the Uniform Commercial
Code.
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.
[58]
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, as explained above, the common law is no different from the
UCC, so dodging the UCC does not help the plaintiff trying to foreclose without
having possession of the note.
When the
consumer agrees to buys a new home and goes to the closing, the lending bank
overwhelms the new homeowner with legal paper, after legal paper, after legal
paper which the borrower must sign or the loan will not go through.
At this end of the transaction the bank is
very careful to make sure everything is in apple pie order and that every
"i" is dotted and every "t" is crossed.
Call me a madcap fool if you will, but I
think that at the other end of the transaction when banks are attempting to
take someone's home, they ought to be required to follow the law then too.
As the Third Circuit has commented in a case
where the foreclosing bank could not produce the necessary proof, "Financial
institutions, noted for insisting on their customers' compliance with numerous
ritualistic formalities, are not sympathetic petitioners in urging relaxation
of an elementary business practice."
[59]
Article 3 of the Uniform Commercial Code has been adopted in
all jurisdictions in the United States.
New York has adopted only the original version of Article 3, but in that
state, the relevant citations and the law remain the same with only minor
variations in language.
The "mort" portion of the
word mortgage comes from Latin for "death" (as in
"mortician," "morgue," "mortal," etc.) because on
the payment of the promissory note debt, the mortgage deed dies.
RealtyTrac Staff,
Record 2.9 Million U.S. Properties Receive Foreclosure Filings in 2010
Despite 30-Month Low in December,
http://www.realtytrac.com/content/press-releases/record-29-million-us-properties-receive-foreclosure-filings-in-2010-despite-30-month-low-in-december-6309
(last updated Jan. 12, 2011). This immediately followed late 2009, where the
third quarter saw 937,840 homes receive some sort of foreclosure letter, which
at that point was “‘the worst three months of all time.’” Les Christie,
Foreclosures: ‘Worst three months of all
time’, http://money.cnn.com/2009/10/15/real_estate/foreclosure_crisis_deepens/
(last updated Oct. 15, 2009).
See HSBC
Bank USA, N.A. v. Charlevagne, 872 N.Y.S.2d 691 (table), 2008 WL 2954767
(N.Y. Sup. Ct. 2008)
and HSBC Bank USA, Nat. Assn. v. Antrobus, 872 N.Y.S.2d 691 (table), 2008 WL
2928553 (N.Y. Sup. Ct. 2008)
(Describing “possible incestuous relationship” between HSBC
Bank, Ocwen Loan Servicing, Delta Funding Corporation, and Mortgage Electronic
Registration Systems, Inc., due to the fact that the entities all share the
same office space at 1661 Worthington Road, Suite 100, West Palm Beach,
Florida. HSBC also supplied affidavits in support of foreclosure from
individuals who claimed simultaneously to be officers of more than one of these
corporations.).
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 economy, 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 h
as even ruled that since it
makes no loans MERS cannot be the mortgagee on a deed filed in the Arkansas
property records; see Mortg. Elec. Registration Sys., Inc. v. S.W.
Homes of Ark., 2009 Ark. 152
(2009). In one Utah trial court
decision, reported in news articles, 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
particular home owner is a major beneficiary of the MERS mess.
MERS has been
under much greater attacks lately. News articles have reported that 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."
Uniform
Commercial Code §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).
Uniform
Commercial Code §3-418(d) is also referenced in the PETE definition but
it has to do with recreating the rights of indorsers in instrument paid by
mistake, which is not something that arises in mortgage foreclosure cases.
See
e.g. Riggs v. Aurora Loan Services, 36 So. 3d 932 (Fla. 4th Dist. App. 2010).
See
Uniform Commercial Code § 3-204, Official Comment 1.
L.S. Presnell,
Country Banking In The Industrial Revolution 172-73 (Oxford 1956)
(discussed in J. Rogers,
The End Of
Negotiable Instruments: Bringing Payment Systems Law Out of the Past 32
(Oxford 2011)).
See
Adams v. Madison Realty & Dev., Inc., 853 F.2d 163, 167 (3d Cir. 1988)
(Mere folding of the alleged allonge around the note insufficient—$19.5 million
lost because of this legal error!);
HSBC
Bank USA v. Thompson, 940 N.E.2d 986 (Ohio App. 2nd Dist. 2011)
(unattached pages cannot be an allonge);
In re
Weisband, 427 B.R. 13, 20 (Bankr. D. Ariz. 2010) (same).
I know of no paper clip cases, but it
does seem unlikely a court would hold that such a clip would "firmly
affix" one piece of paper to another.
As for staples,
see Lamson v. Commercial Credit Corp., 187
Colo. 382 (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 un-stapling.”);
accord S.W. Res. Corp. v. Watson, 964 S.W.2d 262, 263 (Tex. 1997)
. I tell my
law students that they'll know they've hit the big time if they're in the Colorado
Supreme Court arguing about whether a staple firmly affixes an allonge to the
original instrument.
One court has also
blessed the use of an Acco fastener;
see Fed. Home
Loan Mortg. Corp. v. Madison, 2011 WL 2690617 (D. Ariz. July 12, 2011).
The leading (misleading?) case is
Anderson v. Burson, 424 Md.
232 (2011).
Uniform Commercial Code § 3-201
(Thieves can qualify as a "holder" of a negotiable instrument and
thereafter validly negotiate same to another);
See also Uniform Commercial Code § 3-201, Official Comment 1
(giving an example involving a thief).
See
In re Veal, 450 B.R. 897 (9th Cir. BAP 2011); Anderson v. Burson, 424 Md. 232
(2011); Leyva v. National Default Servicing Corp., 255 P.3d 1275 (Nev. 2011); In
re Kang Jin Hwang, 396 B.R. 757 (Bankr. C.D. Cal. 2008).
Uniform Commercial Code §3-309. The
2002 version has slightly different wording of (a):
(a)
A person not in possession of an instrument is entitled to enforce the
instrument if:
(1) the person seeking to enforce the
instrument:
(A)
was entitled to enforce the instrument when loss of possession occurred; or
(B)
has directly or indirectly acquired ownership of the instrument from a person
who was entitled to enforce the instrument when loss of possession occurred;
(2) the loss of possession was not the
result of a transfer by the person or a lawful seizure; and
(3) 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.
The
2002 rewrite of (a) was done to allow an assignee
of the entity which lost the note to enforce it, a result that most courts reached
even without this clarification. See Atlantic Nat. Trust, LLC v. McNamee, 984 So.2d 375 (Ala. 2007).
See
In re Carter, 681 S.E.2d 864 (N.C. App. 2009) (In one major misstep, a bank
in Florida, in a "paper reduction effort" is reputed to have deliberately
put the notes through a paper shredder after making photocopies of them!
Any attorney who approved such a practice
should be disbarred.).
See Bank of New York v. Romero, 302 P.3d 1 (N.M. 2014);
255 P.3d at 1275; In
re David A. Simpson, P.C., 711 S.E.2d 165 (N.C.App. 2011);
Schwartzwald, 194
Ohio App. 3d at 644; U.S. Bank Nat. Ass'n v. Kimball, 27 A.3d 1087 (Vt. 2011).
In
re Miller,
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.").
666 F.3d at 1255; 450 B.R. at 914; 2007 WL 3232430; In re Sheridan, 2009 WL 631355
(Bankr. D. Idaho Mar. 12, 2009)
(a moving party which
has the burden of proof must make a showing that it is actually a party in
interest to the proceedings); In re
Wilhelm, 407 B.R. 392 (Bankr. D. Idaho 2009); In re
Weisband, 427 B.R. 13 (Bankr.
D.Ariz. 2010); In re Jacobson, 402 B.R. 354 (Bankr. W.D.Wash.
2009) (where movants attempted to show that they were a party in interest with
a deed rather than a note, but the court held that “[h]aving an assignment of
the deed is not sufficient, because the security follows the obligation
secured, rather than the other way around.” Id. at 367 (citations
omitted)). accord I.C. § 45–911
(“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.
See In re Veal, 450 B.R. 897 (9th Cir. BAP
2011) (dueling creditors
attempting to foreclose each held only a copy of the note, but not the
original); McKay v. Capital
Resources Co., 327 Ark. 737, 940 S.W.2d 869
(1997); but see
In re Adams, 204 N.C. App. 318
(2010) (copy of note sufficient as long as
possession of the original note is alleged, but if possession challenged it
must be proven, along with a valid chain of indorsements to demonstrate proper
negotiation). A copy of the note is
also allowed if accompanied by an affidavit attesting to possession of the original
note; see F.D.I.C. v. Cashion, 720 F.3d 169 (4th Cir. 2013).
See 255 P.3d at 1275; 204 N.C. App. at
318; HSBC Bank USA v. Thompson, 2010 WL
3451130 (Ohio App. Sept. 3, 2012).
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, 962-985 (1997).
Uniform Commercial Code §§3-104(a)(3)
and §3-106.
Overton v. Tyler, 3 Pa. 346, 347
(1846).
See
also Uniform Commercial Code §3-106.
See
HSBC Bank USA, Nat. Ass'n v. Gouda, 2010 WL 5128666 (N.J.Super. App.
Div. Dec. 17, 2010);
In re Edwards, 2011 WL 6754073
(Bankr.. E.D.Wis. Dec. 23, 2011).
450
B.R. at 897; see also Fred H. Miller & Alvin C. Harrell, The Law of
Modern Payment Systems § 1.03(1)(b) (2003).
See
Restatement (Second) of Contracts §336
(1981) (Defenses Against an Assignee).
Per Uniform Commerical Code §3-305, a
holder in due course is free of "person" defenses, and only subject
to the short list of "real" ones, which do not include common law
fraud.
Michael W. Hudson, The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America
and Spawned a Global Crisis (Times Books 2012). (This work details how these mortgages came to be).
The most egregious case is
Brown v. Carlson, 26 Mass.L.Rptr. 61 (2009), in
which the mortgage fraud was perpetrated on "a retired crossing guard, widowed and in her sixties, with
an eighth grade education," who lost her home to a holder in due
course. See also In re
Carmichael, 443 B.R. 698 (Bankr.
E.D.Pa. 2011); In re Dixon-Ford, 76 UCC Rep.Serv.2d 247 (Wis. Lab. Ind. Rev.
Com. Dec. 21, 2011).
See
Restatement (Third) of Property:
Mortgages §5.4.
For a historical
discussion of the reification of the underlying obligation in the physical form
of a bill or note,
see James Steven
Rogers,
The End of Negotiable
Instruments: Bringing Payment Systems Law Out of the Past 24 – 39 (Oxford
University Press 2011).
In
re Williams, 395 B.R. 33, 47 (Bankr. S.D. Ohio 2008);
Manufacturers and Traders Trust Co. v. Figueroa, 2003 WL 21007266
at *2 (Conn. Super. Apr. 22, 2003).
“For nearly a
century, Ohio courts have held that whenever a promissory note is secured by a
mortgage, the note constitutes the evidence of the debt and the mortgage is a
mere incident to the obligation.” U.S.
Bank Natl. Assn. v. Marcino, 181 Ohio App. 3d 328, 337 (7th Dist. 2009)
(citing Edgar v. Haines, 109 Ohio St. 159, 164 (1923).) “
Therefore, the negotiation of a note operates as an
equitable assignment of the mortgage, even though the mortgage is not assigned
or delivered.” Marcino,181 Ohio App. 3d at
337. See also Bank of New York v. Romero, 302 P.3d 1 (N.M. 2014).
Deutsche
Bank Nat. Trust. Co. v. Byrams, 275 P.3d 129 (Okla. 2012)
; Bank of America v. Kabba, 276 P.3d
1006 (Okla. 2012).
Various provisions in Article 9, see
§§9-203(b), 9-309(3), 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. Some lawyers 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 homeowner
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).
That has nothing
to do with the Article 3 rules discussed in the body of this law review
article. For a complete discussion of these issues, see the UCC's Permanent
Editorial Board's official explanation: http://www.ali.org/00021333/
PEB%20Report%20-%20November%202011.pdf.
U.S. Bank Nat. Assn. v. Ibanez, 458 Mass. 637
(2011);
see also http://www.businessweek.com/news/2011-01-08/massachusetts-top-court-hands-foreclosure-loss-to-u-s-bancorp.html.
(last accessed Jan. 8, 2011)
The Code's dishonor rules do 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].
Most 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—which is why this discussion of
"presentment" is relegated to a mere footnote.
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.
If the foreclosing entity cannot produce the
original promissory note, how do we know what it says?
Even if the court is convinced that the right
of presentment was waived, that does not have anything to do with the other
requirement of
dishonor of the note
in the hands of a
PETE.
Until such a dishonor occurs per §3-502, the
underlying obligation is still suspended as an independent cause of action.
See
Tina v. Countrywide Home Loans, Inc.,
2008 WL 4790906 (S.D. Cal. Oct. 30, 2008); Castaneda v. Saxon Mortg. Serv.,
Inc., 687 F.Supp.2d 1191 (E.D. Cal. 2009). Interestingly, I can find no state cases from
California agreeing with this federal analysis of the California foreclosure
statute.
See
e.g., In re Doble, 2011 WL
1465559 (Bankr. S.D. Cal. Apr. 14, 2011).
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
from the discussion of the merger rule, requires dishonor of the note. There
are California bankruptcy decisions so saying;
See Id.
See, e.g., Diessner v. Mortg. Elec. Registration Sys., 618 F.Supp.2d 1184 (D. Ariz. 2009);
Mansour v. Cal-Western Reconveyance Corp.,
618 F.Supp.2d 1178 (D. Ariz. 2009).
Happily the more recent decision by the 9th Circuit
Bankruptcy Appellate Panel gets it right in In
re Veal, 450 B.R. 897 (Bankr. App. 9th Cir. 2011) (Arizona law does
not allow foreclosure without production of the original promissory note).
See
PHH Mortg. Corp. v. Barker, 190 Ohio App.3d 71 (2010).
See
Restatement (Second) of Contracts
§333(b) (1981).
Sometimes, faced with such ownership,
the foreclosing entity will conduct the sale, but never record its deed, thus
leaving the now-homeless former owner with continued liability for taxes and
other major expenses.
Since he/she can't
afford these, the properties just deteriorate further.
Urban blight is already a major problem in
many communities, even upscale ones, as house after house sits abandoned,
leading to dropping real estate value of others, and a vicious cycle of
neighborly collapse. What do municipalities do about the resulting crime, fire
hazards, disease, etc.? They can’t raise taxes in today’s economy. Chapter Nine
of the United States Bankruptcy Code provides for municipal bankruptcies, but
we never teach those rules in law school because actual cases were rare in the
past.
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 Nat. Assn. v. Ibanez, 458 Mass. 637
(2011).
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
http://4closurefraud.org/2010/08/04/mother-jones-andy-kroll-exclusive-fannie-and-freddies-foreclosure-barons/].
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 http://www.squattable.com/news/040311/foreclosure-crisis-fed-judges-dismissing-cases-giving-homes-back-homeowners-and-boldly-a.
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.
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
CACH, L.L.C. v. Askew, 2012 WL 135395 (Mo. 2012); Asset Acceptance v. Lodge, 325 S.W.3d
525 (Mo. App. E. Dist. 2010);
Chase Bank
USA, N.A. v. Herskovits, 28 Misc. 3d 1202(A) (table), 2010 WL 2598198 (N.Y.
Civ. Ct. 2010);
DNS Eq. Group, Inc. v.
Lavallee, 907 N.Y.S.2d 436 (table), 2010 WL 682466 (N.Y. Dist. Ct. 2010);
Palisades Collection LLC v. Kalal, 781
N.W.2d 503 (Wis. App. 2010);
Riddle v.
Unifund CCR Partners, 298
S.W.3d 780 (Tex.App.—El Paso 2009);
Unifund
CCR Partners v. Bonfigil, 2010
Vt. Super. LEXIS 24 (Vt. Super. Ct. May 5, 2010);
but see Simien v. Unifund CCR Partners, 321 S.W.3d 235 (Tex. App. –Hous.
[1st Dist.] 2010).
Outside of the UCC, attorneys should
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
and you can be proven. Fraud is the civil action for lying, an ugly thing to
charge someone with, creating great headlines for the media. If fraud has been
at work, well, that's good news for the plaintiff in a lawsuit. 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 in favor of the evil-doer 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.
Uniform Commercial Code § 3-602.
853 F.2d at 169.
-------------------------------------------
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