Motion For Rehearing (Final) r1

Cause No.
12-0342
IN THE SUPREME COURT OF TEXAS ================================================== JAMES ALLEN MCGUIRE Petitioner, vs. FANNIE MAE F/K/A FEDERAL NATION MORTGAGE ASSOCIATION, Respondent.
================================================= ON PETITION FOR REVIEW FROM THE SECOND COURT OF APPEALS, FORT WORTH, TEXAS On appeal from cause no. 02-11-00312-CV Second District Court of Appeals Fort Worth, Texas =================================================
PETITIONER'S MOTION FOR REHEARING ================================================= JAMES ALLEN MCGUIRE (Pro Se) 902 Rusk Dr Euless, Texas 76039 817 420-4151
IN THE SUPREME COURT OF TEXAS ==================================================== JAMES ALLEN MCGUIRE Petitioner, vs. FANNIE MAE F/K/A FEDERAL NATION MORTGAGE ASSOCIATION, Respondent. ===================================================== ON PETITION FOR REVIEW FROM THE SECOND COURT OF APPEALS, FORT WORTH, TEXAS ===================================================== PETITIONER'S MOTION FOR REHEARING ====================================================== TO THE HONORABLE JUSTICES OF THE TEXAS SUPREME COURT: COMES NOW, JAMES ALLEN MCGUIRE, Petitioner herein, and files this Motion for Rehearing, because he believes his Petition for Review was dismissed for want of jurisdiction by the Court, in error. I. Basis for Motion
The Court's August 17, 2012 Order of Dismissal for Want of Jurisdiction, in the above-referenced cause, did not state reasoning for why the Court felt it lacked jurisdiction over this matter. Given the nature of the case, the only plausible reasoning that the Petitioner perceives having caused the dismissal for want of jurisdiction, is a mistaken belief by the Court, that the Appellant's Petition for Review failed to provide the court with jurisdiction as provided for in 22.001. Petitioner McGuire inadvertently failed to include the case of West v. First Baptist Church of Taft, 71 S.W. 2d 1090, 1098 (Tex. 1934) in the statement for jurisdiction, but such failure to include did not take away the fact that the Supreme Court had jurisdiction and such failure to include was a curable error and is so done in this filing of a Motion for Rehearing. The Texas Supreme Court opined West v. First Baptist Church of Taft, 71 S.W. 2d 1090, 1098 (Tex. 1934) and cited the United States Supreme Courts opinion Carpenter v. Longan - 83 U.S. 271, Mortgage follows the Note and as to where the Second Court of Appeals adjudicated that the Note follows the Mortgage flies in opposite to and upends the statutory and legal precedence of this state that the Mortgage (lien) follows the Note. Such error committed by the Second Court of Appeals is in contradiction to well established commercial financial laws and in opposite of statutes
within the Texas Business and Commerce Code/Uniform Commercial Code and opposite of West v. First Baptist Church of Taft. Whereas if the Second Court of Appeals opinion is not corrected then a party would never be assured that their financial investment could be secure from the party in possession of the security of taking ownership of the Note and thus such security holder would then become the Noteholder. Per Texas Local Government Code 22.001(6), the opinion authored by the Second Court of Appeals is of such importance that this court must use its jurisdiction to right a wrong that can result in commercial finance nightmare. The Texas Supreme Court cited Carpenter with approval in a 1934 decision West v. First Baptist Church of Taft, 71 S.W. 2d 1090, 1098 (Tex. 1934); [Exhibit A] (The trial courts finding and conclusion ignore the settled principle that a mortgage securing a negotiable note is but an incident to the note and partakes of its negotiable character. . . .The note and mortgage are inseparable; the former as essential, the latter as an incident. (quoting Carpenter). The West case goes on to state that the mortgage securing the negotiable note (i.e., the deed of trust), is but an incident to the note and partakes of its negotiable character, which appears to directly contradict the notion that you can foreclose without satisfying the UCC requirements.
Texas Rules of Appellate Procedure 56.1. (a) (2) states; whether there is a conflict between the courts of appeals on an important point of law; whereas Texas Government Code 22.001 Jurisdiction (a) (2) states; a case in which one of the courts of appeals holds differently from a prior decision of another court of appeals or of the supreme court on a question of law material to a decision of the case; By statutory authority, Texas Government Code 22.001 provides that it is not only contradictory appellate opinions that invoke the Supreme Courts jurisdiction but also that of contradiction of a prior opinion by the Supreme Court that invokes the Supreme Courts jurisdiction. The Texas Supreme Court does have jurisdiction over this appeal because the Court of Appeals did commit an error of substantive law, and the error is of such importance to the jurisprudence of this state that it requires correction under 22.001 (a)(2) or (6) of the Texas Government Code, which provides in relevant part: 22.001. Jurisdiction (a) The supreme court has appellate jurisdiction, except in criminal law matters, coextensive with the limits of the state and extending to all questions of law arising in the following cases when they have been brought to the courts of appeals from appealable judgment of the trial courts:...
(2) a case in which one of the courts of appeals holds differently from a prior decision of another court of appeals or of the supreme court on a question of law material to a decision of the case..... (6) any other case in which it appears that an error of law has been committed by the court of appeals, and that error is of such importance to the jurisprudence of the state that, in the opinion of the supreme court, it requires correction, but excluding those cases in which the jurisdiction of the court of appeals is made final by statute. Whereas it appears the courts fail to opine according to statutory law as presented by a pro se, I attached an advanced writing (with permission) that will be published this fall by Professor Whaley of Mortiz College of Law, Ohio State University. [Exhibit B] II. Prayer Based on the above and foregoing, this Court has/had jurisdiction and should reverse the Second Court of Appeals and overturn the Trial Court Judgment. WHEREFORE, PREMISES CONSIDERED, Petitioner prays that upon considering this Motion, the Court will set aside its previous order in which it dismissed this case for want of jurisdiction, consider the merits of this case on a substantive basis, and after doing so reverse the holding of the Second Court of Appeals in this case, and set aside and/or
overturn the Trial Court's Judgment, and for such other and further relief to which the Petitioner is entitled.
Respectfully submitted, JAMES ALLEN MCGUIRE (Pro Se) By: /s/ James McGuire 902 Rusk Dr Euless, Texas 76039 817 420-4151

CERTIFICATE OF SERVICE I do hereby certify that a true and correct copy of the foregoing Petitioner's Motion for Rehearing was served on the following counsel of record, via facsimile, on the _______ day of _________, 2012:
Counsel Representing Janna W. Clarke Broude, Smith & Jennings, P.C. 309 West 7th Street Suite 1100 Fort Worth, Texas 76102 JAMES ALLEN MCGUIRE (Pro Se) By: /s/ James McGuire 902 Rusk Dr Euless, Texas 76039
817 420-4151
West v. First Baptist Church of Taft - WestlawNext
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RELATED TOPICS
Bills and Notes
West v. First Baptist Church of Taft

Supreme Court of Texas. May 16, 1934 123 Tex. 388 71 S.W.2d 1090 (Approx. 16 pages)
Actions Character of Bona Fide Holder of Note Question of Good Faith of Holder of Note
Requisites and Validity
WEST et al. v. FIRST BAPTIST CHURCH OF TAFT et al.

No. 6149.
Return to list 1 of 22 results Search term
Bona Fide Holder of Mortgage Notes
May 16, 1934.
Error to Court of Civil Appeals of Fourth Supreme Judicial District. Suit by the First Baptist Church of Taft against Mrs. Ethelyn West, a Mrs. Morris, individuals constituting the Taft Bank, Unincorporated, and others, in which defendants Morris and another filed a cross-complaint. A judgment canceling plaintiff's notes and trust deeds, held by cross-complainants and a codefendant, and a judgment for the bank against plaintiff, were affirmed by the Court of Civil Appeals (42 S.W.(2d) 1078), and defendants West and others bring error. Reversed and remanded.
West Headnotes (25)

Change View 1 Bills and Notes Burden of Proof as to Bona Fides in General Payee's agreement not to negotiate construction loan notes until completion of building and payment of money to maker constituted infirmity in notes, and negotiation thereof in violation of agreement rendered seller's title defective, as respects necessity of proof of good faith (Vernon's Ann.Civ.St. art. 5935, 52-55).
Bills and Notes Knowledge as to Consideration or Collateral Agreements or Securities Knowledge that note was given in consideration of executory agreement by payee will not deprive indorsee of character of holder in due course, unless he has notice of breach of agreement (Vernon's Ann.Civ.St. art. 5935, 52, 56).
Bills and Notes Good Faith and Payment of Value Evidence in suit to cancel notes held not to support trial court's finding that one purchasing them knew of infirmity therein and defect in seller's title because of premature negotiation thereof in violation of payee's agreement (Vernon's Ann.Civ.St. art. 5935, 52-56).
Bills and Notes Good Faith in General One purchasing negotiable instrument in good faith for valuable consideration may recover thereon, even if grossly negligent, regardless of how seller acquired possession thereof (Vernon's Ann.Civ.St. art. 5935, 56). 3 Cases that cite this headnote
Bills and Notes Good Faith in General Knowledge of facts merely sufficient to cause person of ordinary prudence to make inquiry as to infirmity in negotiable instrument and defect in holder's title,
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with failure to make such inquiry before purchasing it, is not evidence of purchaser's bad faith barring recovery thereon by him (Vernon's Ann.Civ.St. art. 5935, 56). 5 Cases that cite this headnote 6 Bills and Notes Good Faith in General Even gross negligence does not establish bad faith in purchasing negotiable instrument from holder whose title was defective (Vernon's Ann.Civ.St. art. 5935, 56).
Bills and Notes
Good Faith in General
To constitute evidence of bad faith in purchasing negotiable instrument from holder whose title is defective, facts known to taker must reasonably warrant inference that he acted in dishonest disregard of payee's rights (Vernon's Ann.Civ.St. art. 5935, 56). 2 Cases that cite this headnote 8 Bills and Notes Good Faith in General To support finding of bad faith in purchasing negotiable instrument from holder whose title is defective, unheeded suspicious circumstances must be so substantial and strong that bad faith, rather than mere negligence, can reasonably be inferred therefrom (Vernon's Ann.Civ.St. art. 5935, 56). 4 Cases that cite this headnote 9 Evidence Importance in General Evidence may be admissible as tending to prove fact without being sufficient to support finding of such fact.
10
Bills and Notes Good Faith and Payment of Value Evidence in suit to cancel notes held not to support trial court's finding of bad faith of one paying full value therefor in purchasing them from corporation prematurely negotiating them in violation of payee's agreement (Vernon's Ann.Civ.St. art. 5935, 56).
11
Bills and Notes Good Faith in General Gross negligence, as in acquiring negotiable instrument from holder with defective title, consists of omission of care which even inattentive and thoughtless men never fail to take of their own property.
12
Mortgages Bona Fide Purchasers of Negotiable Instruments Secured by Mortgage Mortgage securing negotiable note is but incident to note and partakes of latter's negotiable character. 1 Case that cites this headnote
13
Mortgages Bona Fide Purchasers of Negotiable Instruments Secured by Mortgage Bona fide purchaser of notes for value before maturity became bona fide holder of trust deed securing them. 1 Case that cites this headnote
14
Mortgages Necessity Trust deed must be delivered to be effective.
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15
Mortgages
Evidence
Undisputed evidence in suit to cancel notes and trust deeds securing them held to establish constructive delivery of deeds to payee.
16
Mortgages
Record or Delivery for Record
Mortgagor's filing for record in proper office of mortgage given pursuant to parties' previous agreement to place and accept mortgage on specific property is sufficient delivery thereof. 1 Case that cites this headnote 17 Mortgages Record or Delivery for Record Sufficient delivery of mortgage by mortgagor's filing thereof for record is not counteracted by fact that mortgagor subsequently obtained possession thereof from recorder's office and retained it.
18
Mortgages Record or Delivery for Record Mortgagor's retention of trust deed, executed and filed for record by mortgagor for purpose of creating lien securing latter's notes, held unimportant in determining question of constructive delivery thereof.
19
Mortgages Necessity Title may pass by trust deed without actual manual delivery thereof; controlling question being grantor's intention.
20
Mortgages Bona Fide Purchasers of Negotiable Instruments Secured by Mortgage Trust deeds, filed for record by mortgagor with intention to create liens securing construction loan notes, which payee corporation orally agreed to hold until completion of building, passed to one purchasing notes from payee's parent corporation discharged of equities, to which subject while in payee's hands, to same extent as notes. 7 Cases that cite this headnote
21
Mechanics' Liens Advances of Money Mechanic's or materialman's lien does not exist in favor of person advancing money to pay for labor or material furnished (Vernon's Ann.Civ.St. art. 5452; Const. art. 16, 37). 2 Cases that cite this headnote
22
Liens Express Lien on realty cannot be given by parol agreement. 2 Cases that cite this headnote
23
Mortgages Priorities of Mortgages in General Bank's lien on realty for money advanced to owner after latter's execution of notes to mortgage company for loan of money, agreed to be paid church when building on property was completed, and filing of trust deeds securing them, held inferior and subordinate to lien of such deeds. 2 Cases that cite this headnote
24
Estoppel Acts Making Injury Possible as Between Actor and Another Equally Blameless If one of two innocent persons must suffer by deceit, one who puts trust and confidence in deceiver, rather than stranger, would be loser.
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2 Cases that cite this headnote 25 Mortgages Necessity and Sufficiency of Writing in General Mortgage on realty cannot be given by parol agreement. 1 Case that cites this headnote
Attorneys and Law Firms

*390 **1091 Milling, Godchaux, Saal & Milling, of New Orleans, La., John C. North, of Corpus Christi, and Robert W. Stayton, of Austin, for plaintiffs in error. *391 Gordon Boone and Felix Raymer, both of Corpus Christi, and Templeton, Brooks, Napier & Brown, of San Antonio, for defendants in error.
Opinion
SMEDLEY, Commissioner. The First Baptist Church of Taft, for the purpose of constructing a church building on lots owned by it in Taft, Tex., made application to Southern Mortgage Company, of Abilene, Tex., for a loan of $20,000. Before the building was begun, the church, on the request of the mortgage company, executed and **1092 delivered to the mortgage company, for the purpose of closing the loan, twenty-two promissory negotiable notes aggregating the principal sum of $20,000, payable to Southern Mortgage Company, at the office of Mortgage & Securities Company in New Orleans. At the same time the church executed a deed of trust securing the notes and covering the lots upon which the church was to be built and also other lots owned by the church upon which a parsonage was situated. This deed of trust expressly provided that it covered also all brildings, fixtures, furniture, and equipment then located or thereafter to be located upon the lots upon which the church was to be *392 built. A second and subordinate deed of trust was executed securing the two other promissory negotiable notes payable to Southern Mortgage Company, aggregating the principal sum of $1,000. The notes and deeds of trust, while dated March 9, 1929, were in fact executed May 2, 1929. On the same day, at the request of Southern Mortgage Company, the church caused the two deeds of trust to be filed for record in the office of the county clerk of San Patricio county, and on May 8, 1929, pursuant to the same request, the church mailed the notes to Southern Mortgage Company at Abilene, together with a certificate of the county clerk showing that the two deeds of trust had been filed for record. It had theretofore been agreed, in the course of the negotiations for the loan, that none of the money should be paid to the church until the building had been entirely completed according to the plans and specifications. It had further been agreed by Southern Mortgage Company that the notes would be held by it in Abilene until after the money was furnished on the loan. The church made arrangements with the Taft Bank, Unincorporated, whereby the bank agreed to furnish money to the amount of $20,000 to pay for labor and material in the construction of the building, the money to be advanced as the work progressed and to be repaid the bank when the proceeds of the loan from Southern Mortgage Company were procured. There was an oral agreement between the church and the bank that the bank should have a lien to secure the money so advanced. Building operations were begun about May 2, 1929, the bank advancing something more than $20,000, which was used in payment for labor and material. The building was completed about October 1, 1929, after the trial of this suit in district court. A short time after receiving the notes, Southern Mortgage Company forwarded them to Mortgage & Securities Company at New Orleans, advising that the construction of the building had just begun, and that some time would elapse before the loan would be ready for closing. Southern Mortgage Company was a subsidiary of Mortgage & Securities Company, being wholly owned by it and organized by it for the purpose of doing business in Texas, and all the money loaned by Southern Mortgage Company was procured from Mortgage & Securities Company. On June 25, 1929, the company last named sold and delivered the twenty-two first lien
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notes to plaintiff in error Mrs. *393 Ethelyn West, who bought them for her sisters, plaintiffs in error Mrs. Morris and Mrs. Barham, paying for the same their full face value, the principal and accrued interest. The notes had been indorsed without recourse by Southern Mortgage Company, and their payment was guaranteed by Mortgage & Securities Company. A short time thereafter Mortgage & Securities Company failed, and its property was placed in the hands of a receiver. The church received nothing for the notes. This suit was filed by the church against the two mortgage companies, the receiver of Mortgage & Securities Company, the manager of Southern Mortgage Company, Mrs. West and her sisters, Mrs. Morris and Mrs. Barham, and several individuals who constituted the Taft Bank, Unincorporated. The relief sought is cancellation of the notes and the deeds of trust and the removal of clouds from the property of the church. In the alternative, and in the event and notes and deeds of trust are determined to be valid obligations and liens, the church seeks judgment against the two mortgage companies and the manager of Southern Mortgage Company for the amount so determined, with foreclosure of a lien upon any property of the two companies which might be disclosed or discovered. By cross-action, Mrs. Morris and Mrs. Barham allege their ownership of the twenty-two notes, and of the lien securing them, and that they purchased the notes before maturity for value and with no knowledge or notice of the alleged infirmities, and they pray for judgment for the principal of the notes, interest, attorney's fees, and for foreclosure of lien. The Taft Bank alleges the advancement of funds by it for labor and material aggregating about $24,000, that it has a lien securing same which is superior to the lien claimed by Mrs. Morris and Mrs. Barham, and prays for judgment against the church for the amount **1093 advanced, with interest and attorney's fees, and for foreclosure of lien. The case was tried without a jury, the trial court making elaborate findings of fact and conclusions of law. Judgment was rendered canceling the twenty-two notes held by Mrs. Morris and Mrs. Barham and the deed of trust executed to secure the notes, and also canceling the two notes aggregating $1,000 held by Southern Mortgage Company and the deed of trust executed to secure them; and judgment was rendered in favor of the Taft Bank against the church for $22,300, with interest, and for foreclosure of lien upon the property of the church. The church dismissed its suit against the manager of *394 Southern Mortgage Company, and it was adjudged that it take nothing by its alternative suit. The trial court found that the notes were negotiated and sold by the two mortgage companies to Mrs. West in violation of the agreement under which they were executed and delivered, and in fraud of the rights of the church; that the proceeds of the notes were appropriated by Mortgage & Securities Company; and that the church never received any part of the proceeds of the notes, or any consideration for them. The trial court further found that, at the time she purchased the notes for her sisters, Mrs. West had actual knowledge of the fact that the notes were for a construction loan, that said loan was not completed, that said notes were not ready for negotiation, and that same were not in fact then negotiable; and also that defendants Mrs. West, Mrs. Morris and Mrs. Barham, at the time the notes were purchased by them and delivered to them, as aforesaid, took same with notice of the defects in the title of Mortgage and Securities Company mentioned in preceding paragraphs of these findings, and did not purchase same without notice in good faith and are not purchasers in good faith for value or holders in due course. The Court of Civil Appeals on first hearing reversed and remanded the cause, holding that there was no evidence charging Mrs. West and her sisters with fraud or bad faith, and that they were innocent purchasers of the notes for value before maturity. On rehearing, the judgment of the trial court was affirmed, the majority of the Court of Civil Appeals holding that there was evidence sufficient to sustain the finding of the trial court upon the issue of bad faith. 42 S.W.(2d) 1078. 1 Within the terms of the Negotiable Instruments Law there was infirmity in the notes, and the title of Mortgage & Securities Company which negotiated them was defective, because it had been agreed that the notes were to be held and not negotiated until the building was completed and the money represented sented by the notes paid, and because the notes were negotiated in violation of this agreement, in breach of faith and in fraud of the church. Sections 52-55, art. 5935, R. C. S. 1925.
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2 3 The important question presented is whether there is any evidence to sustain the findings of the trial court that Mrs. West had actual knowledge of the infirmity or of the defect in the title, and that she did not act in good faith in acquiring the notes. By the terms of section 52 of of article 5935 one is not a holder in due course who, although he purchased a negotiable instrument before maturity and for value, had notice at the time it *395 was negotiated of any infirmity in the instrument or defect in the title of the person negotiating it. Section 56 of the said article is as follows: To constitute notice of an infirmity in the instrument or defect in the title of the person negotiating the same, the person to whom it is negotiated must have had actual knowledge of the infirmity or defect, or knowledge of such facts that his action in taking the instrument amounted to bad faith. The first inquiry is whether there is any evidence that Mrs. West at the time she purchased the notes had actual knowledge of the infirmity or defect. As has been stated, the infirmity in the notes was the agreement of Southern Mortgage Company that they would be held and not negotiated until the building was completed and the money represented by the notes paid to the church, and the defect in the title of Mortgage & Securities Company, which negotiated the notes, was that it negotiated them violation of that agreement. Neither Mrs. Morris nor Mrs. Barham had any connection with the negotiations by which the notes were acquired. Mrs. West acted for her two sisters, buying part of the notes for one and part for the other. The three sisters resided in Louisiana. None of them had any acquaintance with or in Taft, Tex. They had no communication with the church at Taft. Mrs. West had bought other notes from Mortgage & Securities Company. The representatives of that company knew that she would take no construction loans, that is, loans secured by buildings to be completed. **1094 The notes were first presented to Mrs. West in the early part of May, 1929, by one Wood, who was a salesman for Mortgage & Securities Company. He submitted to her and left in her possession for examination a prospectus of the loan, the written application of the church to Southern Mortgage Company for the loan, and certain other written and printed information. The application described the notes to be executed, stating that they were to be dated on or about May 1, 1929, and would be secured by a deed of trust upon the property owned by the church, describing it, and that the lots would be improved by a two-story and basement brick church building estimated to cost $37,500. It stated that the building would be completed on or before July 1, 1929. Contrary to the agreement between the church and Southern Mortgage Company that no money would be advanced until the building was finished, the application stated that the proceeds of the loan would be available as the construction proceeded, no payment *396 to be made, however, until construction had reached the point where the net proceeds to be advanced by the mortgage company would complete the building, and that 15 per cent. of the total amount of the contract price should remain in the hands of the mortgage company until completion of the work and final inspection. Mr. Wood testified substantially as follows: That he showed Mrs. West the data which he had received from the files of Mortgage & Securities Company, including the application for the loan; that he discussed the merits of the loan with Mrs. West, but did not recall making any particular statements or representations to her concerning the notes or the deed of trust other than what was shown in the data submitted to her; that he was informed while handling the account of Mrs. West and her sisters that all securities purchased by them must be on completed properties and not on properties in process of construction; that when he made the preliminary offering of the loan he knew that the building was in process of construction, but, when the notes were delivered to her, he was convinced that the building had been fully completed; and that at the time he delivered the notes and accepted payment for them he did not know that the money represented by the notes had not been paid to the church, and did not advise Mrs. West that it had not been paid. Mr. Jackson, vice president of Mortgage & Securities Company, testified that some time before the notes were sold Mrs. West asked him whether or not he considered the Taft church loan a sound one, and he told her he considered it a good loan when ready for delivery, and that he made no other statements to her as to the loan, the notes, of the deed
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of trust. Mrs. West, after going over the instruments left with her and considering the loan for three or four days, advised Mr. Wood that she would take the loan when it was ready for delivery. About six weeks after her first conversation with Mr. Wood he telephoned her that the loan was ready for delivery. Thereupon she went to the office of the Mortgage & Securities Company, examined the notes, the indorsement of Southern Mortgage Company, and the guaranty of Mortgage & Securities Company, and completed the purchase. She made no inquiry about the building or the loan of any other person than those who represented the mortgage company with which she dealt. She did not undertake by correspondence or otherwise to ascertain whether the building had been completed or whether it had been erected at all. She testified that she relied upon the statement made to her by Mr. Wood that the loan was ready *397 for delivery; that nothing had occurred to cause her to be suspicious about the legality or validity of the notes; and that she did not know that the church had raised any question as to the notes until a short time before this suit was filed. Mrs. West, when interrogated on cross-examination as to her knowledge with respect to the notes, testified as follows: As to whether or not it struck me as being worthy of investigation that the application showed that it was a construction loan, I desire to state that the loan was not to be bought by me until it was a finished thing. I knew at the time it was first presented to me that it was not a finished thing. When Mr. Wood first approached me with reference to buying these notes and exhibited to me the papers, including the application, I did look it over. I wanted to see what security I was getting. From that application I saw it was on a building not yet completed. I thought the application stated that the building had not yet been completed. I did not know that it had not been started. At the time he first presented the loan to me he did not offer it for sale. He gave me these notes, if I wanted the loan, when it was a finished thing. He gave me that prospectus and this descriptive matter and this application so I could go over it and consider it and determine if I wanted the loan when it was finished. With reference to my taking his word for it when he told me the loan was **1095 finished, I had no reason to doubt his statement. I took the notes. I had this application in my possession at the time, but I had every reason to believe the building was completed. * * * With reference to my making any attempt to ascertain whether or not this church building had been erected as contemplated to be erected and completed, I desire to state that Mr. Wood had called me and said that the building was completed and that the loan was ready for delivery. It was perfectly understood by me and everybody in the Mortgage & Securities Company that I would take no loan except completed loans. * * * With reference to whether or not I made any attempt to ascertain from the officials of this church whether or not that building had been completed, and with reference to whether or not I merely took the word of Mr. Wood that the loan was ready for delivery, I desire to state that I took the word of a supposedly reputable man. * * * I did ask for a picture of the completed church. When the notes were being delivered to me I saw Mr. Ogden when I got up to leave with the notes. He asked me if Mr Wood fixed me up all right and I said, Yes, but I want a picture of *398 the finished church. I told him that I had just bought the First Baptist Church of Taft notes, and he said, You have not got it? and I said No, and I want it, and he said, We will have to get it for you, and I said, I want Mrs. Morris and Mrs. Barham to see the churh upon which they have loaned their money. He told me that he thought he would get it for me in about a week. * * * With reference to whether or not it occurred to me that the best source of information with reference to the character of the building and as to whether or not the building had been completed and had been accepted by the First Baptist Church of Taft as completed would be the officers of that church, I desire to state that I had no reason to doubt any of the representations that were made by an entirely responsible company. * * * With reference to whether or not I knew as a matter of fact that if that building had not been completed there would have been a question raised about those securities, I had no knowledge of any dealings between Mortgage & Securities Company and the Church of Taft, Texas. * * * Mrs. West testified with reference to another loan offered her: I said to him, That loan was offered to us before, and it is a construction loan, and I said I would not touch a construction loan with a forty foot pole.'
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It is apparent from the testimony of Mrs. West and the other two witnesses, as above quoted and stated, that in their use of such phrases as the loan is not ready for delivery, the loan is not a finished thing, and the like, they were referring to the fact that the building was not completed, and that, knowing that Mrs. West would not accept a construction loan or one secured by an unfinished building, they meant to say that the notes therefore were not ready for delivery to her. Thus the information which she acquired from the application for the loan and from the statements made to her by the representatives of Mortgage & Securities Company was that when the notes were first presented to her the building was not completed, and that at least a part of the consideration for the notes had not been paid by the mortgage company. She knew that the consideration was executory or in part executory. But this did not amount to knowledge that there would be a breach of the mortgage company's executory obligation. Knowledge that a note was given in consideration of the executory agreement of the payee will not deprive the indorsee of the character of a holder in due course unless he has notice of a breach *399 of such agreement. In the absence of knowledge or notice of a breach he may presume that the agreement will be performed as stipulated. Lozano v. Meyers (Tex. Com. App.) 18 S.W.(2d) 588; C. H. Mountjoy Parts Co. v. San Antonio National Bank (Tex. Civ. App.) 12 S.W.(2d) 609; Foster v. Enid, etc., R. Co. (Tex. Civ. App.) 176 S. W. 788; Buchanan v. Wren, 10 Tex. Civ. App. 560, 30 S. W. 1077; 3 R. C. L. p. 1067. The fact that the building was unfinished, in the absence of knowledge of the oral agreement to hold the notes, in no way affected the negotiability of the notes. There is no evidence that Mrs. West ever knew of the agreement between the church and Southern Mortgage Company that the notes would be held at Abilene and not negotiated until the building had been completed and the money paid. The finding of the trial court that Mrs. West and her sisters knew at the time of their purchase of the notes of the infirmity in them and of the defect in the title of the mortgage company is not supported by evidence. The second inquiry is whether there is any evidence that Mrs. West, at the time the notes were acquired, had knowledge of such facts **1096 that her action in taking them amounted to bad faith. The trial court found both actual knowledge of the infirmity and defect in title and bad faith on the part of Mrs. West. The affirmance by the Court of Civil Appeals appears to rest upon the conslusion that there was evidence sufficient to support the trial court's finding that Mrs. West acted in bad faith in acquiring the notes. 4 Judge Garrett, in Wilson v. Denton, 82 Tex. 531, 535, 18 S. W. 620, 622, 27 Am. St. Rep. 908, thus stated and explained the settled rule in this state and in practically all of the other states, and of which section 56 of article 5935 is but a restatement: The ordinary rule of constructive notice which applies to the purchaser of property is not applicable in the case of negotiable instruments. As promotive of their circulation, a liberal view is taken, which makes the bona fides of the transaction the decisive test of the holder's right. He is entitled to recover upon it if he has come by it honestly. Greneaux v. Wheeler, 6 Tex. 525; 1 Daniel, Neg. Inst. s 775. It matters not how the vendor came in possession of the bill or note, whether by theft or fraud or honestly. The title of the transferee does not depend upon the title of the vendor, but upon his possession; and if the buyer has acted in good faith, and paid a valuable consideration, his title cannot be impugned. An early English case (Gill v. Cubitt, 3 Barn. & C. 466) laid down the *400 principle that, although the holder had given value for the bill or note, yet, if he took it under circumstances which ought to have excited the suspicions of a prudent and careful man, he could not recover. This was a departure from the earlier rule, which regarded the bona fides as the crucial test by which it was to be determined whether or not the purchaser should be protected against defenses that would be valid against the transferrer of the note. But the earlier rule was soon again reverted to, and afterwards made even more liberal; and it became the law that, while gross negligence might be evidence tending to show mala fides, and, as such, admissible, it did not in itself amount to proof of mala fides, and was not sufficient to deprive the holder of his right to recover. If it should be left to a jury to determine as to the degree of caution which a prudent man must exercise on taking such an instrument, it would lead to much perplexity, and to frequent injustice. Thus is the law deduced from the English decisions by Mr. Daniel in his admirable work on Negotiable Instruments (section 770 et seq.). (Italics ours.) In that case, Wilson, the payee, intrusted negotiable notes to Denton to sell for him to a designated person. Denton, in violation of his trust, sold the notes to Cotter and McMullan
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for their two notes payable to Denton's wife, and at a substantial discount. The purchasers, although they met both the payee and the maker daily, did not speak to them about the transaction or about the notes. They relied implicitly upon the statements made to them by Denton. A judgment in favor of the purchasers of the notes was affirmed, the court holding that they did not have actual knowledge of the invalidity of Denton's title, and that the facts were not sufficient to charge them with a want of good faith. In the comparatively recent case, Campbell v. Rosenow (Tex. Civ. App.) 32 S.W. (2d) 372, in which application for writ of error was refused, it was held that there was not even a circumstance to sustain the judgment of the trial court that an indorsee of promissory notes was not a purchaser in good faith, although the evidence was that notes in the principal sum of $9,050 payable to the order of the maker and bearing no other indorsement than his in blank were bought for $7,500 from a stranger a short time after their execution and without any inquiry whatever. Goodman v. Simonds, 20 How. 343, 15 L. Ed. 934, one of the leading cases on the question under consideration, announces substantially the same rule as that quoted above from Wilson v. Denton. It holds that facts and circumstances which *401 would excite the suspicion of a careful and prudent man are not sufficient to destroy the title of the purchaser of a negotiable instrument for value. It approves what the opinion states to be the settled law in all English courts that proof that the plaintiff had been guilty of gross negligence in acquiring the bill ought not to defeat his right to recover. The case last referred to is approved and followed in Murray v. Lardner, 2 Wall. 110, 121, 17 L. Ed. 857, 859, in which the court thus states its conclusion: Suspicion of defect of title or the knowledge of circumstances which would excite such suspicion in the mind of a prudent man, or gross negligence on the part of the taker, at the time of the transfer, will not defeat his title. That result can be produced only by bad faith on his part. The same rule is announced in Cromwell v. County of Sac, 96 U. S. (6 Otto) 51, 24 L. Ed. 681, 686. In **1097 Foster v. Augustanna College & Theological Seminary, 92 Okl. 96, 218 P. 335, 337, 37 A. L. R. 854, the court, after stating there must be either actual knowledge or bad faith to deprive a purchaser before maturity and for value of the privilege of being a holder in due course, said: Even gross negligence on the part of a taker of a negotiable instrument will not defeat the title of a holder for value and before maturity. A carefully written article by George W. Rightmire, entitled The Doctrine of Bad Faith in the Law of Negotiable Instruments, appearing in volume 18, pp. 355 and following, of Michigan Law Review, contains, among others, the following conclusions: That when bad faith is the point of inquiry, suspicious ciscumstances must be of a substantial character, and, if such circumstances do not appear, the court can arrest the inquiry; that we are not brought nearer to an answer to the inquiry, Did he take in bad faith? by considering matters of being put upon inquiry and the reasonably prudent man; that it is not failure to inquire, but the dishonest purchase which establishes bad faith, that is, the facts known to the taker must be such that his buying with such knowledge amounts to dishonest dealing toward the defendant. The views expressed are in harmony with the rules announced by the authorities which have been cited. 5 To summarize:
1. Knowledge of facts merely sufficient to cause one of ordinary prudence to make inquiry, with failure to make such inquiry, is not evidence of bad faith. To apply the contrary *402 rule would be to return to the rejected doctrine of the earlier English case, that one acquiring a negotiable instrument under cirsumstances which ought to excite the suspicion of a prudent person could not recover, for, in the application of such contrary rule, the jury would be permitted to find bad faith where the evidence proves only ordinary negligence. 6 2. Even gross negligence is not the same thing as bad faith and does not of itself amount to proof of bad faith, although it may be evidence tending to prove bad faith. 7 3. To constitute evidence of bad faith, the facts known to the taker must be such as reasonably to form the basis for an inference that in acquiring the negotiable instrument with knowledge of such facts he acted in dishonest disregard of the rights of defendant. 8 9 Statements are found in the declsions, as for example in Kaufman Oil Mill v.
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North Texas National Bank (Tex. Civ. App.) 16 S.W.(2d) 143 (application for writ of error refused), to the effect that such evidence, as would be admissible in an ordinary case to show that the purchaser had knowledge of facts that should put a reasonably prudent person upon inquiry, is admissible as tending to prove that the purchaser of a negotiable instrument in taking it with knowledge of such facts acted in bad faith. This does not mean, however, that knowledge of suspicious cirsumstances of whatever character constitutes evidence from which bad faith may be inferred. The consummation of the purchase of a negotiable instrument with knowledge of suspicious circumstances sufficient only to put an ordinarily prudent person upon inquiry would convict the purchaser of negligence, not of dishonesty. To serve as evidence to support a finding of bad faith, the unheeded suspicious circumstances must be of a substantial character and so strong that bad faith rather than merely negligence can reasonably be inferred from them. Evidence may be admissible as tending to prove a fact to be established without being sufficient of itself to support a finding of the fact. 10 Applying the rules which have been discussed to the facts in the record, we are unable to find any evidence supporting the trial court's finding of bad faith on the part of Mrs. West. A circumstance indicating good faith in her payment of full value for the notes. Such fact is not conclusive evidence, but it tends strongly to prove good faith. Canajoharie National Bank v. Diefendorf, 123 N. Y. 191, 25 N. E. 402, 10 L. R. A. 676; Kelso & Company v. Ellis, 224 N. Y 528, 121 N. E. 364. She was not dealing with a stranger, but with a mortgage company from which she had bought other notes and which, as *403 she testified, she believed responsible. While she did learn six weeks before she bought the notes that they represented a construction loan, the proceeds of which were to be advanced as construction proceeded, and that the building was not then completed, the information thus acquired gave her no knowledge of an infirmity in the notes. Furthermore, she was assured at the time of her purchase, and by the salesman from whom she obtained her first information about the notes, that they were then ready for delivery. In the absence of anything to cause her to doubt the truth of the representations last made to her, she must reasonably have believed from them that during the six weeks the building had been completed and the proceeds of the loan paid. There is not evidence that Mrs. West knew or **1098 had reason to believe that the mortgage company was in financial straits, and no evidence of any statements or acts by representatives of the company which should have aroused suspicion. Even if Mrs. West, in buying the notes without making inquiry of the maker, or of some person other than the seller, in order to ascertain with certainty that the building had been completed and the consideration fully paid, failed to exercise that care which a cautious person, or even one of ordinary prudence, would have exercised (which we need not and do not decide), her action in acquiring the notes without such inquiry would be nothing more than negligence; it would not amount to dishonesty, and would not be evidence of bad faith. 11 Nor do we believe that the facts in the record constitute evidence of gross negligence which, as said in Goodman v. Simonds, 20 How. 343, 367, 15 L. Ed. 934, 942, is defined to consist of the omission of that care which even inattentive and thoughtless men never fail to take of their own property. The trial court found that the deeds of trust, although filed for record by the church upon the request of Southern Mortgage Company, were not filed with the intention to deliver the same, but with the intention that they were not to take effect as liens unless and until the amount of money evidenced by the notes had been advanced by Southern Mortgage Company to the church; and further found that the deeds of trust after they were recorded were not forwarded to the mortgage company or to the trustee, but remained in the possession of the church. Following this finding the trial court concluded that the deeds of trust were ineffective and did not create any lien. Based upon this finding and conclusion defendants in error contend that no lien was created by the deed of trust securing *404 the twenty-two notes because there was not an effective delivery. There is no direct testimony that the deed of trust was not to become effective until the money represented by the notes was paid. Although there is a general statement in the testimony of the witness Binford to the effect that in the preliminary negotiations a representative of Southern Mortgage Company stated that all papers and notes would be held until the completion of the building, the testimony of the witness Tackett to the particular
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agreement relied upon by the church and definitely stated is that Mr. Polk, acting for Southern Mortgage Company, agreed that the notes would be held in Abilene until the money was paid. Later the mortgage company prepared the notes and deeds of trust and forwarded them to the church, requesting that after the execution of them the deeds of trust be filed for record and the notes and a certificate of the county clerk, showing that the deeds of trust had been filed, be returned to the mortgage company. These instructions were followed, and the church, a few days later, mailed the notes and the clerk's certificate to the mortgage company, with a letter stating that it was mailing all closing papers pertaining to the First Baptist Church loan. Thereafter the church caused the deeds of trust to be included in a supplemental abstract and sent it to the mortgage company. If a condition attached to the deeds of trust, it was but the one and same condition that attached to the notes. The deeds of trust were executed for the purpose of securing the notes and were intended to be effective for that purpose and to the same extent that the notes were effective. 12 The trial court's finding and conclusion ignore the settled principle that a mortgage securing a negotiable note is but an incident to the note and partakes of its negotiable character. As stated in the opinion in Carpenter v. Longan, 16 Wall. 271, 274, 21 L. Ed. 313, 315: The note and mortgage are inseparable; the former as essential, the latter as an incident. 13 The Supreme Court of Texas, in Pope v. Beauchamp, 110 Tex. 271, 219 S. W. 447, 448, held that the rule of lis pendens does not affect the right to the debt or lien of the bona fide purchaser of a negotiable note, basing its decision upon the necessary inseparability of the note and lien. Justice Greenwood quoted with approval from the opinion of the Supreme Court of the United States in the case last cited, and said: We are further of the opinion that the protection which the law gives the bona fide holder of negotiable paper extends *405 to a lien which is a mere incident of the debt evidenced by the paper, in the absence of actual or constructive notice of some defect in the lien. The bona fide purchaser has the same right to rely on an incidental and inseparable lien as on any other feature of a negotiable note. Hamblen v. Folts, 70 Tex. 135, 7 S. W. 834. We therefore regard as thoroughly sound the declaration of the Supreme Court of Missouri, in Mayes v. Robinson, 93 Mo. 114, 5 S. W. 611, that-If the defendant took the note discharged of any equities to which it **1099 was subject in the hands of the payee, the deed of trust passed to him discharged of such equities to the same extent. Logan v. Smith, 62 Mo. 455. The deed of trust, being incident to the note, partook of the negotiability of its principal. Hagerman v. Sutton, 91 Mo. 519, 4 S. W. 73, and authorities cited. If the defendant was a bona fide holder of the note, for value, before maturity, without notice, he was in equal measure such bona fide holder of the deed of trust. (Italics ours.) On this authority we conclude that, when Mrs. West became the bona fide holder of the notes for value before maturity, she became in equal measure such bona fide holder of the deed of trust which was executed to secure them. 14 15 It is, of course, true that a deed of trust to be effective must be delivered, but we are of the opinion that a constructive delivery was proven by the undisputed evidence. 16 17 If the mortgage is made in pursuance of a previous agreement of the parties to place a mortgage on the specific property, which the mortgagee has agreed to accept, then the act of the mortgagor in filing it for record in the proper office is a sufficient delivery of it. * * * And when a sufficient delivery has thus been effected, it is not counteracted by the fact that the mortgagor obtains the possession of the mortgage from the recorder's office, after it is recorded, and retains it. 41 C. J. p. 427. See, also, the following authorities which hold that the filing for record by the grantor at the request or with the consent of the grantee or mortgagee amounts to a contructive delivery. Newton v. Emerson, 66 Tex. 142, 18 S. W. 348; Russell v. Beckert (Tex. Civ. App.) 195 S. W. 607; Red River National Bank v. Summers (Tex. Civ. App.) 30 S.W.(2d) 726; 8 R. C. L., p. 1006. 18 19 The retention of the deed of trust by the church after it was filed for record is unimportant if, as clearly appears to be true, it was executed and filed for record for the purpose of creating a lien to secure the notes. Title may pass without actual manual delivery of the instrument. The controlling question is *406 the grantor's intention. Taylor v. Sanford, 108 Tex. 340, 345, 193 S. W. 661, 5 A. L. R. 1660; McCartney v. McCartney, 93 Tex. 359,
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364, 55 S. W. 310. 20 In Koppelmann v. Koppelmann, 94 Tex. 40, 57 S. W. 570, it is held that the depositing of a deed for record by the grantor is sufficient evidence of delivery, but that it is not conclusive, and that, in the absence of actual delivery to the grantee, the effect of a deed thus recorded depends upon the intent with which the acts relied upon as taking the place of actual delivery were done. In the instant case the filing of the deeds of trust was a part of the closing of the loan, and the intention of the grantor undoubtedly was to create liens fully effective to secure the notes if and when they were effective. There is nothing in the record to limit or qualify the grantor's intention, except the oral agreement that the notes would be held until the church was completed. By reason of that oral agreement, the notes and the deeds of trust were subject to equities while the notes were in the hands of the payee, but under the rule announced in Pope v. Beauchamp, above discussed, the deed of trust securing the twenty-two notes sold to Mrs. West passed to her discharged of such equities to the same extent that the notes were discharged of them. 21 Since there is no assignment by the First Baptist Church complaining of the judgment in favor of the Taft Bank for foreclosure of lien, the only question presented here with respect to such lien is whether the bank has a lien superior to that securing the notes purchased by Mrs. West. A lien is asserted to exist in favor of the bank, first, on the ground that it advanced money to pay for labor and material in the construction of the building; and, second, on the ground that the church orally agreed that the bank should have a lien to secure the repayment of the money so advanced. The Constitution and the statute give liens to mechanics and materialmen for the value of labor done and material furnished. They do not provide for liens in favor of persons advancing money to pay for labor or material. Constitution, art. 16, s 37; Revised Civil Statutes, 1925, art. 5452. It was held in Gaylord v. Loughridge, 50 Tex. 573, that a mechanic's lien statute in substantially the same terms as article 5452 did not protect a loan of money made and used for the purchase of material and the payment of labor. That case is cited with approval in Hess & Skinner Engineering Co. v. Turney, 110 Tex. 148, 156, 216 S. W. 621, and in *407 Employers' Casualty Co. v. County of Rockwall, 120 Tex. 441, 448, 35 S.W.(2d) 690, 38 S.W. (2d) 1098. See, also, note and citation of many authorities in 74 A. L. R. pages 522 and following, supporting the general rule that a mechanic's or materialman's lien does not exist in **1100 favor of a third person advancing money with which to pay for labor or material. 22 As to the oral agreement, a mortgage or other lien upon real estate cannot be given by parol. Allen v. Allen, 101 Tex. 362, 107 S. W. 528; Home Investment Co. v. Fidelity Petroleum Co. (Tex. Civ. App.) 249 S. W. 1109 (application for writ of error refused); Aaron Frank Clothing Co. v. Deegan (Tex. Civ. App.) 204 S. W. 471 (application for writ of error refused); 20 Tex. Juris. p. 288, 25 Tex. Juris. p. 796. 23 The bank was fully informed about the negotiations for the loan to be made upon the church property by Southern Mortgage Company, and did not agree to make the temporary advancement to the church until it was shown the definite commitment of the loan company to pay the $20,000 to the church when the building was completed. Two of the members of the partnership constituting the bank were signers of the written instrument guaranteeing the payment of the notes to the Southern Mortgage Company, which instrument described the notes and the deed of trust to be executed. The money advanced by the bank was evidenced by notes executed by the church, the first of date June 4, 1929, and on which date the first money was advanced by the bank. This was long after the execution of the notes to Southern Mortgage Company and the filing of the deeds of trust securing them. Without determining, as between the church and the bank, the correctness of the trial court's judgment that a lien exists in favor of the bank, we conclude, from the facts in the record and under the authorities above cited, that such lien, so adjudged to exist, is inferior and subordinate to the lien created by the deed of trust securing the twenty-two notes. 24 Any decision of this case would work a regrettable hardship upon one or more of the parties. This unfortunate result has its source in the misplaced confidence of the church and the bank in the mortgage company, and more particularly it flows from the act of the church in intrusting the negotiable notes to the mortgage company. If one of two innocent
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persons must suffer by a deceit, it is more consonant to reason that he who puts trust and confidence in the deceiver should be a loser rather than a stranger. Carpenter v. Longan, 16 Wall. 271, 273, 21 L. Ed. 313, 315. The judgment of the Court of Civil Appeals and that of the *408 district court are reversed, and the cause is remanded for trial in accordance with this opinion. Opinion adopted by the Supreme Court.
Parallel Citations
71 S.W.2d 1090
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Moritz College of Law - Faculty: Douglas J. Whaley
http://moritzlaw.osu.edu/faculty/bios.php?ID=66
Moritz Law / Faculty / Directory / Douglas J. Whaley
Douglas J. Whaley
Professor Emeritus of Law
Professor Whaley teaches Contracts, Consumer Law, Commercial Paper, Sales, Secured Transactions, and Debtor-Creditor Law. Prior to joining the Ohio State faculty in 1976, he practiced law in Chicago with Chapman and Cutler and taught at Indiana University Law School in Indianapolis. Professor Whaley has won nine awards from three universities for outstanding teaching, including an Ohio State University Distinguished Teaching Award in 1978. He is the author of seven casebooks (Contracts, Sales, Commercial Paper, Consumer Law, Debtor-Creditor Law, Secured Transactions, and Commercial Law) and a book on warranties. Professor Whaley also travels around the country giving lectures for bankers and their attorneys on "The Law of Checking Accounts."
Douglas J. Whaley
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Dglswhaley@aol.com
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B.A., University of Maryland, 1965 J.D., University of Texas, 1968 (with honors)
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Debtor & Creditor
The Ohio State University | Michael E. Moritz College of Law 55 West 12th Avenue | Columbus, OH 43210-1391 | (614) 292-2631
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Mortgage Foreclosures, Promissory Notes, and the Uniform Commercial Code Douglas J. Whaley As is true of many things in life the Uniform Commercial Codes 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 lets begin with the simple (and basic) rule first. Indeed lets call 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 cant 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.1 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 defendants 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 whos failed to pay the mortgage get away with it if the promissory note cant be found, and that I have to slow down my overly crowded docket in the hundreds of foreclosure cases Ive got pending to hear about this nonsense? Its a wonder the judge doesnt add, If you say one more word about Article Three of the UCC youll be in contempt of court!
Professor Emeritus, The Ohio State University Moritz College of Law. The author would like to thank Professor Stephen McJohn of the Suffolk University Law School for his help in researching this article, and the many attorneys (often former students) whose contacts and questions has gotten him involved in these issues. Professor Whaley's blog has a post which updates current developments in mortgage foreclosure matters; see http://douglaswhaley.blogspot.com/2010/11/update-mortgage-foreclosure-and-missing.html. 1 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.
But the law is the law. If the judge doesnt 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 Threes mandates, as we shall see below. I. The Landscape of the Mortgage Mess 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).1 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. 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 "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.
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).2 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.3 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 RealtyTrac Staff, Record 2.9 Million U.S. Properties Receive Foreclosure Filings in 2010 Despite 30-Month Low in December, RealtyTrac (Jan. 12, 2011), http://www.realtytrac.com/content/press-releases/record-29-million-us-properties-receiveforeclosure-filings-in-2010-despite-30-month-low-in-december-6309. 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, CNN (Oct. 15, 2009, 7:34 AM), http://money.cnn.com/2009/10/15/real_estate/foreclosure_crisis_deepens/. 3 See HSBC Bank USA, N.A. v. Charlevagne (2008), 20 Misc.3d 1128(A), 872 N.Y.S.2d 691 (Table), 2008 WL 2954767, and HSBC Bank USA, Nat. Assn. v. Antrobus (2008), 20 Misc.3d 1127(A), 872 N.Y.S.2d 691,(Table), 2008 WL 2928553 (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 .).
2
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!4 II. The Uniform Commercial Code 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.5 "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 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 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). 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."
4
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.]
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 3-309.6 Let's take them one by one. A. "Holder" 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 indorsement 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. 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 doesnt 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 Section 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.
6
explored 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.7 If the payees indorsement on the back of the note names a new payee (pay to X Company), that's called a special indorsement. Now only the newly nominated payee can be a holder (a status postponed until the new payee acquires the noteyou 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. With the exception mentioned next, the indorsements have to be written on the instrument itself (traditionally on the back). C. The Allonge. Sometimes the indorsement 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 indorsement.8 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 indorsements, so a separate piece of paper, called an "allonge" was glued to the original draft and the new indorsements were placed on the allonge. There are cases from Great Britain where the allonge had over a hundred indorsements before finally being presented to the drawee for payment.9 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
8
9
See, e.g., Riggs v. Aurora Loan Services, 36 So.3d 932 (Fla. App. 2010). See Official Comment 1 (last paragraph) to 3-204.
L.S. PRESNELL, COUNTRY BANKING IN THE INDUSTRIAL REVOLUTION 172-73 (1956), discussed in J. ROGERS, THE END OF NEGOTIABLE INSTRUMENTS 32 (2012).
unless that piece of paper is affixed to the note.10 What does affixed mean? The common law required gluing. Would a paper clip do the trick? A staple?11 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). Another difficulty with allonges that has bothered a number of courts occurs in the following fact pattern. The promissory note apparently has a valid indorsement 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 indorsement.12 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 indorsement to have an ownership interest in the note13 (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 indorsement. Section 3-203(c) provides for it specifically:
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 lost because of this legal error!); Error! Main Document Only.HSBC Bank USA v. Thompson, 2010 WL 3451130 (Ohio App. 2010) (unattached pages cannot be an allonge) In re Weisband, 427 B.R. 13 (Bkrtcy.D.Ariz. 2010) (same). 11 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, 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); accord Southwestern Resolution 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 used of an Acco fastener; Federal Home Loan Mortg. Corp. v. Madison, 2011 WL 2690617 (D. Ariz. 2011). 12 The leading (misleading?) case is Anderson v. Burson, 424 Md. 232, 35 A.3d 452 (2011).
13
10
Thieves can qualify as a "holder" of a negotiable instrument and thereafter validly negotiate same to another; see Official Comment 1 to 3-201, giving an example involving a thief.
(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 payees 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.
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(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 holders 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.14 E. Lost Notes See In re Veal, 450 B.R. 897 (9th Cir. BAP 2011); Anderson v. Burson, 424 Md. 232, 35 A.3d 452 (2011); Leyva v. National Default Servicing Corp., 255 P.3d 1275 (Nev. 2011); In re Kang Jin Hwang, 396 B.R. 757 (Bkrtcy.C.D.Cal. 2008).
14
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.15
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
15
The 2002 version of 3-309 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 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).
each transfer of the instrument from the original payee to the current plaintiff, and explain how and why the note cannot be produced.16 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. The Golden Rule of Mortgage Foreclosure Under the UCC 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 cant 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.17 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 mortgage18 Without the note, the foreclosing entity does not have "standing" to sue (and/ora civil procedure distinction that is not my forteis not the "real party in interest").19 As United States District Judge Christopher Boyko explained throwing out a 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. 17 See Leyva v. National Default Servicing Corp., 255 P.3d 1275 (Nev. 2011); In re David A. Simpson, P.C., 711 S.E.2d 165 (N.C.App. 2011); Fed. Home Loan Mtge. Corp. v. Schwartzwald, 194 Ohio App.3d 644, 957 N.E.2d 790 (2011); U.S. Bank Nat. Ass'n v. Kimball, 27 A.3d 1087 (Vt. 2011). In re Miller, 666 F.3d 1255 (10th Cir. 2012); Veal v. Am. Home Mortg. Servicing, Inc. (In re Veal), 450 B.R. 897, 914 (9th Cir.BAP 2011); In re Foreclosure Cases, 2007 WL 3232430 (N.D.Ohio 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.,2011); Fed. Home Loan Mtge. Corp. v. Schwartzwald, 194 Ohio App.3d 644, 957 N.E.2d 790 (2011); Manufacturers and Traders Trust Co. v. Figueroa, 2003 WL 21007266, 34 Conn. L. Rptr. 452 (Conn. Super. 2003); In re David A. Simpson, P.C., 711 S.E.2d 165 (N.C.App. 2011); U.S. Bank Nat. Ass'n v. Kimball, 27 A.3d 1087 (Vt. 2011) ("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"). 19 In re Miller, 666 F.3d 1255 (10th Cir. 2012); Veal v. Am. Home Mortg. Servicing, Inc. (In re Veal), 450 B.R. 897, 914 (9th Cir.BAP 2011); In re Foreclosure Cases, 2007 WL 3232430 (N.D. Ohio 2007); ; In re Sheridan, 2009 WL 631355 (Bankr.D.Idaho 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
18
16
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 CourtPriceless.20
(Bkrtcy.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 Idaho Code 45911 (The assignment of a debt secured by mortgage carries with it the security. 20 In re Foreclosure Cases, 2007 WL 3232430, footnote 3 (N.D. Ohio 2007).
Nor will a mere copy of the note suffice.21 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).22 Courts must take special care not to expose the maker to such double liability. G. Is the Promissory Note Negotiable? This is a thorny issue. First of all, as the debtors attorney, dont 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.23 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.24 Pennsylvanias Chief Justice John Gibson once said that a negotiable instrument must be a courier without luggage.25 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 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); In re Adams, 204 N.C. App. 318, 693 S.E.2d 705 (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). 22 See Leyva v. National Default Servicing Corp., 255 P.3d 1275 (Nev. 2011); In re Adams, 204 N.C. App. 318, 693 S.E.2d 705 (2010); Error! Main Document Only.HSBC Bank USA v. Thompson, 2010 WL 3451130 (Ohio App. 2010). 23 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, 96285 (1997). 24 UCC 3-104(a)(3), 3-106. 25 Overton v. Tyler, 3 Pa. 346, 347 (1846).
21
few additional items that may be mentioned in an instrument without destroying its negotiable character.26 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.27 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 governedamended most recently in 2002). Courts have been receptive to this analogy argument.28 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.29 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.30 Say, for example, that the homeowner was tricked by fraud into signing the mortgage due to extravagant lies told by the lender (which often
26 27
See also 3-106. 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).
In re Veal, 450 B.R. 897 (9th Cir. BAP 2011); see also Fred H. Miller & Alvin C. Harrell, The Law of Modern Payment Systems 1.03[1][b] (2003). 29 See Restatement (Second) of Contracts 336 (Defenses Against an Assignee). 30 Per UCC 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.
28
happened, particularly in the sub-prime market).31 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.32 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.33
III. The Difference Between the Note and the Mortgage 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. A. "Security Follows the Debt"
How these mortgages came to be is delineated in horrible detail in such books as Michael W. Hudson's "The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America and Spawned a Global Crisis" (2010). The most egregious case is Brown v. Carlson, 26 Mass.L.Rptr. 61, 2009 WL 2914191 (Mass.Super. 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 (Bkrtcy.E.D.Pa. 2011); In re Dixon-Ford, 2011 WL 6749083 (Bkrtcy.D.N.J. 2011). 33 See the Restatement of Property (Mortgages) 5.4 and its Comments. For a historical discussion of the reification of the underlying obligation in the physical form of a bill or note, see J. ROGERS, THE END OF NEGOTIABLE INSTRUMENTS 24-39 (2012).
32
31
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.34 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.35 The United States Supreme Court established the basic rule early in the 1873 case of Carpenter v. Longan:36 "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.37 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 partys sworn affidavit in recordable form stating that default has occurred and that the secured party is entitled to enforce the mortgage non-judicially.38 For a 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). 35 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. Edgar v. Haines 109 Ohio St. 159, 164, 141 N.E. 837 (1923).. Therefore, the negotiation of a note operates as an equitable assignment of the mortgage, even though the mortgage is not assigned or delivered. U.S. Bank Natl. Assn. v. Marcino, 181 Ohio App.3d 328, 908 N.E.2d 1032 (2009). 36 83 U.S. 271, 274 (1873).
37 38 34
Deutsche Bank Nat. Trust Co. v. Byrams, 2012 OK 4, 2012 WL 130661 (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,
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,39 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 9203(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). 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. 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. 39 458 Mass. 637, 2011 WL 38071 (Mass. 2011) ; see also http://www.businessweek.com/news/2011-01-08/massachusetts-top-court-hands-foreclosureloss-to-u-s-bancorp.html.
B. The Merger Rule 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.40 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. The Code's dishonor rules do not create a right of physical "presentment" of the note, but 3501 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 3-501which is why this discussion of "presentment" is relegated to a mere footnote.
40
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 mortgagors 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.41 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 state42 (there are federal California decisions to the contrary43). 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
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. 2008); Castaneda v. Saxon Mortg. Services, 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. 43 See, e.g., In re Doble, 2011 WL 1465559 (Bankr. S.D. Cal. 2011).
42
41
for which the mortgage or transfer is a security" without the original promissory note being involved.44 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.45 Once again I can't find any state decisions from Arizona on point, but the federal courts misread the relevant Arizona foreclosure statute in the same way that the federal courts in California have mistaken the California statute. 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.46 Finally, it should be noted that the federal courts in Nevada have made the same error, but so far this misunderstanding of the law appears to be confined to these three western (federal) jurisdictions. Happily, most states allowing non-judicial foreclosure sales have rightly required the foreclosing entity to be the owner of the note at the time of the foreclosure is commenced.47
IV. How To Resolve These Matters 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. 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 In re Doble, 2011 WL 1465559 (Bankr. S.D. Cal. 2011). 45 See, e.g., Diessner v. Mortgage Electronic Registration Systems, 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 Veal v. Am. Home Mortg. Servicing, Inc. (In re Veal), 450 B.R. 897, 914 (9th Cir.BAP 2011) (Arizona law does not allow foreclosure without production of the original promissory note). 46 Compare Ernestberg v. Mortgage Investors Group, 2009 WL 160241 (D.Nev. 2009), with the relevant Nevada foreclosure statute, which only allows foreclosure " after a breach of the obligation for which the transfer is security" [N.R.S. 107.080]. 47 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).
44
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.48 If a court rules that the bank cant 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 its 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 wont 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,49 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 shouldnt buy something unless your seller can prove good title. If the foreclosing bank wins the lawsuit but doesnt 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 its 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
48 49
See PHH Mortgage Corp. v. Barker, 190 Ohio App.3d 71, 940 N.E.2d 662 (2010). See Restatement of Contracts (Second) 333(b).
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?50 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 ones parents? If you are a consumer considering buying a new home, think again. Doing so can be asking for 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 cant raise taxes in todays 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.
50
trouble even if you can afford to pay cashwill 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) its 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. V. Conclusion 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,51 robo-signing and foreclosure mills,52 proof of business records 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). 52 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-jonesandy-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 didnt 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 judges 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-fedjudges-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.
51
establishing the right to foreclose,53 and fraud.54 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.55 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,
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). 54 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 its 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 attorneys 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 theorythey are truly outlaws in the literal meaning of that term. 55 UCC 3-602.
53
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."56
56
Adams v. Madison Realty & Dev., Inc., 853 F.2d 163, 169 (C.A.3d 1988).

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WestlawNext. 2012 Thomson Reuters

Moritz College of Law - Faculty: Douglas J. Whaley

Moritz Law / Faculty / Directory / Douglas J. Whaley

Summer 2012 Courses

Uniform Commercial Code 3-412. Obligation of Issuer of Note or Cashier's Check.

The 2002 version of 3-309 has slightly different wording of (a):

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