Tag Archives: UCC Article 3

Whitman on Foreclosing on E-Note

Posted on by

Professor Dale Whitman posted a commentary on Good v. Wells Fargo Bank, 18 N.E.3d  618 (Ind. App. 2014) on the Dirt listserv. The case addresses whether a lender foreclosing a mortgage securing an electronic note must provide proof that it had “control” of the note when it filed the foreclosure action. This is an interesting new take on an old issue. Dale’s commentary reads:

By now, everyone is familiar with the requirements of UCC Article 3 with respect to enforcement of negotiable notes. Article 3 requires either proof that the party enforcing the note has possession of the original note, or as an alternative, requires submission of a lost note affidavit. With conventional paper notes, it has become common for courts in judicial foreclosure states to require, as a condition of standing to foreclose, that the note holder or its servicer have had possession of the note on the date the foreclosure complaint or petition was filed. This requirement is problematic if (as is often true) the endorsement on the note is undated. In such cases, the servicer will usually be expected to provide additional proof (commonly in the form of affidavits of employees of the holder and/or servicer) that the note had been delivered to the foreclosing party before the date of filing of the action. See, e.g., Deutsche Bank N.T. v. Beneficial New Mexico, Inc., 335 P.3d 217 (N.M. App. 2014); Boyd v. Wells Fargo Bank, N.A., 143 So.3d 1128 (Fla.App. 2014); U.S. Bank, N.A. v. Faruque, 991 N.Y.S.2d 630 (N.Y.App.Div. 2014).

Suppose, however, that the note was electronic rather than paper. Such notes are enforceable under eSign and UETA, but these statutes modify the concepts of delivery and possession. Because an electronic note can be reproduced as many times as desired, and each copy is indistinguishable from the original, eSign creates the concept of the note as a “transferrable record.” Such records must have the following characteristics:

1.  The record must be held within a system in which “a single authoritative copy of the record (the note) exists, which is unique, identifiable, and unalterable.”

2.  To have the equivalent of possession of such a note, if it has been transferred, a person must have “control” in the sense that the system for tracking such notes must reliably establish that the person enforcing the note is the one to whom the record was transferred.

3.  Finally, if the record has been transferred, the authoritative copy of the record itself must indicate the identity of the person who whom it was most recently transferred.

See 15 U.S.C. sec. 7021.

There are very few cases thus far involving foreclosures of mortgages securing e-notes, and little authority on exactly what the holder must prove in order to properly foreclose. In the Good case Wells Fargo was acting as servicer for Fannie Mae, the holder of an e-note that was registered in the MERS e-registry. (MERS’ role with e-notes is very different than for paper notes. In paper note transactions, MERS does not take possession of the note and has no dealings with it, but in e-note transactions, MERS operates a registry to track who has control of the note.)

Accompanying its foreclosure complaint, Wells filed an affidavit by one of its officers, stating that Wells was the servicer, that it maintained a copy of the note, and that its systems provided controls to assure that each note was maintained accurately and protected against alteration. Finally, it stated that the paper copy it submitted with the foreclosure complaint was a true and correct copy of the original e-note.

Unfortunately for Wells, the court found that this affidavit was woefully inadequate to establish Wells’ standing to foreclose the mortgage. Here is the court’s list of particulars:

1.  The affidavit stated that Wells possessed the note, but the court couldn’t tell whether it meant the electronic note or a paper copy.

2.  The affidavit did not assert that Wells had “control” of the record, either by maintaining the single authoritative copy itself in its own system, or by being identified as having control of the single authoritative copy in the MERS registry system.

3.  In fact, Wells never even mentioned the MERS registry system in its affidavit, even though it is obvious from the facts that the note was being tracked within that system.

Wells tried to repair the damage at trial; an employee of Wells testified that Wells was in control of the note, currently maintained it, and serviced the loan. But the court found that this testimony was “conclusory” (as indeed it was) and was insufficient to establish that Wells had control of the note.

Comment: The court provides an extremely useful road map for counsel representing a servicer in the judicial foreclosure of a e-note. The statute itself provides (in 15 U.S.C. 7021(f)) that the person enforcing the note must provide “reasonable proof” that it was in control of the note, and the court felt this must be detailed information and not merely a bare statement.

While the case involved a judicial foreclosure, one might well ask how the “reasonable proof” requirement would be satisfied in a nonjudicial foreclosure. In about eight states, the courts have held (with paper notes) that their nonjudicial foreclosure statutes do not require any assertion or proof of possession of the note. But it is arguable that, if the note is electronic rather than paper, eSign overrides this conclusion by virtue of its express requirement of “reasonable proof.” And since eSign is a federal statute, it is quite capable of preempting any contrary state legislation.  On the other hand, the “reasonable proof” requirement only applies “if requested by a person against which enforcement is sought.” In a nonjudicial foreclosure proceeding, how would the borrower make such a request? These are interesting, but highly speculative questions.

This Note and Mortgage Are Unenforceable

Posted on by

The Bankruptcy Appellate Panel of the Sixth Circuit issued a thoughtful opinion in In re: Dorsey, File No. 14b0002n.06 (March 7, 2014) but it leaves me dissatisfied. As Elizabeth Renuart and Dale Whitman have each demonstrated, courts have had a hard time parsing how UCC Article 3 relates to the enforceability of mortgage notes. That is not the problem with this opinion — the Court carefully applies UCC Article 3, but still concludes that the possessor of the note could not establish that it was a Person Entitled To Enforce it. As a result, the Court concludes that the possessor of the note cannot enforce the note and as a result, the mortgage is “no longer enforceable under Kentucky law.” (12)

Because of the complexity of the analysis, I refer interested readers directly to the opinion itself, which is as clear as can be expected for such a technical subject. But I will note that the Court’s result means that a party that holds the note itself and has much circumstantial evidence that the note was transferred to it by the original lender under the note can forfeit the entire value of the note and mortgage. I generally believe that lenders should be held to strict standards when seeking to enforce the terms of a mortgage loan. But in this bankruptcy proceeding, the possessor of the note is left with nothing and the borrower is granted a windfall — the entire mortgage debt has been extinguished. This does not seem to be consistent with the principles of equity.

I am curious to know what others think, particularly bankruptcy experts. Perhaps I am missing something.

 

[HT April Charney]

Levitin on the Uncertainty of Mortgage Title

Posted on by

Adam Levitin has posted The Paper Chase: Securitization, Foreclosure, and the Uncertainty of Mortgage Title to SSRN.  This paper adds to a small (here and here, for instance), but important body of literature that seeks to harmonize the application of foreclosure laws with the Uniform Commercial Code. Levitin’s abstract reads

The mortgage foreclosure crisis raises legal questions as important as its economic impact. Questions that were straightforward and uncontroversial a generation ago today threaten the stability of a $13 trillion mortgage market: Who has standing to foreclose? If a foreclosure was done improperly, what is the effect? And what is the proper legal method for transferring mortgages? These questions implicate the clarity of title for property nationwide and pose a too- big-to-fail problem for the courts.

The legal confusion stems from the existence of competing systems for establishing title to mortgages and transferring those rights. Historically, mortgage title was established and transferred through the “public demonstration” regimes of UCC Article 3 and land recordation systems. This arrangement worked satisfactorily when mortgages were rarely transferred. Mortgage finance, however, shifted to securitization, which involves repeated bulk transfers of mortgages.

To facilitate securitization, deal architects developed alternative “contracting” regimes for mortgage title: UCC Article 9 and MERS, a private mortgage registry. These new regimes reduced the cost of securitization by dispensing with demonstrative formalities, but at the expense of reduced clarity of title, which raised the costs of mortgage enforcement. This trade-off benefitted the securitization industry at the expense of securitization investors because it became apparent only subsequently with the rise in mortgage foreclosures. The harm, however, has not been limited to securitization investors. Clouded mortgage title has significant negative externalities on the economy as a whole.

This Article proposes reconciling the competing title systems through an integrated system of note registration and mortgage recordation, with compliance as a prerequisite to foreclosure. Such a system would resolve questions about standing, remove the potential cloud to real-estate title, and facilitate mortgage financing by clarifying property rights.

I had to agree with one of his conclusions:  “Reduction of transaction costs is ultimately a second-order move for commercial law. The first-order move, so elemental it is easy to forget, is clarification of the property being transferred.” (723-24) The others are pretty compelling too.

Enforcing The Mortgage Note

Posted on by

Elizabeth Renuart has posted Uneasy Intersections: The Right to Foreclose and the UCC to SSRN. This is a subject that Brad and I have touched on a bit in the context of the Show Me The Note! defense, but Renuart has done a magisterial fifty state review of how state foreclosure laws interact with the Uniform Commercial Code which has been adopted in all 50 states (NY has an older version it on the books for now). The case law in this area is incredibly confused and confusing.  The article helps to chart a path to navigate the intersection between these two areas of law.

Renuart provides a taxonomy of the caselaw, dividing it into three categories:

1.  The UCC States: “courts in these states explicitly join the right to foreclose on a mortgage that secures the negotiable note with the” UCC. (44)

2.  The Foreclosure-Statute-Definition States: “the courts focus on relevant words in the state’s foreclosure statute, such as ‘mortgagee’ where mortgages are used, ‘beneficiary’ where deeds of trust are used, ‘holder’, or ‘owner.’ Next, they determine if that state’s legislature intended that these designations refer to the note holder or the one with the right to act on behalf of the note holder. These courts may or may not reference the UCC in their decisions but the result generally is consistent with” the UCC. (45)

3.  The UCC- Does-Not-Apply States: “courts in these states reason that the state’s foreclosure scheme is comprehensive, inclusive of the prerequisites to foreclose, or does not define the secured party as the one entitled to repayment on the secured monetary obligation. As a result, the UCC does not apply in any way to identify the party who possesses the right to foreclose. To date, these decisions have arisen exclusively in nonjudicial foreclosure states.” (47)

She concludes that the “methodology utilized in Category 1 and 2 states properly harmonizes the relevant UCC rules with state foreclosure law. Category 3 states dismiss the UCC’s role outright. It is these decisions that muddy the law and create inconsistent outcomes from state to state.” (47-48)

It is no exaggeration to say that the discussions about this topic in the blogosphere are virtually incoherent, so this article may provide guidance for those who are looking for it.