Chapter IVII
Transfer by the
Mortgagee
■ ANALYSIS
A.
Nature of the Mortgagee’s Interest
1.
2.
3.
The Twofold Nature of the Mortgagee’s Interest
Primary Importance of the Obligation
Enforcement of the Obligation, Ownership of the Obligation, and Governing Law
B.
Transferring Ownership
C.
Transferring Entitlement to Enforce (or PETE Status)
1.
2.
3.
D.
Assignment of the Note and Mortgage for Security Purposes
1.
2.
3.
4.
E.
The Application of UCC Article 9 to Transfers of Mortgage Notes as Security
How Is Perfection Accomplished?
Which Method of Perfection Should Be Used?
How Does a Security Assignee Realize on the Security?
Rights and Obligations of the Assignee Relative to the Mortgagor
1.
2.
3.
4.
5.
F.
Negotiable Notes
Nonnegotiable Notes
Can an Assignee Other than a PETE Foreclose Nonjudicially?
Qualifying as a Holder in Due Course (HDC)
The Rights of an Assignee Who Is a HDC
Non-HDC Status
Limitations on the Holder in Due Course Doctrine
Payment to Assignor as a Defense
Impact of Recording Acts
1.
2.
3.
4.
5.
6.
Need for Recording of Mortgage Assignment
Effect of Recording the Mortgage Assignment and Payment on the Mortgage Debt
Wrongful Satisfaction of the Mortgage by the Original Mortgagee
Recording as Means of Gaining Notice of Litigation
Wrongful Satisfaction by a Trustee Under a Deed of Trust
Mortgage Electronic Registration System (MERS)
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G.
Participations
1.
2.
3.
Rights of the Participants After Default
Lead Lender Misconduct
Lead Lender Bankruptcy
TRANSFER BY THE MORTGAGEE
It is a common practice for mortgagees to sell some or all of their mortgage loans to other
investors shortly after origination of the loans. The sale of a loan is often loosely referred
to as an “assignment” of the mortgage. Such sales are most often made by “mortgage
bankers,” whose business consists of originating loans for immediate sale to other
institutional lenders. Other originating lenders, such as savings banks and commercial
banks, may retain in their own portfolios some of the mortgage loans they originate, while
selling others.
The market into which these sales occur is the secondary mortgage market. Numerous
entities, both private and governmental, actively participate in purchasing mortgage
loans in the secondary market. Some of the agencies and their significant economic impact
on the housing industry are described in Chapter XI, infra. Two of the largest, Fannie
Mae and Freddie Mac, are federally-chartered corporations. This Chapter focuses on the
legal rights and obligations that arise from secondary market transactions.
During the period from the 1990s to the mid-2000s, it became increasingly common for
pools or packages of mortgage loans to be “securitized.” Securitization is a process by
which the mortgage loans are assigned to and held by a custodian or trustee on behalf of
a “special purpose entity” (SPE). The SPE issues debt securities in the capital markets
and sells these securities to investors, with the payments to the investors being derived
from payments made by the mortgagors on the underlying mortgages. These securities
may take one of several forms:

The pool of mortgage loans may be divided into fractional shares, and the
securities sold to investors may represent ownership interests in the mortgage
notes in the pool. Such securities are often known as “participation
certificates” or “PCs.” See Bankers Trust (Delaware) v. 236 Beltway Invst., 865
F.Supp. 1186 (E.D.Va.1994).

The pool of mortgage loans may be pledged as collateral for a set of debt
securities that are sold to investors with the understanding that each investor
will receive a fractional share of the payments of principal and interest made by
the mortgagors on the underlying mortgage loans. These are usually termed
“pass-through” securities, because the mortgage payments are passed through
directly to the securities investors. These securities differ from the PCs
mentioned above because here the mortgage loans serve as collateral for the
securities, while in the PC arrangement the securities are actual shares of
ownership in the mortgage loans. The Government National Mortgage
Association (GNMA) guarantees payment on pass-through securities of this
type, collateralized by FHA and VA residential mortgage loans. See U.S. v.
Logan, 250 F.3d 350 (6th Cir.2001).

The pool of mortgage loans may be pledged as collateral for a set of securities
that do not individually represent fractional shares of the payments of principal
and interest (although in the aggregate, the payouts on the securities must, of
course, mirror the payments being made on the mortgage loans). The securities
may be issued in as many as ten to twenty different classes or “tranches,” each
of which has different characteristics in terms of interest rate, timing of payment
of principal and/or interest, and priority of payment relative to the other
securities issued out of the same pool. Each “tranche” may appeal to somewhat
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different investors. If the mortgages employed to make up a pool of this type are
large loans on commercial property, the securities are often termed
“commercial mortgage-backed securities” or simply “CMBS.” See Recupito
v. Prudential Securities, Inc., 112 F.Supp.2d 449 (D.Md.2000). But securitization
can involve the pledging of large pools of residential loans for this purpose as
well, and these securities are termed “residential mortgage-backed securities”
or “RMBS.”
No matter which form of mortgage securitization is involved, all securitizations require
that the mortgages be assigned to a trustee or custodian to be held for the benefit and
protection of the securities investors. Hence, the problems involving the transfer of notes
and the assignment of mortgages are equally applicable to securitizations as to the
traditional sale of mortgages on the secondary mortgage market.
A. Nature of the Mortgagee’s Interest
1. The Twofold Nature of the Mortgagee’s Interest
A real estate mortgagee owns two interests: the personal obligation owed by the
mortgagor (usually evidenced by a promissory note) and the interest in the real
estate that is the security for that obligation (usually evidenced by a mortgage
or deed of trust).
2. Primary Importance of the Obligation
When there is a transfer of the mortgagee’s interest, the primary object of the
transfer is the personal obligation, usually represented by a promissory note.
The mortgage security is an important but subsidiary aspect of the transaction.
The security follows the obligation unless the parties express a contrary intent
(which is rare indeed). Whoever is the transferee of the note automatically
obtains the benefit of the mortgage on the land. See Restatement (Third) of
Property (Mortgages) § 5.4(a); Horvath v. Bank of New York, N.A., 641 F.3d 617
(4th Cir. 2011).
3. Enforcement of the Obligation, Ownership of the
Obligation, and Governing Law
When considering the “transfer” of a promissory note, recognize that there are
two distinct sets of rights that can be transferred: the right to enforce the note,
and ownership (or “title”) to the note. These two sets of rights are distinct from
one another, and a great deal of confusion and nonsense has been created by
muddling the two concepts.
Entitlement to enforce a note means that one can sue on it or (if applicable
foreclosure requirements are met) foreclose the mortgage that secures it. The
maker of the note (the mortgagor) is the party most concerned with the identity
of the person entitled to enforce the note (or the “PETE”). The concept is designed
to protect the maker against having to pay twice or defend against multiple
claims on the note. If the maker pays the PETE in full, the maker is discharged
and the mortgage that secures the note is extinguished.
TRANSFER BY THE MORTGAGEE
By contrast, the “owner” of the note is the person ultimately entitled to its
economic value. Thus, the owner of the note is the person who can claim the
payments, including regular installment payments, a voluntary payoff, and the
proceeds of a short sale or a foreclosure.
PETE status and ownership of the note are not necessarily synonymous. A
person need not be the owner of a note to be the PETE, and one can be the owner
of a note without being the PETE. See Permanent Editorial Board for the
Uniform Commercial Code, Application of the Uniform Commercial Code to
Selected Issues Relating to Mortgage Notes (Nov. 14, 2011) (“PEB Report”);
U.C.C. § 3–301 (“A person may be a person entitled to enforce the instrument
even though the person is not the owner of the instrument. . . .”). This is so
because, PETE status and ownership are governed by two separate legal regimes
that establish different criteria.
Transfers of ownership of notes (either outright sale transfers or transfers of
security interests) are governed by UCC Article 9. U.C.C. § 9–109(a)(3) (Article
9 applies to “a sale of . . . promissory notes”), regardless of whether the notes are
negotiable instruments or nonnegotiable instruments. By contrast, PETE status
and the transfer of PETE status is governed by UCC Article 3 if the note is
negotiable, but by the common law of contracts if the note is nonnegotiable. (All
references to UCC Article 3 in these materials are to Revised Article 3 (1990)).
In the mortgage context, one obvious application of the distinction between
ownership and PETE status is that the servicer of a mortgage in a securitized
mortgage pool might well be the PETE (assuming it meets the requirements of
applicable law), but the trustee of the securitization trust (as the owner of the
note) would be entitled to have the proceeds of the enforcement action remitted
to it. For example, suppose that Fannie Mae purchased a mortgage loan and
placed it into a securitization pool, but that ABC Bank is servicing the loan for
Fannie Mae. If the mortgagor goes into default and foreclosure is necessary,
Fannie Mae can deliver the note to ABC Bank (the servicer) so that the servicer
can foreclose, and that foreclosure may even occur in the name of the servicer.
Yet the proceeds of the foreclosure sale obviously flow, under the servicing
agreement, back to Fannie Mae. In other words, Fannie Mae remains the owner
of the note while its servicer, ABC Bank, is the PETE. See, e.g., Giles v. Wells
Fargo Bank, N.A., 519 Fed.Appx. 576 (11th Cir. 2013); In re Veal, 450 B.R. 897
(9th Cir. B.A.P. 2011).
B. Transferring Ownership
As noted above, UCC Article 9 governs transfers of ownership of promissory notes
(including those secured by real estate mortgages). A note an “instrument” in the
lexicon of Article 9. See U.C.C. § 9–102(a)(47) (“instrument” is “a negotiable
instrument or any other writing that evidences a right to the payment of a monetary
obligation . . . and is of a type that in ordinary course of business is transferred by
delivery with any necessary endorsement or assignment”). Thus, Article 9 governs
the transfer of ownership interests in both negotiable and nonnegotiable notes.
Unfortunately for our purposes, Article 9 is written in the terminology of creation of
security interests in collateral. The Code then (rather obliquely) defines “security
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interest” to include transfers of ownership; under § 1–201(b)(35), “security interest”
includes “an interest of a buyer of . . . a promissory note.” This peculiarity makes
Article 9’s wording confusing and difficult to follow as applied to outright sales of
notes. To avoid this problem, we have rewritten § 9–203(b), the section dealing with
creation of security interests, as though it were solely about sales of notes. As so
rewritten, § 9–203(b) reads in pertinent part:
[A] [sale of an interest in a promissory note] is enforceable against the [seller]
and third parties with respect to the [note] only if:
(1) value has been given;
(2) the [seller] has rights in the [note] or the power to transfer rights in the
[note] to a [buyer]; and
(3) one of the following conditions is met:
(A) the [seller] has authenticated a [sale] . . . agreement that provides a
description of the [note] . . . ; [or]
(B) the [note] is in the possession of the [buyer] under Section 9–313
pursuant to the [seller’s] agreement.
Thus, assuming the seller has rights in the note (or is an agent of someone who has
such rights), and assuming the buyer gives value, ownership can be transferred in
either of two ways: (1) by a signed, written agreement (or its electronic equivalent),
such as a contract of sale or a written assignment, or (2) by delivering possession of
the note to the buyer, provided that there is some agreement (though not necessarily
written or signed) indicating that ownership is to be transferred. A sale of ownership
rights in the note automatically transfers the corresponding ownership rights the
real estate mortgage securing that note. See U.C.C. § 9–203(g). This means that
whoever is entitled to the economic benefits of the note is entitled to the economic
benefits of the mortgage as well.
C. Transferring Entitlement to Enforce (or PETE Status)
Under UCC Article 3, a note may either be negotiable or nonnegotiable. Article 3 says
nothing at all about nonnegotiable notes; thus, their enforcement is left to the
common law of contracts. There is little modern case law concerning their transfer,
perhaps because courts tend to assume (often without analysis) that the notes before
them are negotiable.
1. Negotiable Notes
If a note is negotiable, then under U.C.C. § 3–301, there are only three
permissible ways in which one can acquire PETE status:

Becoming a holder. This will occur if the note has been delivered to and
is in the possession of the person enforcing it, with an appropriate
endorsement. The endorsement may be in blank, which makes the note
a “bearer note,” or it may be a special endorsement that specifically
identifies the person to whom the note is delivered. U.C.C. § 3–201.
These actions will constitute the person who takes the note a “holder,”
entitling him or her to enforce the note.
TRANSFER BY THE MORTGAGEE

Becoming a nonholder who has the rights of a holder. This will occur if
the note has been delivered to and is in the possession of the person
seeking to enforce it, but without a proper endorsement. Absent a
proper endorsement, the person taking delivery of the note cannot be
a holder, but can still get the right of enforcement if he or she can prove
that the delivery occurred for the purpose of transferring the right to
enforce the note. See, e.g., U.S. Bank, N.A. v. Squadron VCD, LLC, 504
Fed.Appx. 30 (2d Cir. 2012).

Providing a “lost note affidavit.” Under U.C.C. § 3–309, a person who
is not a holder (or a nonholder who has the rights of a holder) may still
enforce it if they can provide a “lost note affidavit.” The requirements
for the affidavit are quite strict:
o
The person providing the affidavit must have been in
possession of the note (and the PETE) at the time the note
was lost;
o
The loss of possession must not have been the result of a
transfer by the person or a lawful seizure of the note; and
o
The note must have been destroyed, its whereabouts not
discoverable, or it must be in the wrongful possession of an
unknown person or one who cannot be found or served.
Before accepting such an affidavit, a court might well demand evidence as to
efforts made to locate the note. In addition, the court can require the enforcing
party to provide assurance (typically in the form of a bond or indemnity) against
the possibility that the borrower will have to pay twice.
The 2002 amendments to Article 3 allow a person to enforce a note by providing
a lost note affidavit if he or she “has directly or indirectly acquired ownership of
the instrument from a person who was entitled to enforce the instrument when
loss of possession occurred.” U.C.C. § 3–309(a)(1)(B) (2002). However, because
the 2002 amendments to Article 3 have been adopted in only twelve states, a
secondary market purchaser may be unable to use the lost note procedure if it
purchased a note that was lost or destroyed by its predecessor.
For the transferee to become a holder or a nonholder with the rights of a holder,
the note must be physically transferred into the hands of the person seeking to
enforce it. The parties can use a separate document of assignment, but it cannot
substitute for delivery of the note. See, e.g., Bank of New York Mellon v. Deane,
41 Misc.3d 494, 970 N.Y.S.2d 427 (2013); State St. Bank & Trust Co. v. Lord,
851 So.2d 790 (Fla.Ct.App.2003). If the delivery is accompanied by a proper
endorsement of the note, the transfer is known as a “negotiation,” U.C.C. § 3–
201(a), and the transferee (if otherwise qualified) may become a holder in due
course, as discussed in the next section.
2. Nonnegotiable Notes
By contrast, if a note is nonnegotiable, the right to enforce it can be transferred
by assignment. This may occur by (1) endorsement on the note by the original
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payee-mortgagee; (2) execution by the payee-mortgagee of a separate document
stating that rights under the note are transferred to the assignee; or (3) an oral
statement to the assignee that a transfer is being made. See, e.g., In re Stralem,
303 A.D.2d 120, 758 N.Y.S.2d 345 (2003) (no particular words necessary to effect
assignment; test is whether the assignor “intended to transfer some present
interest”). To assign a nonnegotiable note, it is not strictly necessary that
possession of the note itself be given to the transferee, although a delivery of
possession will almost certainly transfer the right to enforce the note. See, e.g.,
YYY Corp. v. Gazda, 761 A.2d 395 (N.H.2000).
A question sometimes arises whether the right to enforce a nonnegotiable
mortgage note can be transferred by an assignment of the mortgage securing the
debt. If the document assigning the mortgage states that the note or debt is being
transferred, an effective transfer of the note occurs. If the document assigning
the mortgage is silent, courts have split as to whether the document implicitly
assigns the note as well. Some courts treat the assignment as ineffective. See,
e.g., Homecomings Financial, LLC v. Guldi, 108 A.3d 506, 969 N.Y.S.2d 470
(2013); Wells Fargo Bank, N.A. v. Heath, 280 P.3d 328 (Okla.2012). Others hold
that assignment of the mortgage implicitly assigns the obligation absent proof
that the parties had a contrary intent, and the Restatement takes this view.
Restatement (Third) of Property: Mortgages § 5.4(b) (1997); Reinagel v. Deutsche
Bank Nat’l Trust Co., 735 F.3d 220 (5th Cir. 2013).
3. Can an Assignee Other than a PETE Foreclose
Nonjudicially?
Because UCC Article 3 has been enacted in all American states—and it imposes
uniform rules for transferring the right to enforce a negotiable note—one would
expect nonjudicial foreclosures (discussed in further detail in Chapter __) to
operate under the same concepts as judicial foreclosure with respect to the
question of who can initiate foreclosure. For negotiable notes, a person seeking
to foreclose should not be able to do so unless that person is a PETE. See Nelson,
Whitman, Burkhart & Freyermuth, Real Estate Finance Law § 5.28, at 387 (6th
ed. 2015).
Nevertheless, eight states (AL, AZ, CA, GA, ID, MN, MI, and TX) have construed
their nonjudicial foreclosure statutes to disregard Article 3’s requirements, and
have held that the foreclosing party need not demonstrate the right to enforce
the note. Some courts have reached this result by reasoning (wrongly) that
nonjudicial foreclosure is not a method of enforcing the promissory note, See,
e.g., Reardean v. CitiMortgage, Inc., 2011 WL 3268307 (W.D. Tex. 2011). Other
courts have reasoned that the state’s nonjudicial foreclosure statute provides
comprehensive rules for conducting nonjudicial foreclosures that supersede
Article 3. See, e.g., Debrunner v. Deutsche Bank Nat’l Trust Co., 204 Cal.App.4th
433, 138 Cal.Rptr.3d 830 (2012). These decisions are poorly reasoned and fail to
acknowledge the role that PETE status plays in protecting the borrower against
the risk of double enforcement. See Whitman & Milner, Foreclosing on Nothing:
The Curious Problem of the Deed of Trust Foreclosure Without Entitlement to
TRANSFER BY THE MORTGAGEE
Enforce the Note, 66 Ark.L.Rev. 21 (2013); Nelson, Whitman, Burkhart &
Freyermuth, Real Estate Finance Law § 5.28, at 389 (6th ed. 2015).
Fortunately, numerous other states have recognized the correct approach that
the party seeking nonjudicial foreclosure must be a PETE and must provide
some evidence of that fact, typically in the form of an affidavit. See, e.g., Ark.
Code Ann. § 18–50–103(2) (notice initiating foreclosure must include a true copy
of the note with all required indorsements, the name of the holder, and the
physical location of the original note).
D. Assignment of the Note and Mortgage for Security Purposes
Mortgagees often obtain loans by pledging their notes and mortgages as collateral for
the loans. In essence, what results might be termed a mortgage on a note and
mortgage. Sometimes an individual mortgagee may borrow money by pledging a
single note and mortgage as security. More commonly, a mortgage banker will obtain
short-term commercial financing from a bank (often called a warehouse line of credit
or warehouse loan) by delivering a package of notes and mortgages to the bank as
collateral. When the mortgage banker finds permanent purchasers for those notes
and mortgages on the secondary market, it will often pay off the warehouse loan, take
back possession of the notes and mortgages from the warehouse lender, and deliver
them to the permanent purchasers.
Consistent with the rules discussed above (and for additional reasons discussed
below), a prudent warehouse lender would have the notes properly indorsed and
would take possession of the notes. [Where the notes are negotiable, this would place
the warehouse lender in the position of a PETE should the mortgage banker default
on the warehouse loan.] Often, however, the package of loans is delivered to the
warehouse lender with no formal assignment or endorsements. Sometimes, no
physical delivery at all takes place, and the mortgage banker simply designates itself
as custodian for the warehouse lender. As discussed below, this is a particularly risky
procedure.
1. The Application of UCC Article 9 to Transfers of Mortgage
Notes as Security
As discussed above, a transfer of a promissory note will automatically assign the
mortgage that secures the note; no separate assignment is necessary (although
it may well be desirable for the reasons in Section __ of this Chapter). This is
equally true of a transfer as security as it is of an outright transfer by sale of the
note.
When a mortgage note is assigned as security, however, the assignee must also
take care to accomplish “perfection” of the assignee’s security interest. Perfection
of security interests in promissory notes (“instruments”) is governed by UCC
Article 9. As the drafters of Revised Article 9 stated:
The security interest in the promissory note is covered by this Article even
though the note is secured by a real-property mortgage. Also [the creditor’s]
security interest in the note gives [the creditor] an attached security
interest in the mortgage lien that secures the note. . . . One cannot obtain a
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security interest in a lien, such as a mortgage on real property, that is not
also coupled with an equally effective security interest in the secured
obligation. [U.C.C. § 9–109, Comment 7.]
Perfection under Article 9 is critically important in two distinct contexts:

Assume that the original mortgagee, having transferred the note as
security to an assignee, later experiences financial distress and gives
another security interest in the same note to another creditor. [This is
termed “double-pledging” the note, and it occurs more frequently than
it should.] Which security interest would have priority? In other words,
which assignee would be entitled to collect the payments made on the
note? The original assignee has priority over the later assignee only if
its security interest in the note is perfected and was perfected before
the later assignee perfected its interest. See U.C.C. § 9–322(a)(1)
(“Conflicting perfected security interests . . . rank according to priority
in time of filing or perfection.”); U.C.C. § 9–322(a)(2) (“A perfected
security interest . . . has priority over a conflicting unperfected security
interest. . . .”).

Assume that the original mortgagee, having transferred the note as
security to an assignee, becomes insolvent and files bankruptcy. A
trustee in bankruptcy has the “strong-arm” power, under § 544(a) of
the Bankruptcy Code, which gives the trustee that status of a judgment
lien creditor of the bankrupt as of the date of bankruptcy. Acting under
this power, the trustee might claim the note as against the first
assignee. See U.C.C. § 9–317(a)(2)(A) (security interest is subordinate
to judgment lien that arose before security interest was perfected). If
the assignee had not taken steps to perfect its security interest before
the bankruptcy petition, the trustee can avoid (invalidate) the
assignee’s unperfected security interest under § 544(a). This would
permit the bankruptcy trustee to collect the payments on the note and
use those payments for expenses of bankruptcy and payment of
unsecured creditors.
If the assignee properly perfects its security interest in the note, Revised Article
9 makes it clear that the assignee is also perfected as to the mortgage. See U.C.C.
§ 9–308(g) (“Perfection of a security interest in a right to payment or
performance also perfects a security interest in a lien on personal or real
property securing the right, notwithstanding other law to the contrary.”). Thus,
if the assignee has properly perfected its interest in the note, the assignee does not
have to record a mortgage assignment in the real property records to perfect as to
the real estate collateral.
2. How Is Perfection Accomplished?
UCC Article 9 characterizes a promissory note (whether it is negotiable or not)
as an “instrument,” and it provides two distinct methods of perfecting security
interests in instruments:
TRANSFER BY THE MORTGAGEE

The assignee may perfect by taking possession of the original note. This
is the safest method. U.C.C. § 9–313(a). Incidentally (but very
importantly), taking possession really does require the physical
moving of the note. The courts are very disinclined to accept anything
less than a manual transfer of possession to the secured partyassignee. For example, it is most unwise for the assignee to leave the
note in the hands of the mortgagee-assignor as the assignee’s “trustee,”
“nominee,” “agent,” or the like. See, e.g., Prime Financial Servs. LLC
v. Vinton, 761 N.W.2d 694 (Mich.Ct.App.2008) (“A debtor cannot
qualify as the agent for a secured party for purposes of taking
possession of collateral because the continued possession by the debtor
establishes the opportunity for fraud.”); In re Executive Growth
Investments, Inc., 40 B.R. 417 (Bankr.C.D.Cal.1984).

The assignee may perfect by filing a financing statement (a UCC–1
form), typically with the Secretary of State’s office. U.C.C. § 9–312(a).
3. Which Method of Perfection Should Be Used?
Financings secured by mortgage notes and other consumer notes are often for
short periods of time and involve large numbers of notes. Transferring physical
possession of the notes to the creditor and back again can be burdensome, and
notes can become lost or mislaid. Filing a financing statement is obviously much
easier, because a single filing can cover a large number of notes, can be
accomplished electronically in most states, and costs only a small fee. For this
reason, Article 9 permits the assignee of a mortgage note to perfect its interest
by filing a financing statement.
Nevertheless, perfection by filing is “second-rate” perfection, because it can be
“trumped” if the debtor later gives actual possession of the notes to a different
creditor who gave value and did not know about the first assignment. See U.C.C.
§ 9–330(d) (“[A] purchaser of an instrument has priority over a security interest
in the instrument perfected by a method other than possession if the purchaser
gives value and takes possession of the instrument in good faith and without
knowledge that the purchase violates the rights of the secured party.”). Filing a
financing statement is sufficient to protect the assignee against a subsequent
trustee in bankruptcy of the assignor-mortgagee. However, it quite clearly
cannot protect the assignee in the “double-pledging” case, if a second assignee
gets possession of the note and does not know about the first assignment. The
fact that the first assignee filed a financing statement is simply irrelevant; the
filing imparts no constructive notice to the second assignee, who (because he or
she is taking possession of an “instrument”) need not do a UCC search for prior
conflicting interests in the note.
4. How Does a Security Assignee Realize on the Security?
Assume that Bank has taken and perfected a security interest in a note and
mortgage as collateral for a debt owed by Mortgagee. Now assume that
Mortgagee defaults on that debt. How does Bank realize (or in mortgage
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parlance, foreclose) on the note and mortgage? Article 9 offers three basic
methods:

Bank can place the mortgage loan on the secondary mortgage market
and sell it to another investor. This is known as “disposition” of the
collateral; U.C.C. § 9–610(a). Such a sale can be a private sale (not an
auction) as long as the sale is “commercially reasonable” in all respects.
U.C.C. § 9–610(b). Bank must give appropriate pre-sale notice to
Mortgagee and others entitled to such notice, as outlined in U.C.C.
§§ 9–611 to 9–614. Note carefully that this is not a foreclosure of the
underlying mortgage, and it is not necessary to conduct an auctiontype sale, as is typically used for mortgage foreclosures.

Bank can step into Mortgagee’s shoes and notify Mortgagor to make all
further payments to Bank. Bank can then enforce the obligations of
Mortgagor by all means that would have been available to Mortgagee,
including a foreclosure of the mortgage or a suit on the note. This is
known as “collection” of the underlying obligation. U.C.C. § 9–607(a).

Bank can accept (and assume ownership) of the underlying note and
mortgage in full or partial satisfaction of Mortgagee’s debt. This is
known as “acceptance.” See U.C.C. § 9–620. [As a practical matter, it
differs little from the “collection” method discussed above.]
Whichever method Bank uses, it is very convenient for Bank to be able to
memorialize its actions in the public real estate records. For example, if Bank
uses the “collection” remedy and subsequently finds it necessary to foreclose the
underlying mortgage, in many states it will be necessary for Bank to be able to
establish a chain of ownership of the mortgage by recorded documents. To
accomplish this, U.C.C. § 9–619 allows Bank to record a “transfer statement”
reciting that Mortgagee defaulted to Bank, that Bank exercised its post-default
remedies with respect to the underlying note and mortgage, and that a
transferee (which may be the creditor, or in the case of a “disposition,” a third
party) has acquired the rights of Mortgagee in the note and mortgage. Thus, the
transfer statement can fill the gap in the chain of title to the mortgage.
E. Rights and Obligations of the Assignee Relative to the
Mortgagor
1. Qualifying as a Holder in Due Course (HDC)
Holder in Due Course (HDC) status confers significant benefits on an assignee
of a note and mortgage, and is highly sought after. The assignee can achieve
HDC status only by satisfying two requirements: (1) the promissory note itself
must be a negotiable instrument and (2) the process by which the note is
transferred must be a proper negotiation. See Nelson, Whitman, Burkhart &
Freyermuth, Real Estate Finance Law § 5.29 (6th ed.2015).
TRANSFER BY THE MORTGAGEE
a. Negotiability
Negotiability requirements are governed by U.C.C. § 3–104(a) and are fairly
complex. The basic requirements for negotiability include the following.

The note must contain the maker’s unconditional promise

to pay a fixed amount of money (with or without interest)

on demand or at a definite time

It must be payable to “order” or “bearer”.

It may not state any other undertaking or instruction to do any
act in addition to the payment of money (with certain exceptions
mentioned below).
Because of the prohibition on including “other undertakings,” it is risky to
include in the note a clause generally incorporating the terms of the
mortgage by reference. See Resolution Trust Corp. v. 1601 Partners, Ltd.,
796 F.Supp. 238 (N.D.Tex.1992). Such an incorporation clause may result
in reading into the note conditions or additional promises contained in the
mortgage that will destroy the note’s negotiability. See, e.g., Guniganti v.
Kalvakuntla, 346 S.W.3d 242 (Tex.Ct.App.2011) (note incorporating
guaranty agreement by reference was nonnegotiable)
However, under U.C.C. § 3–104(a)(3), certain specific references to the
mortgage in the note are permitted and will not impair its negotiability:

The note may include “an undertaking or power to give, maintain,
or protect collateral.” For example, it may state that it is secured
by a mortgage on real estate, and may include or incorporate
mortgage provisions dealing with protection of the real estate,
such as payment of taxes and insurance premiums and avoidance
of waste.

The note may incorporate by reference specific provisions of the
mortgage dealing with prepayment and acceleration rights,
because these provisions simply define the amount of money to be
paid. For example, a statement in the note referring to a due-onsale clause in the mortgage is permissible. In re Knigge, 479 B.R.
500 (8th Cir. B.A.P. 2012).

The note may include authority for the holder of the note to confess
judgment and to dispose of the collateral, and it may include a
waiver by the maker of any law intended to protect him or her.
Example 1:
R executed a promise to build a driveway across Blackacre
for E’s benefit. The promise was secured by a mortgage on
Blackacre. Result: the promise is not a negotiable note
because it does not “contain a promise to pay a fixed amount
of money.”
Example 2:
A $25,000 promissory note payable to Safety Savings and
Loan Association is secured by a first mortgage on
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CHAPTER IVII
Blackacre. In addition to the usual terms, the note also
contains a covenant by the maker (mortgagor) to purchase
certain additional real estate from the mortgagee. Result:
The note is not a negotiable note because the promise to
purchase additional real estate is not among the promises
permitted in a negotiable note under U.C.C. § 3–104(1)(b).
Example 3:
First Bank extends a line of credit, up to $1 million, to Bob
Borrower. Bob’s note promises to repay “$1 million, or so
much thereof as Bob has borrowed from time to time.”
Result: The note is not a negotiable note because the promise
is not to pay a “fixed amount of money.” Yin v. Society Nat’l
Bank, 665 N.E.2d 58 (Ind.Ct.App.1996).
Example 4:
Lender requires Borrower to sign a note which imposes a
covenant that “mortgagor shall use this real estate only as
his personal residence.” Result: The note is not a negotiable
note because it contains an additional undertaking besides
the promise to pay, and the undertaking does not relate to
giving, maintaining, or protecting the collateral. See
Insurance Agency Managers v. Gonzales, 578 S.W.2d 803
(Tex.Ct.App.1979)).
Consider the following types of notes that are sometimes used in real estate
transactions:

Under the pre-1990 version of Article 3, courts held that a note
that provided for an adjustable rate of interest (an “ARM” or
adjustable rate mortgage) was non-negotiable because it did not
provide for payment of a “sum certain.” See Northern Trust Co. v.
E.T. Clancy Export Corp., 612 F.Supp. 712 (N.D.Ill.1985); Taylor
v. Roeder, 360 S.E.2d 191 (Va.1987). The 1990 version of the UCC
reversed this view, and ARM notes can now be negotiable
(assuming they otherwise satisfy the other standards for
negotiability). See U.C.C. § 3–112(b) (“The amount or rate of
interest may be stated or described in the instrument in any
manner and may require reference to information not contained
in the instrument.”); In re McFadden, 471 B.R. 136 (Bankr. D. S.C.
2012).

Under the pre-1990 version of Article 3, a non-recourse note (one
that imposed no personal liability on the debtor, and permitted
collection only out of the real estate) was considered nonnegotiable because it was not an “unconditional” promise to pay.
However, revised Article 3 reversed this rule, providing that a
note is not considered conditional “because payment is limited to
resort to a particular fund or source.” U.C.C. § 3–106((b)(ii).
TRANSFER BY THE MORTGAGEE
b. Negotiation
To constitute a proper negotiation, a promissory note must be transferred by
indorsement (if the note is payable to an identified person, as is almost
always the case with notes secured by real estate) and delivery of
possession of the original note. U.C.C. § 3–201.
The delivery must be of the original note; a photocopy will not do. One
indorses a promissory note in much the same fashion as a check. An
indorsement normally will consist of language similar to the following on
the back of the note:
“Pay to the order of Fannie Mae.”
[Signature of payee/transferor”]
If there is not enough space to write the indorsement on the note, it can be
written on a separate piece of paper (called an “allonge”) which is affixed to
the note and made a part of it. U.C.C. § 3–204(a). But if the allonge is not
firmly affixed, as by stapling or pasting, a court may well disregard it. See
JP Morgan Chase Bank, N.A. v. Murray, 63 A.3d 1258 (Pa.Super.Ct.2013)
(loose allonge did not suffice as indorsement); Adams v. Madison Realty &
Dev., Inc., 853 F.2d 163 (3d Cir.1988) (placing allonge in same file folder
with note did not suffice as proper indorsement).
c.
Taking in Due Course
For the transferee to hold “in due course” under U.C.C. § 3–302, the note
must not be obviously forged, altered, irregular or incomplete. The
assignee must take it for value, in good faith, and without notice that

it is overdue or has been dishonored

it (or another note in the same series) is in default in payment

it contains an unauthorized signature or has been altered

someone else has a claim to it, or

the maker or someone else has a defense or a claim in recoupment
to it.
Normally courts treat the good faith and notice requirements as much the
same thing: one who has notice of a defect cannot take in good faith. The
notice requirement is satisfied if the assignee has either actual knowledge
or “reason to know” of the problem In other words, a person cannot be
“willfully ignorant of information of which an ordinary person would have
become aware.” Nelson, Whitman, Burkhart & Freyermuth, Real Estate
Finance Law § 5.29, at 407 (6th Cir. 2015). By contrast, constructive notice
from filings in the public records will not deprive a holder of HDC status.
U.C.C. § 3–302(b).
Example 1:
Payee sold a promissory note and mortgage to Assignee.
Payee properly indorsed the note, but the note contained
evidence of erasure and modification of the note language
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CHAPTER IVII
stating the due date. In fact, the note was overdue. Result:
Assignee will be held to have knowledge of the note’s
contents, including the discrepancies described above, and
cannot be a HDC.
Example 2:
Payee was an aluminum siding contractor who obtained a
note and mortgage from Homeowner as payment for siding
installation. Payee indorsed and sold the note and mortgage
to Finance Company. Homeowner later refused to pay the
note, claiming that Payee had defrauded Homeowner by
lying about the quality of the siding. Result: If Finance
Company had a long course of dealing with Payee and knew
of Payee’s general practice of defrauding his customers, the
court may hold that Finance Company lacked good faith and
is not a HDC, even though Finance Company had no specific
knowledge of the fraud in this transaction. United States
Fin. Co. v. Jones, 229 So.2d 495 (Ala.1969)). See generally
Nelson, Whitman, Burkhart & Freyermuth, Real Estate
Finance Law § 5.29, at 409–410 (6th ed. 2015) (discussing
“close-connectedness doctrine”).
2. The Rights of an Assignee Who Is a HDC
a. Personal Defenses
A HDC takes free of certain of the defenses against collection or foreclosure
that the maker (mortgagor) of the note could have used against the original
holder-mortgagee. These defenses are called “personal” defenses and include:
failure or lack of consideration, breach of warranty,
unconscionability and garden variety fraud (fraud in the inducement).
Nelson, Whitman, Burkhart & Freyermuth, Real Estate Finance Law
§ 5.31, at 424–425 (6th ed. 2015).
Example:
Mortgagor hired Mortgagee to construct a “shell” house on
Blackacre. To finance the construction, Mortgagor executed
and delivered to Mortgagee a promissory note for $9,700
secured by a mortgage on Blackacre. Mortgagee assigned the
note and mortgage to Assignee, a HDC. After making
installment payments for four years, Mortgagor defaulted
and Assignee filed an action to foreclose. Mortgagor defended
by attempting to prove that the actual value of the “shell
house” was greatly less than the purchase price. Result:
Assignee prevails. Mortgagor’s defense is inadequacy of
consideration, which may not be raised against a HDC. Such
a defense will be ineffective both in a suit on the note and in
a mortgage foreclosure action. See Colburn v. Mid-State
Homes, Inc., 266 So.2d 865 (Ala.1972).
TRANSFER BY THE MORTGAGEE
b. “Real” Defenses
A HDC takes subject to certain defenses known as “real defenses.” These
are described in UCC § 3–305(a)(1):

infancy, to the extent that it is a defense to a simple contract

duress, lack of legal capacity, or illegality of the transaction
which nullifies the maker’s obligation

fraud that induced the party to sign the instrument with neither
knowledge nor reasonable opportunity to obtain knowledge of its
character or its essential terms (usually called “fraud in the
execution or fraud in the factum”)

discharge in insolvency proceedings.
Example:
Waterproofing, Inc. persuaded Frank, an elderly man with no
close relatives, that the basement in Frank’s home needed
waterproofing to protect against serious structural problems.
Frank was only partially sighted and showed some evidence
of senility. Frank paid $2,000 in cash of the $7,000
waterproofing charge and, as maker-mortgagor, executed and
delivered to Waterproofing, Inc. as mortgagee a $5,000
promissory note secured by a mortgage on his house. Frank
did not know that he had mortgaged his house; rather
Waterproofing, Inc. told him that he had signed an unsecured
promissory note. Waterproofing, Inc. then sold the note and
mortgage to Third Federal Savings and Loan, a HDC. Shortly
thereafter the sole shareholder of Waterproofing, Inc. skipped
town and Frank obtained no waterproofing service at all.
Frank refused to make any payments on the promissory note,
and Third Federal initiated a foreclosure action on the
mortgage on Frank’s house. Result: The foreclosure action
against Frank should be dismissed. Even though Third
Federal is a HDC, Frank’s physical and mental infirmities,
Waterproofing, Inc.’s affirmative misrepresentations as to
the character of the instruments, and Frank’s inability to
discover their true character are sufficient to give Frank a
“real” defense, such as fraud in the execution or incapacity.
3. Non-HDC Status
An assignee of the mortgagee’s interest can lack HDC status for one of three
reasons. First, the note itself may be non-negotiable. Second, the transfer in
which the assignee obtained the note may not have sufficed as a negotiation.
Third, even if the note is negotiable and was negotiated, it may have been
obviously irregular or the assignee may not have taken it for value, in good faith
and without notice. However, even a non-HDC is not necessarily subject to all
defenses; as explained below, the non-HDC may still be free of defenses based
on “latent equities”.
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CHAPTER IVII
a. The Patent-Latent Equity Distinction
The term “equities,” as used in this context, means that someone has a claim
to the real estate or the promissory note, or a defense to enforcement of the
note and mortgage. If the maker-mortgagor can assert the claim or defense,
it is a “patent” equity. If a third party is raising the claim or defense, it is
commonly called a “latent” equity. One can think of two distinct categories
of latent equities—those in which the third party has a claim to the real
estate, and those in which the third party has a claim to the promissory note
or other secured obligation. The examples below illustrate these two types of
latent equities.
Example 1:
Trustee held title to Blackacre subject to a trust agreement
for the benefit of Beneficiary. However, the trust agreement
was not recorded and from the recorded documents it
appeared that Trustee held title in his personal capacity.
Trustee executed a mortgage on Blackacre to Mortgagee in
violation of the terms of the trust, which stated that
Beneficiary’s consent was required for any mortgage.
Beneficiary’s defense to foreclosure of the mortgage resides
in a third party and is a latent equity. (See Scott, Trusts
§ 284 (Fratcher ed. 1989)).
Example 2:
Mort holds a note and mortgage on Blackacre, Mort indorses
the note in blank and delivers the note and the mortgage to
Abe. Abe inadvertently loses the note, and Frank finds it.
Frank later transfers the note to George. Subsequently, Abe
discovers that George has the note and sues George for its
return. The claim to ownership of the note is by a third party
(Abe) and is a latent equity.
b. Raising Patent Equity Against Transferee
The mortgagor may raise a patent equity against an assignee to the same
extent that the mortgagor could have raised it against the original
mortgagee. U.C.C. § 3–305(a)(2) (holders who are not HDCs are subject to
any defense “that would be available if the person entitled to enforce the
instrument were enforcing a right to payment under a simple contract”).
c.
Estoppel Certificates
An assignee of a note and mortgagee who believes that HDC status may be
lacking often quite wisely insists on obtaining an estoppel certificate from
the maker-mortgagor before taking the assignment. In this document, the
maker-mortgagor states that the note is valid and that it is not subject to
defenses by the maker-mortgagor. Such a certificate is actually more
powerful and valuable to an assignee than the HDC doctrine, because it
protects the assignee against the maker-mortgagor’s assertion of both real
and personal defenses. However, estoppel certificates only protect the
TRANSFER BY THE MORTGAGEE
assignee against patent equities. The maker-mortgagor’s certificate cannot,
of course, create an estoppel as to third party claims (latent equities).
d. Raising Latent Equities Against Transferee
As mentioned above, U.C.C. § 3–305(a)(2) allows the assertion of “simple
contract” defenses against non-HDCs. In effect, the UCC adopts state case
law in this situation. In general, state law here is favorable to good faith
purchasers for value; thus, the transferee of the note who pays value and
has no notice of the latent equity will usually be held to take free of it,
whether it is a claim of title to the land or a claim of ownership of the note.
This is the better result, because the transferee of the note has no way to
discover such claims.
If the note is negotiable, U.C.C. § 3–306 may govern. It provides that “a
person having rights of a holder in due course takes free of the claim to the
instrument.” Thus, if the transferee is a holder in due course, the UCC
produces the same result as the common law described in the previous
paragraph. Consider the two examples on the preceding page. U.C.C. § 3–
306 would have no bearing on Example 1, because it involves a claim to the
land rather than the note. However, in Example 2, which involves a claim
to the note, § 3–306 would mandate that George would prevail if George is
a holder in due course.
It might appear that the common law and U.C.C. § 3–306 are duplicative in
this context, but that is not quite so. The reason is that, in a sense, it is
easier to be a holder in due course (a UCC concept) than a good faith
purchaser for value (a common law concept). In general, constructive notice
is irrelevant to HDC status; only actual knowledge counts. Thus, mere
constructive notice of a claim or defense derived from the recordation of a
document in the public land records will not preclude the holder of a
negotiable note from establishing HDC status. The same is true of
constructive notice arising from the identity of someone in possession of the
real estate. By contrast, either type of constructive notice can prevent one
from being a BFP.
4. Limitations on the Holder in Due Course Doctrine
The HDC doctrine has been subject to special criticism when it shields assignees
from defenses that relate to the quality of consumer products purchased in credit
transactions. In the real estate setting, the “consumer” is usually someone who
gives a note secured by a mortgage on his or her home to a home improvement
contractor. In the past four decades courts, legislatures and regulatory bodies
have imposed substantial limitations on the HDC doctrine in a wide variety of
consumer lending contexts.
a. The Close-Connectedness Concept
Some courts hold that HDC status may be denied to an assignee of a
negotiable note who is too closely connected to the original payee. Based on
closeness alone, a court may impute to the assignee notice of a defense or
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CHAPTER IVII
lack of good faith even though there is no direct evidence to establish the
knowledge otherwise required to deny HDC status to the assignee. The
standards for finding a “close connection” are somewhat elastic. One wellknown opinion expressed them as follows:
When it appears from the totality of the arrangements between [seller]
and financer that the financer has had a substantial voice in setting
standards for the underlying transaction, or has approved the
standards established by the [seller], and has agreed to take all or a
predetermined or substantial quantity of the negotiable paper which is
backed by such standards, the financer should be considered a
participant in the original transaction and therefore not entitled to
holder in due course status.
Unico v. Owen, 232 A.2d 405 (N.J.1967).
b. Legislation and Other Regulation
1) The Uniform Consumer Credit Code
While many state legislatures have modified the HDC protection in a
variety of consumer lending contexts, the most significant state
legislation limiting or modifying the HDC doctrine is contained in the
Uniform Consumer Credit Code (UCCC) which, in either its 1968 or
1974 version, has been enacted in at least 12 states. This legislation is
extremely complex and subject to variation in many of the adopting
states. In general, it abolishes HDC status for many assignees of
vendor home improvement mortgages (usually junior liens) and a
limited class of first mortgages as well. If the original note and
mortgage run to a third party lender (a “consumer loan”) and the debtor
is able to establish a close connection between the provider of goods
and services and the third party lender, both the lender and
subsequent assignees are “subject to all claims . . . arising from that
sale” although only to the extent of the amount owing to the lender
when he receives notice of the claim. See Nelson, Whitman, Burkhart
& Freyermuth, Real Estate Finance Law § 5.30 (6th ed.2015).
2) The Federal Trade Commission Rule
Under a rule adopted by the Federal Trade Commission in 1975
(entitled “Preservation of Consumer’s Claims and Defenses”), it is an
unfair trade practice for certain sellers of goods and services to finance
a sale without including in the debt instrument specific ten-point-type
bold-face language that makes the holder subject to the maker’s claims
and defenses. See 16 C.F.R. § 433.1–.2. Loans originated by third party
lenders to finance sales of consumer goods and services are covered by
the above requirement if a very broad close-connection test is satisfied.
Close connection exists if the seller of goods or services refers
consumers to the lender or is affiliated with that lender by common
control, contract or business arrangement. See 16 C.F.R. § 433.1(d).
TRANSFER BY THE MORTGAGEE
The FTC Rule applies only to natural persons who purchase goods or
services for personal, family or household use in amounts of $25,000 or
less. Real estate mortgages are affected by the rule only if they secure
payment for such goods or services. Thus, for example, the FTC Rule
applies to a $15,000 note and mortgage given to a home improvement
contractor as a result of the latter having built an addition to the
maker-mortgagor’s house. By contrast, the FTC Rule does not apply to
real estate mortgages arising from sales of interests in real estate,
whether the mortgagee is the vendor or a third party. Consequently,
the typical purchase money real estate mortgage, whatever its lien
priority status, is unaffected by the FTC Rule.
3) Predatory Lending Under HOEPA
Congress enacted the Home Ownership and Equity Protection Act of
1994 (“HOEPA”) to provide protections for consumers entering into
highly disadvantageous (often termed “predatory”) home mortgage
loans. HOEPA originally did not apply to purchase-money mortgages
or home equity loans, but the Dodd-Frank Wall Street Reform and
Consumer Protection Act in 2010 expanded HOEPA to encompass such
loans if secured by the borrower’s principal dwelling. Loans are covered
by HOEPA if they meet any of the following criteria:

The annual percentage rate (APR) exceeds the applicable
average prime rate by more than 6.5 percentage points (for
most first-lien mortgages) or by more than 8.5 percentage
points (for first-lien mortgages under $50,000 on
manufactured homes or for junior lien mortgages);

The transaction’s points and fees exceed 5% of the total
transaction amount or, for loans below $20,000, the lesser of
8% of the total transaction amount or $1,000 (with the dollar
figures adjusted annually for inflation); or

The credit transaction documents permit the creditor to
charge or collect prepayment fees more than 36 months after
the transaction closing, or permit such fees (in the aggregate)
to exceed more than 2% of the amount prepaid.
If a loan is covered by HOEPA, and if the loan is assigned, the HDC
doctrine will not apply (i.e., the assignee will take the loan subject to
personal defenses) unless the assignee can demonstrate that a
reasonable person could not have determined that the loan in question
was covered by HOEPA. 15 U.S.C.A. § 1641(d)(1).
5. Payment to Assignor as a Defense
After the original mortgagee assigns the note and mortgage, to whom should the
maker-mortgagor make payments? Obviously, if the assignee notifies the
mortgagor of the assignment, and the mortgagor nevertheless makes payments
to the original mortgagee, the mortgagor cannot raise those payments as a
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CHAPTER IVII
defense to an action by assignee to collect the debt or to foreclose the mortgage.
The following material, however, focuses on the situation where no notice of the
assignment is given and the mortgagor innocently continues to make mortgage
payments to the original mortgagee. All references below are to the 1990 version
of UCC Article 3. See generally Nelson, Whitman, Burkhart & Freyermuth, Real
Estate Finance Law § 5.33 (6th ed.2015).
a. Negotiable Notes
U.C.C. § 3–602 provides that a negotiable note is paid, and the payor is
discharged, “to the extent that payment is made . . . to a person entitled to
enforce the instrument” (the “PETE,” as discussed above). The PETE
includes a holder to whom the note has been negotiated, U.C.C. § 3–301,
and any person to whom the note is delivered for the purpose of giving the
right of enforcement, even if that person is not a holder, U.C.C. § 3–203(a),
(b). For example, a transfer by delivery of the note without an indorsement
will not constitute the transferee a holder, but the transferee is still a PETE
if the delivery was made for the purpose of transferring the right to enforce
the note.
Why is payment to the actual possessor of the note necessary to discharge
it?
[A negotiable] instrument is a reified right to payment. The right is
represented by the instrument itself. The right to payment is
transferred by delivery of possession of the instrument “by a person
other than its issuer for the purpose of giving to the person receiving
delivery the right to enforce the instrument.” [U.C.C. § 3–203
Comment 1.]
These UCC sections are widely understood to vest the power to discharge
the obligation exclusively in the PETE, even though the Code does not
expressly so state. Hence, if the original payee has delivered possession of a
negotiable note to another person for the purpose of transferring the right of
enforcement, payment to the original payee is not recognized as discharging
the obligation. The payment does not “count” against the assignee. This is
true whether or not the assignee is a HDC and is true even if the payor has
received no notice of the assignment.
Example:
Mortgagor made 40 monthly installment payments of $450
each to Mortgagee on a mortgage whose balance was $45,000
after the 40th payment was made. After the latter payment,
Mortgagee assigned the note and mortgage to Assignee, who
took possession of the note but did not notify Mortgagor of the
transfer. Mortgagor thereafter made ten more monthly
installment payments to Mortgagee. Assignee then declared
the mortgage in default, accelerated the debt and commenced
foreclosure. Mortgagor defended on the ground that
acceleration and foreclosure were improper because no
default existed. Result: Foreclosure is permissible. The ten
TRANSFER BY THE MORTGAGEE
monthly payments made to Mortgagee after the assignment
cannot be credited to the amount of principal and interest due
and owing on the debt. Black v. Adrian, 80 S.W.3d 909
(Mo.Ct.App.2002); Groover v. Peters, 202 S.E.2d 413
(Ga.1973).
This result has been widely criticized in the context of notes secured by
mortgages. It is obviously unrealistic for a mortgagor to demand to see the
note itself before making each installment payment to the original
mortgagee. Yet in principle, the UCC would require precisely that sort of
vigilance by mortgagors. See Whitman, Reforming the Law: The Payment
Rule as a Paradigm, 1998 B.Y.U. L. Rev. 1169 (1998). In 2002, the
Permanent Editorial Board for the UCC proposed changes to U.C.C. § 3–
602 to overturn this result and make payment to the original mortgagee
binding until notice of the assignment is provided to the mortgagor. As yet,
however, these changes have been enacted in only twelve states.
Fortunately, in practice mortgagors are rarely harmed by this rule. This is
because today most institutional purchasers of mortgages on the secondary
market designate the original mortgagee as agent to service (collect
payments on) the loan. Payment to the mortgagee under such
circumstances constitutes valid payment to the assignee. If the secondary
market assignee wishes to assign the servicing to some other agent, or to
assume direct servicing of the loan, it will routinely notify the mortgagor of
that fact, and federal law requires such notice. Hence, the real risks to
mortgagors from the “reified right to payment” theory usually arise in the
context of non-professional mortgagees and assignees.
b. Nonnegotiable Notes
If the note is nonnegotiable, the provisions of UCC Article 3 do not apply.
There is, however, some case authority for the same result, at least in the
context of a final payoff of the note. See Assets Realization Co. v. Clark, 98
N.E.
457
(N.Y.1912);
Johnstone
v.
Mills,
22
B.R.
753
(Bankr.W.D.Wash.1982). However, the better rule is that the assignee of a
nonnegotiable note takes subject to all payments made to the assignor before
the mortgagor received notice of the assignment. Taylor v. Roeder, 360
S.E.2d 191 (Va.1987); Restatement (Third) of Property: Mortgages § 5.5
(1997).
Example:
Same facts as in the previous example, except that the note
is nonnegotiable. Result: Foreclosure is impermissible.
Payment to Mortgagee after the assignment constituted valid
payment of the mortgage debt because no notice of the
assignment was given to Mortgagor. Thus no grounds for
acceleration and foreclosure exist. In re Kennedy Mortgage
Co., 17 B.R. 957 (Bankr.D.N.J.1982) (dictum); contra, but
finding the payment effective on an estoppel theory, Rodgers
v.
Seattle-First
Nat’l
Bank,
697
P.2d
1009
(Wash.Ct.App.1985).
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CHAPTER IVII
A few cases and statutes provide that the recording of a mortgage
assignment constitutes constructive notice of it to the mortgagor. See, e.g.,
EMC Mortg. Corp. v. Chaudhri, 946 A.2d 578 (N.J.App.Div.2008). This is a
minority view and represents a completely unrealistic approach. Few, if
any, mortgagors routinely search the public records prior to making their
mortgage payments, and the burden of doing so would be immense. As a
practical matter, statutes and cases taking this approach remove the
protection that maker-mortgagors of nonnegotiable notes would otherwise
expect and have.
F. Impact of Recording Acts
1. Need for Recording of Mortgage Assignment
As between the parties to the assignment of a mortgage note, it is irrelevant
whether the assignee records an assignment of the mortgage. As explained
earlier, no assignment of the mortgage is even necessary, because the mortgage
follows the note automatically. Thus, even if the assignee does not record an
assignment of the mortgage, the assignment is effective as against the assignor
or holders of other interests in the mortgaged real estate. See, e.g., In re Cook,
457 F.2d 561 (6th Cir. 2006); In re Knigge, 479 B.R. 500 (8th Cir. B.A.P. 2012);
Aurora Loan Services, LLC v. Taylor, 25 N.Y.3d 355 (2015).
Example:
Mortgagor grants Mortgagee a mortgage on Blackacre. Later,
Mortgagee assigns the mortgage note to Assignee. Mortgagee
prepares and delivers to Assignee an assignment of the mortgage,
but Assignee does not record it. Later, Mortgagor files a
bankruptcy petition, and the bankruptcy trustee brings an action
to invalidate the mortgage lien based on Assignee’s failure to
record an assignment of the mortgage. Result: The trustee’s action
will fail. Although bankruptcy gives the trustee the status of a
bona fide purchaser of Blackacre, 11 U.S.C.A. § 544(a)(3), this
status does not permit the trustee to claim title to Blackacre free
of the mortgage, which Mortgagee duly recorded. Assignee’s
priority as against the trustee is not affected by Assignee’s failure
to record the assignment. See, e.g., In re Patton, 314 B.R. 826
(Bankr.D.Kan.2004).
There are roughly ten states in which the assignee cannot foreclose using
nonjudicial foreclosure unless the assignee can demonstrate a recorded chain of
assignments from the original mortgagee. It is not obvious what important
policy is served by this requirement, as the existence of a recorded mortgage
assignment is no proof that the foreclosing party is a person entitled to enforce
the note (PETE). Nevertheless, in these states, while the assignee need not
record an assignment of the mortgage for the assignment to be effective,
recording would be required as a prerequisite to nonjudicial foreclosure. See
Nelson, Whitman, Burkhart & Freyermuth, Real Estate Finance Law § 5.34, at
457 (6th ed. 2015).
TRANSFER BY THE MORTGAGEE
2. Effect of Recording the Mortgage Assignment and
Payment on the Mortgage Debt
As noted above, it makes little sense to suggest that the recording of a mortgage
assignment gives constructive notice of the assignment to a mortgagor who is
continuing to make payments to the original mortgagee because the mortgagor
has not received notice of the assignment. Suppose, however, the mortgagor sells
the real estate to a grantee after the mortgage assignment has been recorded.
Here, it makes excellent sense to hold that the recordation of the assignment
provides constructive notice of the assignment to the grantee, and the weight of
authority so holds. The reason is that the grantee is expected to search the public
records anyway to determine whether the mortgagor’s title is satisfactory.
Hence, holding the grantee to notice of the recorded assignment imposes no
additional burden on grantee at all, and thus grantee could not satisfy the
remaining debt by payment to the original mortgagee. Consequently, recording
an assignment of the mortgage saves the assignee of a nonnegotiable note the
trouble of giving actual notice to someone who may subsequently buy the land.
Example 1: Rogers borrows money from Eaton and gives Eaton a
nonnegotiable note secured by a mortgage. Eaton assigns the note
and mortgage to Able, who records the assignment but does not
notify Rogers that he now holds the note and mortgage. Result: If
Rogers now pays Eaton the balance due on the loan, the better
view considers the mortgage to be satisfied. The recordation of the
assignment has no effect on Rogers.
Example 2: Same facts as Example 1, but now assume that Rogers sells the
real estate to Grant, and Grant purports to pay off the loan to
Eaton. Grant’s payment will not be effective to discharge the
mortgage as against Able. Because Grant had reason to search the
records at the time he bought the land, he should have discovered
that Eaton had assigned the mortgage to Able. See In re Kennedy
Mortgage Co., 17 B.R. 957, 965 n. 5 (Bankr.D.N.J.1982).
Note that if the note is negotiable, the above rule is superfluous because (as
noted above) present UCC Article 3 provides that a payment to anyone other
than the possessor of a negotiable note (or the authorized agent of the possessor)
is ineffective.
3. Wrongful Satisfaction of the Mortgage by the Original
Mortgagee
While the assignment of a mortgage note would be legally effective even if the
assignee does not record an assignment of the mortgage, there are good reasons
why the assignee may choose to record such an assignment. One reason is to
protect against the consequences of a fraudulent release of the mortgage by the
original mortgagee. If the assignee fails to record an assignment of the mortgage
before the original mortgagee records a release of the mortgage, and the
mortgagor later conveys the land to a grantee who is a bona fide purchaser for
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26
CHAPTER IVII
value, the grantee will take the land free and clear of the mortgage even if the
assignee never received payment of the mortgage debt.
Example:
Rogers borrows money from Eaton and gives Eaton a note secured
by a recorded mortgage. Eaton indorses the note and assigns the
mortgage to Able, who does not record the assignment. Later,
Rogers and Eaton collude; Eaton (who has no legal right to do so)
releases the mortgage on the public record, and Rogers sells the
land, purportedly free and clear of the mortgage, to Grant, a good
faith purchaser for value. Rogers and Eaton split their ill-gotten
gains and disappear. Result: Grant takes the land free of the
mortgage lien under the recording act. In re Beaulac, 298 B.R. 31
(Bankr. D. Mass. 2003); Brenner v. Neu, 170 N.E.2d 897 (Ill. Ct.
App. 1960).
This result follows even if the note is negotiable and the assignee is a HDC. This
situation presents a conflict between the UCC and the law of negotiability on
the one hand and the real estate recording system on the other. The result
reflects ultimate victory for the innocent land buyer who relies on the public
records. See Nelson, Whitman, Burkhart & Freyermuth, Real Estate Finance
Law § 5.34, at 446–447 (6th ed.2015). If the note in question is nonnegotiable, it
is all the more clear that the BFP grantee of the land will prevail, as there is
then no competing UCC policy to weigh against the recording act argument
made by the grantee.
4. Recording as a Means of Gaining Notice of Litigation
There is another important reason that recording an assignment is useful to the
assignee: it will ensure that the assignee will receive notice of any litigation that
might affect the real estate or the validity of the mortgage. Such litigation might
include a housing, building, or zoning code enforcement proceeding; an eminent
domain action; or a suit to force cleanup of hazardous waste on the land.
Litigation might also raise a question about the expected priority of the
mortgage. Obviously, it is in the best interest of the assignee to learn about (and
potentially to participate in) such litigation. If the party filing the action cannot
find the mortgage assignment by means of a title examination, because it has
not been recorded, then notice or service of process will go only to the original
mortgagee (who may or may not inform the assignee of the litigation).
5. Wrongful Satisfaction by a Trustee Under a Deed of Trust
A trustee under a deed of trust has two alternative functions. One is to reconvey
the land to the mortgagor if the mortgagor pays off the mortgage debt. The other
is to foreclose if there is a default in payment of that debt. When the original
beneficiary (mortgagee) assigns the note, the trustee normally is not replaced.
Consequently, potential subsequent grantees are entitled to assume that the
trustee is acting in accordance with the noteholder’s instructions when
reconveying the land to the mortgagor.
TRANSFER BY THE MORTGAGEE
Example:
Blackacre (which was worth $50,000 free and clear of liens) was
owned by Rogers, subject to a deed of trust that was security for
Rogers’s $25,000 indebtedness to Eaton. Eaton then sold the note
that represented that indebtedness to Able, who promptly
recorded the assignment. Rogers and Trump, the trustee under
the deed of trust, then carried out the following scheme without
Able’s knowledge. Trump recorded a release of the deed of trust.
Rogers then conveyed Blackacre to Grant, who paid $50,000 in
cash to Rogers (who in turn paid part of it to Trump as
compensation for Trump’s disloyal service to Eaton). Grant was at
all times unaware of the scheming of Rogers and Trump. Able,
after discovering what had happened, sought a judicial
declaration that her note was still secured by a deed of trust on
Blackacre. Result: Grant owns Blackacre free and clear of the deed
of trust. Grant is entitled to rely on the release by Trump,
notwithstanding Grant’s notice of the assignment.
6. Mortgage Electronic Registration System (MERS)
With the expansion of securitization, it has become common for mortgage loans
to be assigned multiple times on the secondary market. For secondary market
investors who take seriously the implicit obligation to record mortgage
assignments (to gain the benefits discussed above), the increased number of
transfers has created a substantial administrative and record-keeping burden.
If each transfer was accompanied by a written assignment of the mortgage, and
the recording of each assignment, a chain of transfers could result in nontrivial
costs for attorney fees and recording fees.
In the mid-1990s, Fannie Mae, Freddie Mac, and major lenders and trade
associations founded the Mortgage Electronic Registration System (MERS) to
address this problem. MERS functions to hold mortgages of record as a nominee
for the person who holds the mortgage note. If a residential mortgage lender is
a member of MERS, then when that lender makes a mortgage loan, it either
names MERS as the original mortgagee, or it assigns the mortgage to MERS
immediately after origination. When the originating mortgagee later transfers
the loan on the secondary market to another member of MERS, there is no need
to prepare and record an assignment of the mortgage—MERS simply continues
to be the record holder of the mortgage, but now as the nominee for the assignee
rather than the original mortgagee. MERS maintains a database of note holders
and servicers, and a borrower can query this database to determine who holds
and who services his or her mortgage loan. Under the MERS system, MERS is
always the mortgage holder as shown in the local public records, and thus
someone searching the public records would need to consult MERS’s own records
to determine who actually holds the loan. If a suit is filed that affects a MERS
mortgage or the real estate it covers, MERS (as the mortgagee of record) is
served with process, and it in turn notifies the actual holder of the note.
MERS does not hold or take possession of the promissory notes (except in the
case of electronic notes). Its responsibility is exclusively to hold the mortgages
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CHAPTER IVII
as nominee for the note holders. In most cases, no further assignment of the
mortgage is ever recorded by MERS, unless the note is transferred to a nonMERS member or an assignment is made to the servicer in preparation for
foreclosure.
MERS served its function relatively smoothly until the mortgage crisis began in
2007. In the ensuing years, foreclosure defense lawyers launched a tide of
litigation attacking numerous aspects of the MERS system. Among the issues
they raised were the following:

Is MERS a “real party in interest” or otherwise entitled to notice of
suits or administrative actions that might affect the interests of
mortgagees?

As a “nominee” for the mortgage holder, does MERS have authority to
execute assignments or (in states using deeds of trust) to appoint
substitute trustees?

Does MERS have standing to foreclose mortgages in its own name? [In
2011, MERS ceased allowing members to bring foreclosuring
proceedings in the name of MERS, but prior to 2011, this practice
caused remarkable controversy, with critics appropriately noting that
lenders were seeking to foreclose on homeowners without taking the
public relations “hit” of doing it in their own names.]

Is MERS wrongfully depriving local recorders of the revenue they
would earn if mortgage assignments were still being recorded locally?

Does placing the mortgage in the name of MERS, when MERS is not
the holder or beneficial owner of the note, improperly separate the note
from the mortgage and thus make the mortgage unenforceable?

Are assignments by MERS valid, given the fact that they are typically
executed by employees of the secondary market participants, who serve
as nominal (and unpaid) officers of MERS? [There were also many
attacks on the technical aspects of these assignments, often alleging
them to be “robosigned.”]
Most of the attacks on MERS were flimsy in terms of legal credibility, and MERS
prevailed in court most of the time. See, e.g., Culhane v. Aurora Loan Servs. of
Nebraska, 708 F.3d 282 (1st Cir. 2013) (upholding assignment by MERS); Woods
v. Wells Fargo Bank, N.A., 733 F.3d 349 (1st Cir. 2013) (assignment of mortgage
to MERS did not “split” the note from the mortgage and thus invalidate the
mortgage); Brown v. MERS, 738 F.3d 926 (8th Cir. 2013) (MERS did improperly
deprive local recording offices of recording fees given that mortgagees have no
legal obligation to record mortgage assignments in any event). But defending
these attacks became extremely costly, and they took a real toll in terms of
MERS’ public reputation, as defaulting borrowers repeatedly claimed on blog
posts that “MERS is taking my house.”
Many critics assert that MERS’s records of mortgage ownership are inaccurate.
It is difficult to assess the truth of this assertion, but it would not be surprising
if it were true. MERS has no real leverage to require its members to report loan
TRANSFER BY THE MORTGAGEE
transfers to MERS, and thus it is possible that transfers are not reported. One
cannot treat MERS as a correct source of information about the identity of
mortgage loan investors and servicers (any more one could hope to rely on the
public land records for that information). For this reason, many have suggested
that Congress should establish a federal registration system for ownership of
mortgage notes. See Whitman, A Proposal for a National Mortgage Registry:
MERS Done Right, 78 Mo.L.Rev. 1 (2013). As yet, no such federal system exists.
G. Participations
Sometimes a mortgage lender, rather than selling and assigning a note and mortgage
to a single secondary market investor, will sell fractional interests in one or more
mortgage loans to multiple investors. This is often referred to as the sale of
“participation” interests. The originating or “lead” lender may sell fractional interests
in a single large mortgage loan, or may assemble a large portfolio of loans and then
sell fractional interests in the portfolio. In either situation, the fractional interests
will be evidenced by participation certificates (PCs). The certificates, in turn, will
refer to and be governed by a detailed participation agreement. See Nelson,
Whitman, Burkhart & Freyermuth, Real Estate Finance Law § 5.35 (6th ed.2015);
In re Autostyle Plastics, Inc., 1999 WL 1005647 (W.D.Mich.1999).
Participants sometimes argue (usually after the underlying loans have gone into
default) that the lead lender has misled them as to the quality of the underlying loans
or the qualifications of the borrowers. See, e.g., Southern Pacific Thrift & Loan Ass’n
v. Savings Ass’n Mortg. Co., 82 Cal. Rptr. 2d 874 (Ct.App.1999). In general, the lead
lender does not owe a fiduciary duty to the participants. Its liability for
misrepresentations is governed by the general law of fraud and the terms of the
participation agreement.
1. Rights of the Participants After Default
Where one or more loans go into default almost all courts today, in the absence of
a contrary agreement, grant a pro-rata priority among the participants.
Example:
E–1 held a mortgage loan with a $400,000 principal balance. E–1
sold a 25% participation interest in the loan to E–2 and later sold
a 50% participation interest to E–3. The mortgagor defaulted in
payment on the loan, the mortgaged real estate was foreclosed and
the foreclosure purchaser paid $300,000. The mortgagor was
judgment-proof and thus a deficiency judgment was uncollectible.
Result: Unless the participation agreement contains contrary
language, each participant’s share of the foreclosure proceeds is
determined by multiplying the foreclosure proceeds by that party’s
participation percentage. Thus, E–1’s share would be 25% of
$300,000 or $75,000, E–2’s share would be the same, and E–3’s
share would be 50% of $300,000 or $150,000.
A few early decisions took the position that the participants should not share
the proceeds on a pro-rata basis, but that each would be assigned a priority based
on the order that such participant received its participation interest. Under this
approach in the above example, E–1 received its participation interest first, E–
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CHAPTER IVII
2 second, and E–3 last, so the $300,000 would be divided as follows: E–1 would
receive its full $100,000 investment; next, E–2 would likewise receive its full
$100,000 investment; E–3, being third in priority, would receive the remaining
$100,000 (half of its initial investment).
As between the lead lender and the participants, under the better and majority
view, absent a guarantee of payment, the participants have no special priority
relative to the lead lender. See Domeyer v. O’Connell, 4 N.E.2d 830 (Ill.1936).
This rule is consistent with the result reached in the foregoing example. There
are a few contrary cases, which follow a variety of approaches. Some hold that
the lead lender is a trustee who should not be able to recover from the mortgage
security at the other participants’ expense. Others take the position that
delivery of the participation interests to each of the participants creates an
implied agreement by the lead lender to subordinate its interest to those of the
participants. These priority rules are seldom of practical importance today
because the participation agreement itself almost always delineates the
priorities of the parties in detail, and it is quite common for some participants
to be given a higher priority than others or than the lead lender.
2. Lead Lender Misconduct
Because the original loan instruments remain in the lead lender’s hands, there
are many opportunities for specific misconduct on its part. For example, the lead
lender could reassign or “double-assign” some or all of the notes and mortgages.
In theory, it could purport to sell an unlimited number of additional
participation interests. It could pledge some or all of the loans to secure new or
existing debts. Historically few precautions were taken against such potential
misconduct because most institutional lenders had confidence in the integrity of
their fellow lenders. In recent decades, well-publicized financial misdealings by
major banking institutions have made loan participants reevaluate this lax
attitude.
To avoid some of the above problems the participants can insist that the notes
be marked so as to provide notice to non-participant third parties that they are
subject to the existing rights of participants. While this expedient will be
effective in preventing most lead lender misconduct, it will create practical
complications. For example, where the portfolio contains numerous loans, it
would require that every time a loan is paid off, consent to cancellation of the
note would be required of each participant. Hence, this approach is more
workable where the participation is in a single large loan.
An alternative method of preventing misdealing by the lead lender is to insist
that the original mortgage documents be placed in the hands of an independent
trustee or custodian, such as a bank or trust company with no other involvement
in the transaction. A detailed set of instructions is necessary to delineate the
conditions under which the trustee is to release possession of the mortgage
documents. This approach is more practical when the participation is in a
portfolio consisting of a large number of small loans.
TRANSFER BY THE MORTGAGEE
3. Lead Lender Bankruptcy
If the lead lender goes into bankruptcy, its general creditors or trustee in
bankruptcy may claim that the participation arrangement was not sufficient to
transfer ownership of the notes to the participants and that the notes therefore
remain a part of the lead lender’s bankruptcy estate. Two arguments are
sometimes advanced to support this position.
a. Loan of Money by Participants to Lead Lender
According to this argument, the participation really amounts to a loan of
money by the participants to the lead lender with the notes and mortgages
constituting security for the loan. See In re Coronet Capital Co., 142 B.R.
78 (Bankr.S.D.N.Y.1992). To be insulated from the “strong-arm” powers of
the trustee in bankruptcy, it is essential that these security interests in the
underlying mortgage loans be perfected under UCC Article 9. However,
such perfection can be accomplished only by the filing of a UCC financing
statement or by transfer of physical possession of the mortgage notes to the
participants or their representative. In re Churchill Mortg. Inv. Corp., 233
B.R. 61 (Bankr.S.D.N.Y.1999). If these steps are not taken, the participants
remain vulnerable to attack by the lead lender’s trustee in bankruptcy.
To help avoid this argument, the participation agreement should make it
absolutely clear that the transaction is intended to be a sale, not a collateral
security arrangement. It is also helpful to transfer possession of the
underlying mortgage documents to an independent custodian who
represents the participants, as discussed above. With proper precautions,
the participation will survive an attack in bankruptcy. See In re Okura &
Co. (America), Inc., 249 B.R. 596 (Bankr.S.D.N.Y.2000).
b. Assignment of Mortgage Loan Proceeds
Under this argument, the participants do not receive property interests in
the notes themselves but rather only assignments of the loan proceeds. Only
the lead lender, as assignor, so this theory goes, has the right to enforce the
mortgage notes and thus the participants have no ownership interests.
This argument plainly places form over substance. The lead lender’s
capacity to enforce the underlying notes and mortgages is readily explained
on the ground that the lead lender is the agent of the participants for that
purpose. An equally plausible position is that the lead lender is a trustee
for the participants and that therefore the former’s legal title is held for the
participants as the beneficial owners of the notes. Either argument ought
to be sufficient to withstand attack from the lead lender’s general creditors
or claims of its trustee in bankruptcy.
c.
Buttressing the Participant’s Position by Drafting
To enhance the participants’ positions, the participation agreement should
include the following provisions:
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CHAPTER IVII
1.
a statement that a transfer of ownership is intended;
2.
a disavowal of the idea that the transaction was intended to effect a
loan to the lead lender;
3.
the lead lender should specifically be designated as either an agent or
trustee for the participants and its powers should be spelled out by
using agency or trust language; and
4.
the interest yield to the participants and the term of the participation
should be tied to the yield and terms on the mortgage or mortgages in
the portfolio rather than computed on some independent basis. See
Nelson, Whitman, Burkhart & Freyermuth, Real Estate Finance Law
§ 5.35 (6th ed.2015); Came Realty LLC v. DeMaio, 746 N.Y.S.2d 555
(Sup.Ct.2002).
Review Questions
1.
T or F
The secondary mortgage market refers to lenders who deal in second or
junior mortgages.
2.
T or F
A promissory note secured by a real estate mortgage is non-negotiable
if it includes any reference to the mortgage.
3.
T or F
Able, a dishonest lawyer, persuaded Murray, his client, who had a fourth
grade education and virtually no legal or commercial sophistication, to
execute a $10,000 negotiable promissory note payable to the order of
Able and a mortgage on Blackacre to secure it. Able told Murray that
the documents gave Able a power of attorney to deal with personal
injury litigation that Able had commenced on Murray’s behalf. Able then
sold the note and mortgage to Henrietta, a holder in due course. Murray
has a valid defense to any action by Henrietta to collect the note or to
foreclose the mortgage.
4.
Why would a transferee of a promissory note and mortgage use an estoppel
certificate?
5.
T or F
“Close connectedness” is a judicial doctrine aimed at expanding holder
in due course protection to greater number of holders of promissory
notes.
6.
T or F
Murray obtained a mortgage loan from Bank, executing a negotiable
promissory note and a mortgage on his office building. Bank later
assigned the note to Investor, who qualifies as a holder in due course.
Murray, who was not notified of the transfer, continued to make
monthly payments to Bank, but Bank did not forward these payments
to Investor. The payments made to Bank following the assignment must
be credited on the mortgage debt.
7.
Suppose the promissory note referred to in last question was non-negotiable.
Would your answer be different? Explain.
TRANSFER BY THE MORTGAGEE
8.
T or F
Bank holds possession of a promissory note executed by Mary and
secured by a mortgage on Blackacre. Bank assigned the note and
mortgage to Assignee, who promptly recorded the assignment. Mary
then conveyed Blackacre to Gary, a “subject to” grantee who continued
to make mortgage payments to Bank. Assignee does not have to credit
against the mortgage debt any payments made by Gary to Bank after
Assignee recorded the assignment of the mortgage.
9.
T or F
Bank holds possession of a negotiable promissory note executed by Mark
and secured by a mortgage on Blackacre. Bank assigned the note to
Assignee, who is a holder in due course but who did not immediately
record an assignment of the mortgage. Bank later mistakenly satisfied
the mortgage of record and Mark thereafter sold and conveyed
Blackacre to Griffin, who paid full value for Blackacre, had no
knowledge of the unrecorded assignment, and immediately recorded his
deed. Subsequently, Assignee recorded the assignment of the mortgage.
Griffin now owns Blackacre subject to the mortgage.
10.
T or F
A valid pledge of a promissory note and mortgage to secure a loan to the
holder is governed by Article 9 of the UCC.
11.
T or F
Four lenders, Bank One, Bank Two, Bank Three, and Bank Four, in
chronological order, each took a 25% participation interest in a mortgage
on Blackacre. The mortgage later went into default at a time when the
outstanding balance due was $1,000,000. The mortgage was foreclosed
and the sale yielded $500,000. Mortgagor was judgment-proof, so no
deficiency judgment was sought against him. The participation
agreement was silent on the priority of the parties’ claims to foreclosure
proceeds. Thus, Bank One and Bank Two should each receive $250,000
and Bank Three and Bank Four should take nothing.
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