14 Dec California Foreclosure Primer: The Basics of Note Enforceability Part 1 of 2
In many California foreclosure cases, lenders are all together disregarding the underlying model provisions of UCC article 3 and 9, which California has codified in its California Commercial Code.
These lenders appear to be bypassing the most elementary and beginning stage of any foreclosure proceeding, California Commercial Code 3-301, which governs the underlying promissory note as a negotiable instrument and who is entitled to enforce it.
In a typical foreclosure, ABC Company, the last entity the borrower was paying, simply contacts its foreclosure company to issue a Notice of Default and move forward with the foreclosure process. Everyone seems to assume that ABC Company has the ability to foreclose in the first place since that was who the borrower was paying recently and who the borrower may have received a notice that their loan was “sold” to.
Because of these assumptions, most lenders, attorneys, and borrowers altogether skip orcompletely assume thenegotiabilityrequirements of UCC article 3 have been met during all previous transfers of the promissory note, and jump straight to the UCC article 9 security interests issues.
Such assumptions are akin to an airline pilot assuming his plane has fuel for flying, without ever inspecting any fuel tanks for fuel! Just like a plane can not fly without proper fuel, a foreclosure can not take place with proper possession and endorsement/holder rights in an underlying promissory note. Pilots do not skip fuel checks, so why are foreclosures skipping note enforceability issues? Maybe because no lives are at stake? It takes too long? Its never been an issues before? It costs too much money?
Check your Deed of Trust and Promissory Note. Chances are that XYZ Company is the original lender, not ABC company, and you simply received notice that your loan was sold some time ago. But keep in mind what really took place. Chances are, in today’s securitization market, that your note was securitized in a pool with other notes to a Trust, that was then sold to a substantial number of investors on Wall Street.
In this example, XYZ company may have originated the note andfunded the original mortgage with the aid of a the warehouse lender which provided interim funding (the warehouse lender normally just files a UCC-1 financing statement as to the notes or claims perfection by possession and is rarely an actual transferee of the note).
A Sponsor then organized the securitization of the mortgage and submitted the original registration statements to the Securities and Exchange Commission. Finally, a Depositor then transferred the note a Trust.
So in effect, even though XYZ originated the note, the note eventually concluded its transfers and now resides in a Trust. Or, as which often happens, the Trust owns the note, but somewhere along the note transfers, the actual possession of the note never made it to the Trust.
Irrespective, the Trustee of the Trust, is the actual entity that owns the notes for the benefit of the parties who invested in the various tranches of bonds issued by the Trust. Each tranche of bond holders has a different interest in the principal and interest income streams generated by the mortgage notes in the Trust or from fees and charges recovered by the servicers from the consumers (the rights of these bond holders are specified in the Pooling and Servicing Agreement, the Prospectus and the Prospectus Supplement).
So in this example, we will assume that New York Bank is the Trustee now owning the note in the ZZZ-1234 trust. Whether New York Bank actually possesses the Note is a different matter. And since possession allows enforcement rights, it is possible that New York Bank may own the Note, but has no ability to foreclose.
An example is where you own a $100 bill, left it at you home, and are trying to buy something at the store and can not do so since you can not present them with the $100 bill, which if you read it, it states it is a “Federal Reserve Note.” Foreclosures all turn on possession of Notes. The promissory note to a mortgage is very similar to money. They are both notes and have certain value. Possession is the only way to enforce them.
New York Bank then, as the owner of the note, has the ability to foreclose. Of course, this all assumes that the underlying note was properly transferred in the forgoing chain of transfers and is now in New York Bank’s possession. However, to be properly transferred, each transfer had to comply with California Commercial Code3-301, which states:
"Person entitled to enforce" an instrument means (a) the holder of the instrument, (b) a nonholder in possession of the instrument who has the rights of a holder, or (c) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3309 or subdivision (d) of Section 3418.
In a perfect world, the transfers were all proper and New York Bank as Trustee of the ZZZ-1234 Trust has the ability to enforce the note and foreclose if payments are not made. Nevertheless, Trustee of the Trust does not service the note. Instead, another entity services the note. Sometimes, it may be the original party that originated the note, such as XYZ company in this example, and the borrower thinks they had the same lender the entire time without knowing their loan was sold.
Often, however, is that the servicer changes and the borrower concludes that the new servicer owns the note. Again, this is not true since the Trust owns the note and the new servicer is simply servicing the note on behalf of the Trust. Then, when a foreclosure action is started, another entity usually enters the scene since the Servicer typically hires an outside foreclosure entity to conduct the Trustee sale, such as ReconTrust, Quality Loan Servicing, etc.
The confusing transfers of the Note should also not be confused with the Deed of Trust filed with the County Recorder, and any of its subsequent transfers and assignments. While the underlying Note is the genesis to any enforcement issues, the Deed of Trust is merely an accessory to the underlying note, and only provides rights to the collateral real estate if payments are not met. The Deed of Trust is meaningless without a Promissory Note. Indeed, case law is well defined in California, that a Deed of Trust without the underlying note is a “Legal Nullity.”
So the issue of enforcing a foreclosure on the underlying note has nothing to do with whether or not Trust has a perfected security interest in the residential real estate via the deed of trust. While perfection deals with recording the deed of trust with the County Recorder when the loan is originated and is typically done in most cases, the party still attempting to enforce the note must still qualify under the laws to enforce the note pursuant to CCC 3-301. Perfection should not be confused with transfer, assignment and ownership rights in the mortgage notes on the one hand and in the deed of trust and mortgage on the other.
If the forgoing is starting to make your head spin, it should. But beforewarned, this is only a rudimentary analysis of the typical securitized mortgage in California. Its actually much more complex than what is being written, and would take volumes to fully explain. Perhaps this is why many Lenders, Consumers, Servicers, Attorneys, and Judges are perplexed when it comes to litigation involving real estate notes.
Assuming an outside foreclosing agent such as Recontrust is now attempting to foreclosure on the property, the most fundamental question then arises: Are they acting on behalf of an entity that has the LEGAL RIGHT TO ENFORCE THE NOTE?
In part 2 of this blog, we will explore whether the foreclosing agent has the legal right to enforce the note.
Written byMichael G. Doan
Bankruptcy Law Network (BLN)
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