In a complex commercial financing, efforts to reduce liability for New York's mortgage recording tax result in long chains of active promissory notes encompassing a number of financings over decades. Some of the original notes may be missing altogether or may have been improperly endorsed along the way. Since ownership of the notes is critical to a party's ability to enforce the borrower's obligations, practitioners focus on confirming that possession of the notes themselves and the chain of ownership is clear.
While a review of note endorsements obviously aids this effort, until recently, the prevalent practice among lenders was to transfer notes by physical delivery, without any form of endorsement. Though customary, and in fact, not prejudicial, this practice creates deficiencies that can be problematic for the national commercial mortgage-backed securities (CMBS) industry. Despite the uncertainties attendant to incomplete loan documentation, lenders may rely on consolidated notes and language in assignments of mortgage documents to shore up any gaps in physical possession of the note.
Mortgage assignments, when properly drafted, assign both the mortgage and the note. Assuming the chain of mortgage assignments is intact, lenders can gain comfort knowing that under New York case law they have standing to enforce the full amount of the debt evidenced by these assignments. Nevertheless, defendants in foreclosure proceedings often challenge the lenders' standing to enforce the note, demanding that lenders demonstrate physical possession of the note to initiate a foreclosure despite the fact that physical possession is not required by the law.
A lender who initiates a foreclosure proceeding must establish prima facie entitlement to summary judgment, which necessarily includes tendering evidence of the mortgage and unpaid note, along with evidence that the lender is entitled to exercise foreclosure remedies.1 It is incumbent upon the defendant to raise any question of lender's standing and once raised, the plaintiff lender must prove that it is entitled to enforce the note and mortgage.2
New York Majority View. New York case law provides that a plaintiff has standing to enforce a note where the plaintiff was either (1) assigned the underlying note or (2) received physical delivery of the note prior to commencement of the foreclosure action.3 New York courts have been flexible with this standard, finding written assignments sufficient to satisfy the standing requirement in varying scenarios. The courts' awareness of the common practices in financings has allowed the CMBS market to continue to function uninterrupted despite documentation deficiencies that may be carried over from decades earlier. For example, in Deutsche Bank Trust v. Codio, in the face of a challenge to its standing, the plaintiff did not produce the original note; instead, it submitted a document entitled "allonge to note."4 The court determined the allonge functioned as a written assignment sufficient to establish standing. More commonly, lenders establish standing based on an assignment of mortgage that conveys both the mortgage and the note.
In In re Mims, the bankruptcy court made plain the potential consequence to lenders that do not effect this sort of assignment properly. In that case, the lender did not have physical possession of the note it sought to enforce when it attempted to lift the automatic stay imposed by the initiation of bankruptcy proceedings so it could foreclose on a mortgage.5 The assignment of mortgage, however, did not contain language that also assigned the note. Because there was no written assignment of the note, the lender lacked standing and the court refused to lift the stay. The court stated that "[h]ad the assignor desired to assign the Note using the [assignment of mortgage], it could have used different language to accomplish this end."6 The court then cited a statutory form of assignment of mortgage, which contains language transferring the mortgage "together with the bond or obligation described in said mortgage, and the moneys due and to grow due thereon with interest…"7 A multitude of other New York decisions confirm that an assignment of mortgage making reference to a corresponding transfer of the note is effective to transfer both the mortgage and the note for standing purposes.
Likewise, a foreclosing lender holding a validly executed consolidated extension and modification agreement (CEMA) has standing to foreclose. A CEMA is often used by lenders in New York to consolidate multiple notes into one obligation, and operates to supersede and replace the original notes of the previous indebtedness. New York courts that analyze CEMAs will enforce them as encompassing the primary payment obligation as long as the payee of the CEMA was either assigned or had physical possession of all of the notes purported to be consolidated. For example, in Wells Fargo Bank, N.A. v. Gallo, the court accepted the CEMA as evidence that the lender was in possession of the note and mortgage, however it found the CEMA improperly executed because one note purported to be consolidated into the CEMA had never been assigned or physically possessed by the parties to the agreement.8 Thus, lenders can foreclose on CEMAs but must confirm that they owned the original indebtedness prior to consolidation.
New York courts demonstrate an understanding of the practical problems that real property financings face in New York, thus allowing a foreclosing lender to establish its standing in a number of ways. In a recent case, the New York Supreme Court sitting in Brooklyn in The Bank of N.Y. Mellon v. Deane9 followed the established case law but noted that under the New York Uniform Commercial Code (UCC), transfers of notes are only effectuated by physical delivery of the note.
Note Transfers Under the UCC. In Deane, a plaintiff lender sought to foreclose on a mortgage after the defendant borrowers defaulted. Defendants challenged plaintiff's standing to enforce the note and foreclose the mortgage. The court began by restating the case law test for determining rights to enforce a note (i.e., written assignment or possession of the note). The plaintiff was unable to produce a written assignment or evidence of actual possession of the note. As such, the court applied the case law approach and found that the plaintiff did not have standing.
Although the Deane court found the case law approach determinative in the outcome of the decision, curiously, it turned to a discussion of Article 3 of the UCC, which it found suggests a different result. The court began by stating that under the UCC persons who may enforce a note are "the holder of the instrument, and a nonholder in possession of the instrument who has the rights of a holder."10 The court explained that under the UCC a person may become a "holder" of a specially endorsed note only if the note has been physically delivered to that person.11 The same is true for a holder of a note endorsed in blank.12
Thus, the court found physical possession of the note to be determinative regardless of whether a written assignment was executed. The court criticized the approach followed by case law in New York, stating that allowing an assignee to have standing without possession of the note "would be inconsistent with Revised Article 3, and put New York out-of-step with the 49 states that have adopted the revision[.]"13 Notably, however, New York has opted not to adopt those proposed revisions to Article 3. The court continued, "that misstep, however, if such it is, has apparently already been taken. The case law quoted and cited above clearly speaks, in the disjunctive, of standing obtained by 'assignment' or 'physical delivery' of the note[.]"14
Deane's discussion of New York case law in relation to revised Article 3 is unsettling because it does not take into account the practical considerations of mortgage financings in New York. Nor does Deane's approach clarify whether consolidated notes and mortgages would be effective to establish standing in a foreclosing proceeding without possession of each prior instrument. Nevertheless, even if the UCC were to be strictly followed by courts in the foreclosure setting, improper endorsements and lost notes are not fatal to a foreclosing lender's standing.
Note Transfers by Allonge. In New York real estate transactions, as explained above, there are long chains of note transfers that often do not include allonges or are otherwise improperly endorsed. Nevertheless, possession of a note, even improperly endorsed, grants the transferee right to enforce the note and therefore standing in a foreclosure proceeding.15
In order to properly transfer rights in a promissory note under Article 3 of the UCC, the note must be "indorsed", that is, signed by the payee.16 This is often done by stamping the face of the note, or more commonly now, because the original note may not be readily available, through an allonge. An allonge is an endorsement of a note located on a separate piece of paper.17 Importantly, a voluntary transfer of a note, even if it is not properly endorsed by signature or allonge grants to the transferee the same rights in the note that the transferor had, including the right to enforce the note.18 Thus, even under the strictures of the UCC, the transferee of an unendorsed note is a person entitled to enforce the note and has standing to enforce its remedies against a borrower in foreclosure proceeding.
Lost, Destroyed, or Stolen Notes. Loan documentation evidencing long chains of note ownership are often missing the original notes themselves. Fortunately, the UCC permits recovery for a lender who has rights to a lost or destroyed note. The UCC states that "[t]he owner of an instrument which is lost, whether by destruction, theft or otherwise, may maintain an action in his own name and recover from any party liable thereon upon due proof of his ownership, the facts which prevent his production of the instrument and its terms."19 Normally, this is accomplished through a lost note affidavit, in which the lender attests, among other things, that it has not transferred the note to another person.
New York courts in the cases described herein consistently follow well-established precedent permitting standing in a foreclosure action without the plaintiff having physical possession of the original notes. New York case law makes clear that physical possession of all notes in a chain of loan assignments and refinancings is unnecessary for standing in a foreclosure action and that proper execution of a CEMA is sufficient to confer standing when missing notes have been consolidated. Likewise, inclusion of an allonge or other endorsement for every note transfer is not required under New York law for standing in a foreclosure action when the note has been assigned by other means, such as through a properly drafted assignment of mortgage.
Jeffrey B. Steiner, Jason R. Goldstein and Joshua Sohn are members of DLA Piper. Matthew S. McElroy, an associate at the firm, assisted in the preparation of this article.
1. The Bank of N.Y. Mellon v. Deane, 2013 NY Slip Op. 23224 (Sup. Ct. July 11, 2013)(quoting Capstone Bus Credit, v. Imperia Family Realty, 70 A.D.3d 882, 883, 2010 N.Y. Slip Op. 01450 (App. Div. 2010)).
2. Id. (quoting HSBC Bank USA, N.A. v. Taher, 104 A.D.3d 815, 817, 962 N.Y.S.2d 301, 304, 2013 N.Y. Slip Op. 01806 (App. Div. 2013)).
3. In re Idicula, 484 B.R. 284 (Bankr. S.D.N.Y. 2013)(citing N.Y. Real Property Law §244). Notably, the lender must also be assigned the mortgage in addition to the note. See Bank of N.Y. v. Silverberg, 926 N.Y.S.2d 532, 536 (App. Div. 2011). While this is true, it is never an issue since transfer of the note automatically brings with it the power to enforce the mortgage because the mortgage follows incident to the note. In re Idicula, 484 B.R. at 288. In fact, an assignment of the mortgage without the debt is a nullity. Id.
4. Deutsche Bank Trust v. Codio, 94 AD3d 1040,1041 (App. Div. 2012).
5. In re Mims, 438 B.R. 52, at 53 (Bankr. S.D.N.Y. 2010).
6. Id. At 57.
7. Id.; see N.Y. Real Property Law §258.
8. Wells Fargo Bank, N.A. v. Gallo, 2011 N.Y. Slip Op. 33318[U] (Sup. Ct. June 27, 2011).
9. The Bank of N.Y. Mellon v. Deane, 2013 N.Y. Slip Op. 23224 (Sup. Ct. July 11, 2013).
10. Id. at 4 (citing revised U.C.C. §301).
11. Id. (citing N.Y. U.C.C. 3-202). A note that is endorsed in blank is "negotiated" only by delivery so that the transferee becomes a holder in due course. N.Y. U.C.C. 3-204.
12. Id. (citing N.Y. U.C.C. 1-201).
13. Id. at 9.
15. See N.Y. U.C.C. §3-302.
16. See N.Y. U.C.C. §3-204.
17. See N.Y. U.C.C. §3-202(2).
18. See N.Y. U.C.C. §3-302.
19. See N.Y. U.C.C. §3-804.