OLD DOGS WON'T ADOPT NEW TRICKS, BUT CONTINUE TO BEFUDDLE THEIR OWN: NEW YORK'S ANTIQUATED UCC ARTICLE 3 AND THE AMBIGUITY OF ASSIGNMENT REQUIREMENTS IN MORTGAGE FORECLOSURE ACTIONS.

• Author: Baumeister, Heather M.

INTRODUCTION

In the mid to late 2000s, the rise of bundling mortgage loans and reselling those loans created a sense of promise for American homeowners, leading them to believe there was a new avenue for homeownership. (1) In 2006, "the system began to unravel." (2) As a result, "[m]illions of Americans borrowed money against their homes and [could not] afford to repay" the loans, leading to defaults on mortgage payments. (3) Financiers claimed that the subprime mortgage process would create new opportunities for Americans to afford homes; in reality, Americans bought homes they would never be able to afford. (4) By 2008, the bundling of mortgages and the subprime market took a toll on the average American, plunging the American economy into a recession, the "magnitude [of which had] not [been] seen since the Great Depression." (5)

The recession created financial problems for Americans, and the issues of enforcement of bundled mortgages were lurking in the background. (6) Lending standards with bundled mortgages were loose, and the risk was high. (7) The loose standards of the bundling process in the 2000s set the table for original promissory notes (associated with the individual mortgages) to get lost in the mix. (8) Lost promissory notes, as well as the failure to transfer promissory notes with their corresponding mortgages, gives rise to problems of enforceability for mortgagees and creates defenses by borrowers/owners. (9) The enormous mortgage bundling transactions, which led to recession and mortgage defaults, have required courts to address the issue of standing in several different procedural contexts. (10) Given the sheer number of mortgage loans extended during the bundling era, the prevalence of mortgage foreclosures arising from these bundled mortgage loans continues today, carrying with it the standing issues arising from sloppy document keeping, as well as sloppy transfers of promissory notes. (11) Of course, it is not only bundled mortgages that can give rise to standing issues in a foreclosure action. To successfully foreclose, the mortgagee needs to legally hold both the note and mortgage. (12)

A mortgage is a lien against real property, through which the lender that granted the mortgage loan secures the obligations, so as to receive payment of those obligations out of a foreclosure sale of the real property in the event of a borrower's default. (13) This seems simple enough: a person takes out a mortgage loan from a lender and, if the borrower defaults, the lender produces the original promissory note as evidence of the loan and proceeds with foreclosure of its mortgage. (14) Issues arise where the holder of a mortgage assigns it to a third party, and then there is a subsequent default. (15) A mortgage assignment is the transfer of a mortgage from the original lender to a third party. (16) In the instance of an assignment, the questions become (1) whether there was a valid assignment of the mortgage, and (2) whether there was a valid transfer of the underlying note, such that the assignee has standing to foreclose. (17)

Assignments of mortgages are commonplace. (18) Bundled mortgages, by their very nature, are assigned from the original lender into a securitized form. (19) Mortgages are sold or assigned for a number of reasons, including freeing up money to lend to other borrowers, both as a realization of profit or disposing of troubled loans at a discount. (20) In New York, there is a tax associated with recording a mortgage related to property. (21) An assignment of the mortgage waives "a portion of tax imposed for recording such mortgage," making mortgage assignments a popular avenue even if a borrower is simply refinancing an existing mortgage. (22) However, in the event of default, transfer or assignment of a mortgage is pointless for the assignee unless the transfer includes the promissory note. (23)

Promissory notes are negotiable instruments under the Uniform Commercial Code (UCC)--a negotiable instrument is termed an "unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it... is payable to [the] bearer or to order at the time it is issued or first comes into possession of a holder...." (24) "An instrument is a 'note' if it is a promise...." (25) It is the promissory note that secures the mortgage loan, giving the lender the power to foreclose. (26)

During the formation of the New York Uniform Commercial Code (N.Y. UCC), (27) and its enactment in 1964, three goals were sought to be achieved: "(a) to simplify, clarify and modernize the law governing commercial transactions; (b) to permit the continued expansion of commercial practices through custom, usage and agreement of the parties; [and] (c) to make uniform the law among the various jurisdictions." (28) At this point in time, the provisions New York adopted were similar to those in the UCC. (29) In following the ideology above, it is puzzling that New York did not adopt some of the amendments to the UCC, proposed in the 1990s and early 2000s--particularly those in Article 3. (30)

Article 3 of the N.Y. UCC, entitled "Commercial Paper," deals with negotiable instruments (such as promissory notes) and the provisions associated with their use and transfer. (31) In the 1990s, some of the articles in the UCC were amended; but the only state that did not adopt the 1990s revisions to Article 3 was New York. (32) Additional amendments were proposed in 2002 as a means of keeping up with "developments of legal rules in other areas" of law--however, only 11 states have adopted the 2002 changes to Article 3. (33) New York's Article 3 has been left intact and unchanged since it was first enacted in 1964. (34) This, in essence, poses problems for uniformity of the UCC across the states. (35) The amendments to the UCC's version of Article 3 "eliminate[d] outmoded requirements, including that allonges (indorsements) to notes be physically attached to the related instrument." (36) It is the archaic, ambiguous language in New York's unrevised Article 3 that creates issues when it comes to mortgage assignments--specifically the question of whether it is necessary to hold physical possession of the promissory note in order to be able to foreclose on the underlying mortgage. (37)

The amended UCC provides that "[a]n instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument." (38) It is clear that delivery is a requirement. The N.Y. UCC provides "any transfer for value of an instrument not then payable to bearer gives the transferee the specifically enforceable right to have the unqualified indorsement of the transferor." (39) Here, there is no mention of delivery, which causes analytical problems down the line.

One of the issues with mortgage assignments is whether the assignee can show that they are the actual holder of the note. (40) Both prior to and after the 2008 recession, many large transactions occurred with the assigning of mortgages from bank to bank. (41) The bundling of mortgages led to enormous transactions, each involving a multitude of bundled mortgages, resulting in sloppy recordkeeping and mortgage assignments without physical transfer of the note. (42) With the promissory note lost in the mix, how can one be sure that the person to whom the mortgage was assigned is the actual holder of the note? The mortgage is not enforceable unless the assignee is the holder, or received a legally valid transfer, of the note. (43) It is the note that provides the basis for enforcement of the mortgage. (44) Without the rights arising from the note, the mortgage, although held by the assignee, is worthless. (45) Branching from this is the overarching question whether the assignee has standing to foreclose.

There has been much debate over the requirements for a valid mortgage assignment, especially when it comes to the issue of mortgage foreclosure: can a person's home be foreclosed upon if the holder of the mortgage does not have physical possession of the original promissory note, but does have a document that purports to assign a note that cannot be produced. (46) It is clear that "whoever has rights to the note also has rights to the mortgage method of enforcing the note (i.e., foreclosure)." (47) Under the amended version of UCC Article 3, there is no question that indorsement of the promissory note requires physical delivery of the note to the new owner of the mortgage. (48) But in New York it is not as clear.

This issue arises when a homeowner defaults on his or her mortgage payments (or other obligations associated with the loan), the original mortgage has been assigned, and the assignee commences a foreclosure action. (49) In cases where there has not been a default by the homeowner, it is commonplace for the non-defaulting homeowner to receive notice of the assignment and simply pay the assignee thereafter (i.e., continuing to make mortgage payments but to a different person). (50) Here, the non-defaulting homeowner would have no reason to know if there has been a valid assignment--and likely would not inquire. (51) The non-defaulting homeowner, after receiving such a notice, would simply direct their mortgage payments to the assignee, even though that person may not be the valid holder of the note. (52) It is unlikely an assignee would even respond to a request to produce proof of proper transfer of the note outside of the context of a foreclosure proceeding. (53)

If a mortgage holder forecloses, the borrower/homeowner becomes entitled to place standing at issue and compel the mortgage holder to prove its standing. (54) However, most people who have defaulted also do not realize that they may have the defense and remedy of challenging standing in a mortgage foreclosure action. (55) The defense of standing requires that...