In re Cornerstone Homes, Inc., 544 B.R. 492 (Bankr. W.D. N.Y. 2015) –

A chapter 11 trustee sought a judgment that a series of mortgages were unenforceable as a matter of law because the written assignments transferring them to the current mortgagees were insufficient. If the trustee prevailed, the mortgage loans would be transformed from secured to unsecured claims.

The debtor bought, renovated and then sold or rented single-family homes. At the time of its bankruptcy filing it owned over 700 properties valued at more than $18 million. Originally the debtor financed its operations by soliciting money from hundreds of individual investors. Later it obtained financing through commercial lenders that involved consolidating individual investor notes in combination with new advances.

Each individual investor held a note that was secured by a mortgage. In connection with consolidation of some of these notes, the individual investor executed a written assignment of its mortgage to a commercial lender that included the following language: “[T]he assignor … hereby assigns unto [the assignee] … a certain mortgage made by [debtor] … together with the bond or obligation described in said mortgage ….” The commercial lender both acquired the existing notes and mortgages and advanced new money, as evidenced by a consolidated note secured by a consolidated mortgage. The individual investors did not indorse or physically deliver the underlying notes.

The court viewed the question as whether a lender would have standing to enforce the mortgage based on the assignment without endorsement or delivery of the related note.

The trustee’s argument was “based on the fundamental tenet of real estate law: ‘a transfer of the mortgage without the debt is a nullity, and no interest is acquired by it.'” Thus he argued that the mortgagees must show that they were entitled to enforce both the mortgages and the underlying notes. Since the notes were negotiable instruments under Article 3 of the UCC, he argued that they could only be negotiated by endorsement and physical delivery, and thus the written assignments were insufficient.

There were no allegations that the assignments were forgeries, the investors did not have the legal right to transfer their notes and mortgages, or that “any shenanigans were afoot.” The argument was simply that the written assignment without endorsement and delivery of the note failed as a matter of law.

The trustee’s position required the court to disagree with a long line of cases holding that either a written assignment or physical delivery would be valid to transfer a note. The trustee contended that these cases conflicted with the UCC requirements for negotiation and could be traced back to a single “infirm” case.

On the other hand, the lenders contended that a written assignment was sufficient – pointing to sections of the state real property law statute which provided that a note and mortgage could be transferred by an assignment, as well as the long line of cases that the trustee was asking the court to ignore. One of the lenders made the further point that the court was dealing with the consolidated notes, as opposed to the original investor notes, and the lenders were clearly holders of the consolidated notes.

Further two of the lenders argued that the trustee was relying on a body of law applicable to the consumer residential mortgage lending context that was designed to deal with problems arising from MERS (Mortgage Electronic Recording System). Finally some of the lenders argued that at a minimum the new advances made by the lenders should be treated as secured claims. (The trustee asked the court to wait to rule on this final point.)

The court noted that cases discussing enforceability of a mortgage typically occur in the context of a foreclosure. To establish standing to foreclose, a mortgagee must be able to enforce both the mortgage and the note, and it was well-established that a mortgage cannot exist independent of the debt so that “a transfer or assignment of only the mortgage without the debt is a nullity and no interest is acquired by it.”

However, the court rejected the next step in the trustee’s argument, finding that the “formulaic application” of the UCC was not supported by a substantial majority of the federal and state court decisions, citing a dozen cases to illustrate the point that and assignee has standing to foreclose and either a written assignment or physical delivery of the note is sufficient.

The court went out of its way to emphasize that (1) the individual investors actually signed mortgage assignments that (2) specifically referenced the bond or obligation described in the mortgages, and (3) there was no dispute about the fact that the individual investors could legally assign their notes and mortgages. It went on to distinguish the MERS line of cases by noting that MERS held only the mortgage and had no legal rights to the underlying note. The court also distinguished cases where there was an assignment of a mortgage without reference to the underlying debt.

Consequently, the court found that the commercial lenders had standing to enforce their consolidated notes and mortgages based on valid assignments and denied the trustee’s motion.

Any transfer of mortgage loans needs to be handled with care and attention to detail, and the intersection between the UCC and real estate law can be tricky. As indicated by this case, doing things the right way (whatever that is) can mean the difference between holding a secured claim and an unsecured claim.

Vicki R Harding, Esq.