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Note and Mortgage. The typical “mortgage” transaction involves two separate documents: 1. A note 2. A mortgage. We have been considering some of the variables in notes. We now turn to take an even longer look at the variables among and within mortgages and mortgage substitutes.

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Note and mortgage
Note and Mortgage

  • The typical “mortgage” transaction involves two separate documents:

    • 1. A note

    • 2. A mortgage.

  • We have been considering some of the variables in notes.

  • We now turn to take an even longer look at the variables among and within mortgages and mortgage substitutes.

  • We’ll then take up the law of the notes.

Donald J. Weidner


Dragnet clause in mortgage text p 416
DRAGNET CLAUSE IN MORTGAGE(Text p. 416)

  • A dragnet clause in a mortgage uses a single property to secure the original debt and any other debt owed, or to be owed, by the mortgagor to the mortgagee.

    • The clause “drags” other debts into the mortgage

Donald J. Weidner


Dragnet clause in mortgage cont d
DRAGNET CLAUSE IN MORTGAGE(Cont’d)

  • Courts vary in approach to dragnet clauses

  • Some “interpret” dragnet clauses narrowly, holding, ex., that dragnet clauses will only secure subsequent debts directly related to the property.

  • Some “presume” that a future advances clause only covers advances of the same quality or relating to the same transaction,

    • perhaps unless the documentation concerning the subsequent advance refers to the original mortgage as providing security.

Donald J. Weidner


State bank of albany v fioravanti text p 416
State Bank of Albany v.Fioravanti(Text p. 416)

  • 1966: Fee Owner executed $2,500 Note #1 and Mortgage #1 on Lot 1.

    • Mortgage #1 had a dragnet clauseproviding that additional subsequent debt would be secured by the mortgage, but no more than $2,500.

    • Lender recorded Mortgage #1.

  • 1973: Fee Owner executed $6,800 Note #2 & Mortgage #2 on Lot 2 to same Lender.

    • No reference was made to Lot 1.

  • Fee Owner conveyed Lot 1 to Grantee who assumed “the payment” of Mortgage #1 on Lot 1.

Donald J. Weidner


Fioravanti cont d
Fioravanti (cont’d)

  • Fee Owner paid in full the 1966 Lot 1 Note #1 in connection with which Mortgage #1 (with the dragnet clause) was issued and recorded on Lot 1.

  • Fee Owner defaulted on the 1973 Note #2, causing Lender to foreclose Mortgage #2 on Lot 2.

    • Lender got a $3000 deficiency judgment in the foreclosure of Mortgage #2.

  • Lender sued Grantee of Lot 1 to foreclose Mortgage #1 on Lot 1 to recover $2,500 of the $3,000 deficiency from the foreclosure of Mortgage #2 on Lot 2.

    • Recall, the dragnet clause in Mortgage #1 had a $2,500 limit on the additional debt that could be dragged in.

Donald J. Weidner


Fioravanti cont d1
Fioravanti (cont’d)

  • HELD: “payment of the 1966 note [secured by Mortgage #1 on Lot 1] could not terminate the bank’s right to foreclose the mortgage [#1].”

    • To decide otherwise would defeat intent.

  • TO EMPHASIZE: The note and mortgage are two separate instruments. One can survive the other.

  • Dissent: Lender’s document did not specify that the Lot 1 Mortgage would survive the payment of the Lot 1 Note

    • Construe a document that is at best ambiguous against the person that drafted it.

Donald J. Weidner


Note 1 to fioravanti
Note 1 to Fioravanti

  • In Florida, dragnet clauses are construed against the drafter.

  • In particular, pre-existing debt must be specifically included.

    • United Nat’l Bank v. Tellam, 644 So.2d 97 (FL 3d DCA 1994) (invalidated attempt to drag in pre-existing debt rather than future debt). Existing debts must be specified and future debts may not be dragged in if they were not anticipated at making of the Mortgage.

Donald J. Weidner


Note 2 to fioravanti p 416
Note 2 to Fioravanti(p. 416)

  • The Restatement of Mortgages permits dragnet clauses only if

    (a) the future debt is incurred in a transaction similar to the original mortgage; [or]

    (b) the original mortgage described with adequate specificity the additional types of loans that will be secured by the mortgage; or

    (c) the parties expressly agreedat the time of the future advance that it would be secured by the original mortgage.

Donald J. Weidner


After acquired property clause text p 416
AFTER ACQUIRED PROPERTY CLAUSE(Text p. 416)

  • Secures a single debt with a mortgage that purports to encumber both the property originally mortgaged and all future property the borrower will acquire.

  • Attempts to bring future property under the mortgage rather than future debt.

  • However, real estate lenders only get limited benefit from after acquired property clauses in mortgages.

Donald J. Weidner


After acquired property cont d
AFTER ACQUIRED PROPERTY (Cont’d)

  • The reason: A mortgage with an After Acquired Property clause will be outside the chain of title of the after-acquired property.

  • Subsequent purchasers or mortgagees of a second parcel will not find the After Acquired Property clause in the recorded chain of title of the second parcel.

    • Hence they will not be bound by that clause.

      • The purpose of the recording acts is to allow buyers and lenders to rely on the instruments properly recorded in a particular parcel’s chain of title.

Donald J. Weidner


After acquired property cont d1
AFTER ACQUIRED PROPERTY (Cont’d)

  • In sum: a subsequent purchaser (or mortgagee) of the second parcel will defeat the lender-mortgagee of the first parcel who is trying to rely on the After Acquired Property clause in the mortgage on the first parcel.

    • This is true whether a tract or a grantor-grantee index is used.

Donald J. Weidner


Evolution of protection of mortgagors text p 367
EVOLUTION OF PROTECTION OF MORTGAGORS(Text p. 367)

The “mortgage deed,”

says the legal historian Maitland,

“is one long suppressio veri and suggestio falsi.”

Donald J. Weidner


Stages in evolution of mortgage law

Borrower

Deed

Lender’s estate ends ONLY if borrower pays everything off exactly on time.

Lender

Fee simple subject to condition subsequent

Stages in Evolution of Mortgage Law

  • Defeasible fee enforced according to its terms

  • Equity relieved Borrower in special circumstances

  • Special circumstances were always found

    • The equity of redemption came to be called an estate in land.

Donald J. Weidner


Stages in evolution of mortgage law cont d
Stages in Evolution of Mortgage Law (cont’d)

  • Lenders were permitted to strictly foreclose the borrower’s equity of redemption

    • Lenders were permitted to end the borrower’s right to redeem the land from the mortgage

    • Strict foreclosure decree states: pay up now or be barred (foreclosed) from asserting any interest in the future.

  • Lenders were required to foreclose by Judicial Sale

    • The proceeds of a foreclosure sale are distributed:

      • First, to the lender, to pay what is due to the lender (principal, interest and costs)

      • Second, any surplus is paid to the borrower.

    • Thus, the lender gets what was promised to the lender, repayment, interest and no more.

Donald J. Weidner


Stages in evolution of mortgage law cont d1
Stages in Evolution of Mortgage Law (cont’d)

  • Legislatures in roughly half the states supplement the equity of redemption and other judicial protections of borrowers with an additional Statutory Right of the Borrower to Redeem from a Foreclosure Sale

    • In short, the mortgagor (and, often, a junior lienor) is permitted, for a specific period of time, to redeem “from the sale” by paying, to the foreclosure sale purchaser, the foreclosure sale price plus, in some cases, certain additional amounts.

    • There are many approaches to the consequences of nullifying the foreclosure sale.

Donald J. Weidner


Stages in evolution of mortgage law conclusion
Stages in Evolution of Mortgage Law (conclusion)

Where that leaves us.

  • Leading Rule today: There may be no contemporaneous (with the loan origination) waiver of the equity of redemption.

    • No matter how clearly stated, understood and agreed to, a contemporaneous waiver of the equity of redemption is unenforceable.

  • However, in many states: Powers of sale, authorizing a sale out of court, whether they are contained in mortgages or in deeds of trust, are enforceable (and popular).

    • In these states, the only two necessary steps to foreclose are notice and sale.

Donald J. Weidner


The practical reality of choice of security interest
THE PRACTICAL REALITY OF CHOICE OF SECURITY INTEREST

  • A Mortgage

  • A Deed of Trust

  • An Absolute Deed Standing by Itself

  • An Absolute Deed with Collateral (accompanying) Documents

    • Collateral documents such as a lease back or an option to repurchase

  • An Installment Land Contract

    • Also called “contract for deed” or “bond for title”

  • A Negative Pledge

  • A Lease

  • A Proprietary Lease in an Cooperative

Donald J. Weidner


Sample balloon mortgage supplement p 31
Sample Balloon Mortgage(Supplement p. 31)

  • “This Mortgage Deed”

  • “Mortgagor hereby grants, bargains, sells, conveys and confirms unto Mortgagee, in fee simple”

  • Legal description of the land conveyed

  • Mortgagor covenants that it “is indefeasibly seized of the Premises in fee simple and has full power and right to convey . . . And does hereby fully warrant title and will defend the same”

Donald J. Weidner


Sample balloon mortgage cont d
Sample Balloon Mortgage(Cont’d)

  • “CONDITIONED, HOWEVER, that . . . If Mortgagor shall fully perform all the covenants, conditions and terms of this Mortgage, then these presents shall be void, otherwise to remain in full force and effect.”

  • The mortgagor also covenants

    • To pay the principal and interest “according to the terms of the Note and this Mortgage.”

    • To pay all taxes and assessments.

    • To keep the buildings and improvements insured

Donald J. Weidner


Sample balloon mortgage cont d1
Sample Balloon Mortgage(Cont’d)

  • The mortgagor also covenants

    • to give the mortgagee the right to spend money to cure defaults [ex., to pay real estate taxes if the mortgagor does not] and add the amount to the mortgage

    • to give the mortgagee the right, on default, to declare the “whole of the indebtedness . . . due and payable” and proceed to foreclosure [the “acceleration” clause]

Donald J. Weidner


Sample balloon mortgage cont d2
Sample Balloon Mortgage(Cont’d)

The mortgagor also covenants that

  • “all rents, profits, incomes . . . are hereby assigned and pledged as further security for payment of the indebtedness hereby secured with the right on the part of the Mortgagee at any time after default hereunder . . . to demand and receive the same and apply the same on the indebtedness hereby secured.”

Donald J. Weidner


Sample balloon mortgage cont d3
Sample Balloon Mortgage(Cont’d)

  • The Mortgagor also covenants

    • “Receiver. In the event suit is instituted to foreclose this Mortgage or enforce the payment of the Note . . . Mortgagee shall be entitled to the appointment of a receiver to take charge of the Premises, to collect the rents, issues and profits . . . and to . . . care for the premises, and such appointment shall be . . . as a matter of right to the Mortgagee.”

Donald J. Weidner


Sample balloon mortgage cont d4
Sample Balloon Mortgage(Cont’d)

The mortgagor also covenants

  • “Subordination. This mortgage” shall be “subject and subordinate to the lien of any and all institutional mortgages that may now or hereafter affect the premises,” provide they are in connection with the property and not more than $500,000.

Donald J. Weidner


Deed of trust
Deed of Trust

  • From Klem v. Washington Mutual, 2013 Wash. LEXIS 151 (Feb. 28, 2013):

    • A deed of trust . . . Is a statutorily blessed “three-party transaction in which land is conveyed by a borrower, the ‘grantor,” to a ‘trustee,’ who holds title in trust for a lender, the ‘beneficiary,’ as security for credit or a loan the lender has given the borrower.”

    • If the trustee acts only at the direction of the beneficiary, then the trustee is a mere agent of the beneficiary and a deed of trust no longer embodies a three party transaction.

Donald J. Weidner


Tahoe nat l bank v phillips text p 369
Tahoe Nat’l Bank v. Phillips (Text p. 369)

  • B was in a real estate development partnership that was overdrawn on its account with L bank. L agreed to lend $34,000 to B, who transferred the funds to her partnership’s account.

  • B gave L a single-payment demand note.

  • B also executed an “Assignment of Rents and Agreement Not to Sell or Encumber Real Property” (also known as a “negative pledge”)

  • The property described in the negative pledge was B’s residence.

  • 6 months later, B filed a Declaration of Homestead.

  • L sued to declare the negative pledge an equitable mortgage on the residence and to foreclose on it.

Donald J. Weidner


Assignment of rents and agreement not to encumber real property negative pledge
“Assignment of Rents and Agreement Not to Encumber Real Property”—Negative Pledge

  • “In consideration and as security for a loan”

  • Certain real estate [B’s residence] was described

  • Borrower “hereby assigns to Bank all monies due . . . on account of such real property reserving unto Borrower the right to collect and retain any such monies prior to Borrower’s default”

  • Borrower “will not create or permit any lien or any encumbrance to exist on said real property.”

  • Borrower “will not transfer, sell, assign or in any manner dispose of said real property . . . without the prior written consent of Bank.”

  • Bank is authorized to record [which Bank did]

  • Agreement is intended to benefit all subsequent holders of the note.

Donald J. Weidner


Tahoe cont d
Tahoe Property”—(cont’d)

  • Majority: “the assignment cannot reasonably be construed as a mortgage at the instance of the party who drafted and selected it.”

  • Note the court emphasized:

    • (1) Lender’s superior bargaining position and

    • (2) Lender’s use of Lender’s standardized form.

      • As in Goebel v. First Federal (Text p. 403—the case on how to implement a note’s provision giving lender the right to increase the rate of interest)

  • Consider the majority’s 4 reasons for not finding a mortgage and ask whether each is persuasive.

Donald J. Weidner


Tahoe cont d majority s reasons why no mortgage
Tahoe Property”—(Cont’d)Majority’s Reasons Why No Mortgage

  • The instrument contains no words of hypothecation

    • Except perhaps the assignment of monies due on account of the property.

    • Compare our Balloon Mortgage: “Mortgagor hereby grants, bargains, sells, conveys and confirms unto Mortgagee, in fee simple, all those certain lands” etc.

Donald J. Weidner


Tahoe cont d majority s reasons why no mortgage1
Tahoe Property”—(Cont’d)Majority’s Reasons Why No Mortgage

2. The instrument includes language inconsistent with a mortgage, that is, a prohibition on junior liens (which the court said might be an invalid restraint on alienation).

  • But see Smith & Lubell (Text p. 712): A prohibition on junior financing is one of the “safeguards now frequently . . . found in the promissory note.”

Donald J. Weidner


Tahoe cont d majority s reasons why no mortgage2
Tahoe Property”—(Cont’d)Majority’s Reasons Why No Mortgage

3. The instrument lacks an acceleration clause.

  • Is an acceleration clause necessary in a demand note?

    4. The subject property was not to be improved by the loan.

  • Similar to what some courts say in the case of a dragnet clause in a mortgage.

  • However, many mortgages secure advances of funds that are not spent on the property being mortgaged.

Donald J. Weidner


Tahoe cont d1
Tahoe Property”—(cont’d)

  • Some lenders use a negative pledge to avoid a prohibition against extending loans that are secured by second mortgages (see Fn. 8).

  • Some lenders use a negative pledge to preserve their right to a direct action on the debt.

  • In general, a Lender has a choice of remedies under the note or under the mortgage.

  • However, some states have a “one action” rule under which the Lender’s only remedy on default is to foreclose.

    • Theory is that, because the mortgaged property is the primary fund for the repayment of the debt, the Lender must exhaust it first, then seek deficiency.

    • The rule is also said to protect the mortgagor from a multitude of suits.

Donald J. Weidner


Tahoe cont d2
Tahoe Property”—(cont’d)

  • Compare our Sample Balloon Mortgage paragraph entitled “Remedies Cumulative”:

    • “In the event of default in payments due under the Note . . . Mortgagee shall have, in addition to the rights and remedies specified herein, all other rights and remedies provided . . . in the Note.”

  • Recall, Tahoe said even though the Lender did not have the benefit of a mortgage, the Lender still had its remedy on the note

    • Including the right to proceed against the property in satisfaction of the note, to the extent there was value in excess of the homestead exemption (see text p. 374)

Donald J. Weidner


Tahoe dissent
Tahoe Property”—Dissent

  • The dissent said the borrower did breach the covenant prohibiting assignment:

    “[D]efendant has also breached the Assignment by declaring a homestead on her property. A declaration of homestead is neither a conveyance nor an encumbrance for other purposes but it does exempt the property from execution or forced sale. Since the purpose of an agreement not to encumber is . . . To acquire a ‘guarantee that property in which the debtor has an equity will remain unencumbered and unconveyed, and thus available for levy and execution should the creditor reduce his debt to judgment,’ a declaration of homestead effectively frustrates the clear purpose of the agreement.”

Donald J. Weidner


Tahoe national bank v phillips
Tahoe National Bank v. Phillips Property”—

HYPO # 1

Deed Absolute with Collateral Documents

Sale

Alleged Borrower

Alleged Lender

2 year option to repurchase

Permits 2 years to pass without exercising option

Borrower

What Kind of Evidence Might Borrower Want to Introduce to Establish that the Sale Coupled with an Option to Purchase Was Intended and Should Be Treated As a Mortgage?

Donald J. Weidner


Factors to consider whether there is an equitable mortgage text p 377
Factors to Consider whether there is an “Equitable Mortgage”(Text p. 377)

“[1]Side agreements providing for reconveyance will readily be connected to the deed to support a finding that the deed and agreement formed a single security transaction. Nor is a written agreement essential. Among other facts that will be considered are:

[2]‘declarations of the grantee;

[3] the relations subsisting between the parties at the time the deedwas executed;

[4] the retention by the grantor . . . of possession . . . and

[5] the exercise of dominion over it in making improvements and repairs,

[6] paying taxes and the like,

[7] the value of the property compared with the consideration actually paid . . . .’ . . ..”

Donald J. Weidner


Equitable mortgage text pp 377 78
Equitable Mortgage Mortgage”(Text pp. 377-78)

  • The “putative deed will probably have been recorded.”

  • “Because a bona fide purchaser from the grantee will generally not be bound to the mortgage transaction, the grantee-lender has good reason to sell or encumber his title as soon as he can, leaving the original grantor with only a personal action against him.”

    • However, a subsequent grantee with notice is bound by the equitable mortgage.

    • See, ex., F.S. 697.01(2).

  • Deeds absolute are also often used by grantors trying to hide assets from other creditors.

Donald J. Weidner


Tahoe national bank v phillips1

Loan Mortgage”

Definite Borrower

Definite Lender #1

Note

Negative pledge [Say identical to Tahoe]

Records

Tahoe National Bank v. Phillips

HYPO #2

  • If Lender #2 records a mortgage, will it be the first mortgage?

  • Would Lender #1 be able to get an injunction to prevent borrower from making an outright conveyance?

    • Tahoe: “Specific performance of the covenant against encumbrances might create an invalid restraint against alienation.”

  • Would it be easier for Lender #1 to enjoin Borrower from giving a mortgage to Lender #2?

    • Tahoe: “Under these circumstances, enforcement as an equitable mortgage, which permits the property to be conveyed subject to the lien, is the only alternative to invalidation of the instrument.”

Applies for loan

Lender #2

Borrower

Insists on 1M

Donald J. Weidner


Enforceability of due on sale due on encumbrance clauses text p 472
Enforceability of Due-on-Sale & Due-on-Encumbrance Clauses Mortgage”(Text p. 472)

  • Prior to 1982, due-on-sale clauses were frequently invalidated by the courts as unreasonable restraints on alienation.

  • Several state legislatures imposed restrictions on the enforceability of due-on-sale clauses--commonly prohibiting enforcing them in residential mortgages unless the mortgagee could establish that a transfer would impair mortgage security.

  • The majority judicial approach held due-on-sale clauses were enforceable (presumption of enforceability) unless the borrower could show the lender engaged in unconscionable conduct.

  • The minority judicial approach generally held due-on-sale clauses enforceable only if (presumption against enforceability) the mortgagee established reasonableness by showing that the transfer would result in security impairment or an increased risk of default.

  • Due-on-encumbrance clauses were rarely litigated and the few reported cases permitted enforcement of the clause only when shown reasonably necessary to protect the lender’s security.

Donald J. Weidner


Enforceability of due on sale due on encumbrance clauses cont d
Enforceability of Due-on-Sale & Due-on-Encumbrance Clauses (Cont’d)

  • The enforcement of due-on-sale clauses by lenders enabled them to force repayment of lower-than-market interest rate loans during periods of rising interest rates upon the sale of the property by the mortgagor.

  • Judicial and state legislative restrictions on the enforceability of due-on-sale clauses imposed severe economic burdens on depository institutions during a period of high inflation.

  • In response, to protect the lenders, Congress passed the Garn-St. Germain Depository Institutions Act of 1982. 12 U.S.C. § 1701j-3.

  • Garn-St. Germain preempts state laws that restrict due-on-sale clauses, and makes these clauses generally enforceable. 12 U.S.C. § 1701j-3(b)(1).

Donald J. Weidner


Due on sale due on encumbrance clauses cont d
Due-on-Sale & Due-on-Encumbrance Clauses (Cont’d) (Cont’d)

  • Garn-St. Germain covers any “person or government agency making a real property loan.” 12 U.S.C. § 1701j-3(a)(2).

  • Due-on-sale clauses are defined broadly as any “contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender's security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender's prior written consent.” 12 U.S.C. § 1701j-3(a)(1) (emphasis added).

    • Thus, the Act defines due on sale clauses to include due-on-encumbrance clauses.

Donald J. Weidner


Enforceability of due on sale due on encumbrance clauses cont d1
Enforceability of Due-on-Sale & Due-on-Encumbrance Clauses (Cont’d)

  • Garn-St.-Germain, as a general rule, says that due on sale clauses and due on encumbrance clauses are enforceable.

  • However, in a certain limited number of situationsinvolving residences, due-on-sale and due-on-encumbrance clauses are not enforceable.

  • The biggest exception is, that in the case of a single family residence, a due on encumbrance clause is unenforceable.

    • For example, an acceleration clause triggered by a subsequent home equity loan is unenforceable.

  • There are other instances in which due-on-sale clauses in residential loans are unenforceable. See12 U.S.C. § 1701j-3(d)(2-9) (Text p. 473).

Donald J. Weidner


Prepayment privileges and penalties text p 474
Prepayment Privileges and Penalties (Cont’d)(Text p. 474)

  • Absent a specific provision in a note governing prepayment, the borrower is generally not entitled to prepay whenever the borrower likes

    • The rationale is that the lender has bargained for a specific debt service schedule

  • However, a minority of jurisdictions disagree.

    • In some, statute provides for a right to prepay unless the note provides to the contrary

    • Some caselaw presumes a right to prepay

    • Federal law preempts state law in limited residential situations

      • And prevents a due-on-sale clause from triggering a penalty

Donald J. Weidner


Florida statute substance not form determines whether mortgage exists
Florida Statute: Substance Not Form Determines Whether Mortgage Exists

  • Fla. Stat. sec. 697.01(1) (Similar to the Balloon Mortgage provision at Supp. 36):

  • “All conveyances, obligations conditioned or defeasible, bills of sale or other instruments of writing conveying or selling property, either real or personal, for the purpose or with the intention of securing the repayment of money, whether such instrument be from the debtor to the creditor or from the debtor to some third person in trust for the creditor, shall be deemed and held mortgages, and shall be subject to the same rules of foreclosure and to the same regulations, restraints and forms as are prescribed in relation to mortgages.”

Donald J. Weidner


Florida statute substance not form determines whether mortgage exists cont d
Florida Statute: Substance Not Form Determines Whether Mortgage Exists (cont’d)

  • Is a negative pledge within FS 697.01(1)?

    • Is it a conveyance?

    • Is it a writing selling property?

  • Reflecting the general rule, FS 697.01(2) provides:

    “Provided, however, that no such conveyance shall be deemed or held to be a mortgage, as against a bona fide purchaser or mortgagee, for value without notice, holding under the grantee.”

Donald J. Weidner


Installment land contracts as mortgage substitutes
Installment Land Contracts as Mortgage Substitutes Mortgage Exists (cont’d)

H & L Land Co. v. Warner, 258 So.2d 293 (Fla. 2d DCA 1972):

  • “An installment land sale contract, or so-called contract for deed, evidences a sale of the land and an obligation of the seller to convey and of the purchaser to pay the purchase price in installments . . . and is essentially a security instrument taking the place of a purchase money mortgage.

    • “The doctrine of equitable conversion is established in Florida. * * * if a land sale contract is specifically enforceable, and is free of equitable imperfections, the vendee becomes the equitable owner of the land and the vendor holds legal title as security for the vendee’s performance.”

  • “[A]n installment land sale contract is in essence a mortgage, and pursuant to Fla.Stat. s 697.01, F.S.A., the safeguards for the debtor and the remedies for the creditor are the same as those between a mortgagor and mortgagee.”

Donald J. Weidner


Three basic theories of mortgages
Three Basic Theories of Mortgages Mortgage Exists (cont’d)

  • Title. Mortgage passes title at outset.

  • Lien. Mortgage is nothing but a lien.

  • Intermediate. Mortgage is a lien at the outset, but passes title upon default.

  • In general, the theories have low predictive value.

  • However, the theories have some predictive value on issues concerning the lender’s right to rents after default and prior to consummation of foreclosure proceedings.

Donald J. Weidner


Commercial mortgage variations
Commercial Mortgage Variations Mortgage Exists (cont’d)

  • Call provision: permits lender to call in the note for complete repayment at specified intervals before the loan has been fully amortized.

  • Participation: gives lender a share in property’s income and/or appreciation in value.

  • Convertible mortgage: analogous to a convertible bond—provides that the lender’s interest as a creditor can be converted into an equity interest.

    • Ex., “a fixed rate loan that entitles the lender at a specified point to convert the unamortized portion of the loan (say, 70% of the property’s initial value) into an equity interest (again 70%) in the property. Frequently, a convertible mortgage will give the lender the right to buy out the mortgagor’s remaining equity interest (here 30%) at a predetermined price or at a price calculated on the basis of a predetermined formula.”

  • Personal liability:most loans on income-producing property are nonrecourse.

Donald J. Weidner


Usury variables
USURY VARIABLES Mortgage Exists (cont’d)

  • Variations Among State Usury Laws

    • Range in rates

    • Range in penalties

    • Range in what is deemed to constitute interest

    • Range in exemptions

  • Because of the above variations, do not assume that the usury case law of one state is persuasive in other states.

Donald J. Weidner


Four elements that must be met before a loan can be considered usurious text p 720
FOUR ELEMENTS THAT MUST BE MET BEFORE A LOAN CAN BE CONSIDERED USURIOUS (Text p. 720):

  • An agreement to lend money

  • Interest in excess of that allowed by statute

  • An absolute, not contingent, obligation to repay the principal

  • An intent to violate the usury laws

    NOTE: Intent, #4, is usually presumed if the other 3 elements are shown.

    NOTE: An absolute obligation to repay, #3, is difficult to avoid without defeating the lender’s business objectives.

    NOTE: Considerable federal preemption of usury limits in residential mortgages (since Pres. Carter).

Donald J. Weidner


Mcelroy v grisham text p 714
McElroy v. Grisham CONSIDERED USURIOUS (Text p. 714)

  • Builder bought 104 acres for $238,000 and spent $19,200 on site preparation.

  • Builder experienced financial difficulty and went shopping for a $100,000 loan.

  • Agreement #1:

    • Builder conveyed property to Partners for $80,000

    • Builder was “to receive a contract for deed allowing [requiring?] him to repurchase the property from Partners for $120,000”

      • $40,000 to be paid in one year

      • $80,000 balloon at the end of year two.

  • Attorney, recommended to Builder by Partners to “complete the necessary paperwork”, suggested “reworking” the contract.

    • Attorney also was made a partner in Partners

Donald J. Weidner


Mcelroy v grisham cont d
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • Agreement # 2:

    • Builder conveyed the land by warranty deed to the Partnership

    • Partnership paid Builder $80,000

    • “At [the attorney’s] suggestion, the contract for deed was changed into an option contract” (Text p. 715). Accordingly:

    • Partnership gave Builder an Option to [re] Purchase

      • Exercisable within one year

      • $40,000 to be paid at the time of exercise

      • Plus $80,000 to be paid within two years

        • No interest

    • Builder was required to release $120,000 in liens against the property (presumably, by using some or all of the $80,000 proceeds to help do this)

Donald J. Weidner


Mcelroy v grisham cont d1
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • Agreement # 3:

    • The parties ignored the option (Partnership later claimed Builder let it lapse) and entered into a “contract for deed” under which Builder agreed to purchase most of the parcels (the Partnership was going to keep three parcels) back for $125,0000 (slightly more than the option price but getting back less than all of the property).

  • Builder defaulted after paying for a while and sued to have the transaction declared a usurious loan.

  • Is there “an agreement to loan money” with an “absolute obligation to repay the principal?”

Donald J. Weidner


Mcelroy v grisham cont d2
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • The case involves what texts call a Deed Absolute (a deed that, on its face, is an “absolute” or unconditional conveyance) with Collateral Documents.

  • The initial collateral document was a “Contract for Deed”

    • another term for an Installment Land Contract

  • The Contract for Deed was replaced with an “Option to Purchase”

  • Why did the Attorney replace the “Contract for Deed” with an “Option to Purchase?”

Donald J. Weidner


Mcelroy v grisham cont d3
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • A specific intent to violate the usury laws is not necessary to find a violation:

    • All that is necessary is an intent to enter a loan transaction that charges interest that exceeds the maximum rate.

  • The question: is this, in substance, a loan secured by a mortgage?

  • Substance will control form--the law will “discard the shell and keep the kernel”

    • Florida statutes insist on this

Donald J. Weidner


Mcelroy v grisham cont d4
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • What factors indicated that, behind the form of a sale, there was the substance of a loan?

    • Alleged borrower had approached other institutions and individuals for a loan and was rejected.

    • Alleged borrower was in dire financial trouble

      • And the alleged lenders were aware of the trouble

    • Alleged borrower approached alleged lender seeking a loan.

    • There was a gross disparity between the alleged “purchase price” and both

      • Historical cost and

      • Appraised value

Donald J. Weidner


Mcelroy v grisham cont d5
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

5. There were collateral documents:

  • Providing for a payment of monies back to the “buyer” (either under the Contract for Deed or upon exercise of the “option” to purchase), and

  • Providing for a reconveyance to the “seller” upon the repayment of those monies (when “seller” performed under the Contract for Deed or “optionee” exercised the “option” to repurchase).

    6. The alleged borrower never intended to relinquish ownership.

    7. Even after the “option” lapsed, discussions continued to get the money back to the “buyer” and the property back to the “seller.”

Donald J. Weidner


Mcelroy v grisham cont d6
McElroy v. Grisham CONSIDERED USURIOUS (cont’d)

  • Conclusion: “none of the parties intended for the property to come into the hands of the [partnership] any more than was necessary to secure the loan”

Donald J. Weidner


Interest contingency rule
Interest Contingency Rule CONSIDERED USURIOUS

  • Assume the loan in McElroy v. Grisham was risky. An investor has a legitimate right to expect a return that reflects that risk

    • How might the loan be structured?

  • The casebook suggests one possible solution: provide the lender a share of the profit on the sale of residences, even if that share of profits ultimately pushes the lender’s total return above the usury level.

  • This type of solution is possible because of the interest contingency rule, which is a fundamental principle in the usury case law.

Donald J. Weidner


Interest contingency rule cont d
Interest Contingency Rule (Cont’d) CONSIDERED USURIOUS

  • One statement of the interest contingency rule:

    • “[A] promise to give the lender a greater profit than the highest permissible rate of interest upon occurrence of a condition, is not usuriousif the return promised on failure of the condition is materially less than the amount or debt with the highest permissible rate of interest.”

  • Note: there may be a different legal risk to the lender who takes a profit share, as opposed, for example, to a share of gross receipts

    • Profit sharing is a strong indication of partnership

Donald J. Weidner


Interest contingency rule cont d1
Interest Contingency Rule (Cont’d) CONSIDERED USURIOUS

  • A second statement of the interest contingency rule:

    • From Golden State Lanes v. Fox, involving a sale-leaseback

    • “in a loan the lender does notshare in the profits of the enterprise, nor does he run any risk of the loss of his capital other than that of the insolvency of the borrower, attendant upon all loans.”

  • However: in a nonrecourse loan, the lender may experience a loss of capital even if the borrower is solvent

Donald J. Weidner


Corporate borrower exemption
Corporate Borrower Exemption CONSIDERED USURIOUS

  • The most common statutory exemption from usury laws is for loans made to corporate borrowers.

  • Text (p. 721): “The central question . . . concerns the extent to which, to qualify [for the corporate borrower exemption], a corporation must have a life and business purpose independent of usury avoidance.”

    • “New York and several other states take the view that any corporation, even one formed exclusively for the purpose of avoiding usury limitations, qualifies for the corporate exemption.”

    • Courts are split.

Donald J. Weidner


Time price doctrine to avoid usury
Time Price Doctrine (to avoid usury) CONSIDERED USURIOUS

  • Is a Seller’s agreement to provide purchase money financing to his Buyer an “agreement to lend money” within the meaning of the usury law?

    • Stated differently, is a seller-provided purchase money mortgage a loan subject to the usury law?

  • The “time-price” doctrine says that a seller has a right to charge more for a sale on credit than for a cash price.

  • What if the seller sells on credit at the cash price but explicitly charges “interest” at a rate in excess of the maximum rate?

    • See Mandelino v. Fribourg (Text p. 721)

Donald J. Weidner


Heller financial inc v lee text p 722
Heller Financial Inc. v. Lee CONSIDERED USURIOUS (Text p. 722)

  • Florida Limited Partnership with a Sole Corporate General Partner took out two loans to purchase an Orlando hotel. This case concerns the smaller loan, which was the junior loan.

  • The $9,900,000 junior loan was made both to the Limited Partnership and to its sole corporate General Partner. The loan was secured by the equity interest in the limited partnership and by the equity interest in its General Partner.

  • After the closing of the loans and hotel acquisition, an unrelated corporation managed the hotel.

Donald J. Weidner


Heller financial inc v lee cont d
Heller Financial Inc. v. Lee (cont’d) CONSIDERED USURIOUS

  • At issue was Section 11(b) in the Note, which made the borrowers’ obligation to repay nonrecourse, subject to a carve-out:

    • “Subject to the provisions set forth below, no Maker shall be personally liable to pay the Loan . . . and Holder agrees to look solely to the Assignments and any other collateral . . . pledged . . . to secure the loan. Notwithstanding the foregoing, each Maker (excluding Robert Ahnert), . . . shall be personally liable for . . . (b) repayment of the Loan and all other obligations of the maker under the loan Documents in the event of [any breach of certain covenants].”

Donald J. Weidner


Heller financial inc v lee cont d1
Heller Financial Inc. v. Lee (cont’d) CONSIDERED USURIOUS

  • The referenced covenants said that each borrower agreed not to permit the filing of any encumbrances on the Hotel other than those provided for in the senior loan documents.

  • Approximately $821,212 in encumbrances were filed (4 tax liens and 2 mechanics liens).

  • Issue: Do the Makers of the note become personally liable on the full $9,900,000 loan because they permitted less than a tenth of that amount ($821,212) in encumbrances to be filed?

    • Or are they only liable for the smaller amount?

  • Held liable for the full loan: “Section 11(b) is not a liquidated damages provision because it provides only for actual damages.”

    • Which the court said was payment of the unamortized loan balance.

Donald J. Weidner


Junction bit tool co v village apts inc supp p 39
Junction Bit & Tool Co. v. Village Apts., Inc. CONSIDERED USURIOUS (Supp. p. 39)

  • In an earlier case, the Supreme Court of Florida had said that an election to sue on a note at law acted as a bar to any subsequent suit for foreclosure of a mortgage executed as security for the note.

  • Here, the Court reversed its earlier decision:

  • If the earlier judgment on the note leaves the creditor unsatisfied

    • that unsatisfied judgment on the note was no remedy and

    • hence, does not bar the remedy of foreclosure on the mortgage.

Donald J. Weidner


A first look at the transfer of notes text p 492
A First Look at the Transfer of Notes (text p. 492) CONSIDERED USURIOUS

  • “Although both the note and mortgage are transferred, the note is viewed as the controlling document.”

  • Article 3 of the Uniform Commercial Code applies.

  • A note transferee who qualifies as a holder in due course takes free of important defenses of the maker of the note.

Donald J. Weidner


A first look at the transfer of notes cont d
A First Look at the Transfer of Notes (cont’d) CONSIDERED USURIOUS

  • To qualify as a holder in due course, the transferee must acquire a negotiable instrumentin good faith and without notice of defenses against it.

  • The UCC (1990) states that good faith (among merchants) “means honesty in fact and the observance of reasonable commercial standards of fair dealing.”

    • 2001 revision comment says honesty in fact is subjective and reasonable commercial standards is objective.

Donald J. Weidner


Notes under the uniform commercial code a quick overview supplement pp 46 48
Notes Under the Uniform Commercial Code: A Quick Overview CONSIDERED USURIOUS (Supplement pp. 46-48)

  • Caveat about the Smith & Lubell statement at text p. 710: “Since the note is evidence of a debt and is a negotiable instrument, only one copy of it should be signed by the borrower.”

    • Under the Uniform Commercial Code, not all notes qualify as negotiable instruments

    • Rights of a holder in due course (UCC 3-305)

    • In general, a holder in due course takes free of “personal defenses” but takes subject to “real defenses” (see next slide)

    • Breach of warranty is a personal defense from which the HDC takes free

Donald J. Weidner


Ucc 3 305 defenses and claims in recoupment
UCC § 3-305 DEFENSES AND CLAIMS IN RECOUPMENT CONSIDERED USURIOUS

A holder in due course is subject only to the following “real” defenses: 

 ”(1) a defense of the obligor based on

(i) infancy of the obligor to the extent it is a defense to a simple contract,

(ii) duress, lack of legal capacity, or illegality of the transaction which, under other law, nullifies the obligation of the obligor,

(iii) fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms, or

(iv) discharge of the obligor in insolvency proceedings;”

A holder in due course is not subject to “personal defenses” (such as breach of warranty).

Donald J. Weidner


Official comment to revised ucc 3 305
Official Comment to Revised UCC 3-305 CONSIDERED USURIOUS

  • The Official Comment to the revised UCC 305 states that the holder in due course doctrine:

    • “applies only to cases in which more than two parties are involved. Its essence is that the holder in due course does not have to suffer the consequences of a defense of the obligor on the instrument that arose from an occurrence with a third party.”

  • The big issue is usually who qualifies as a holder in due course.

    • See UCC 3-302, 3-104, 3-106.

Donald J. Weidner


Ucc 3 302 who is a holder in due course
UCC § 3-302 Who is a Holder in Due Course CONSIDERED USURIOUS

”(a) [With very limited qualification], ‘holder in due course’ means the holder of an instrument if:  (1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity; and  (2) the holder took the instrument

(i) for value,

(ii) in good faith,

(iii) without notice that the instrument is overdue or has been dishonored . . . ,

(iv) without notice that the instrument contains an unauthorized signature or has been altered,

(v) without notice of any claim to the instrument . . . , and

(vi) without notice that any party has a defense or claim in recoupment . . . .”

- § 3-104 (b) provides: “Instrument means a negotiable instrument.”

Donald J. Weidner


Notice
Notice CONSIDERED USURIOUS

  • Consider that a HDC is one who takes without “notice” that the instrument is overdue or of a defense against it.

  • “Notice” is broader than knowledge and is defined in terms of “reason to know.”

    • A person has notice of a fact if the person, “from all the facts and circumstances known to the person at the time in question, has reason to know that it exists.” UCC 1-202(a).

Donald J. Weidner


Ucc 3 104 when instrument is negotiable
UCC § 3-104 When Instrument is Negotiable CONSIDERED USURIOUS

”(a) [With minor exceptions], ‘negotiable instrument’ means an unconditional promiseor orderto pay a fixed amount* of money, with or without interest or other charges . . . if it:  (1) is payable to bearer or to order . . . ;  (2) is payable on demand or at a definite time; and  (3) does not state any other undertaking . . . to do any act in addition to the payment of money,

but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment . . . .

* The old language requiring a “sum certain” was removed. New Section 3-112(b) was added.

Donald J. Weidner


New ucc section 3 112 b and fixed amount
New UCC Section 3-112(b) and “Fixed Amount” CONSIDERED USURIOUS

  • UCC Section 3-112(b) now provides:

    • “(b) [i] Interest may be stated in an instrument as a fixed or variable amount of money or it may be expressed as a fixed or variable rate or rates. [ii] 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.”

  • This language was added in 1990 to dispel any doubts about the negotiability of variable interest rate notes.

  • Furthermore, the entire amount due need not be calculable from what is written in the note itself.

Donald J. Weidner


Ucc 3 106 when promise or order unconditional
UCC § 3-106 When Promise or Order Unconditional CONSIDERED USURIOUS

“(a) [With minor exception], for the purposes of Section 3-104(a), a promise or order is unconditional unless it states (i) an express condition to payment, (ii) that the promise or order is subject to or governed by another record, or (iii) that rights or obligations with respect to the promise or order are stated in another record. A reference to another record does not of itself make the promise or order conditional.(b) A promise or order is not made conditional (i) by a reference to another record for a statement of rights with respect to collateral, prepayment, or acceleration, or (ii) because payment is limited to resort to a particular fund or source.”

Donald J. Weidner


More on whether a note fails the unconditional obligation requirement to be a negotiable instrument
More on Whether a Note Fails the “Unconditional Obligation” Requirement to be a Negotiable Instrument

What result in a 1975 Florida case: the note stated it was “secured by a mortgage on real estate . . . The terms of said mortgage are by this reference made a part hereof.”

- See Holly Hill Acres, LTD. V. Charter Bank of Gainsville, 314 So. 2d 209 (Fl. App. 1975) (text p. 494).

Donald J. Weidner


Ucc 3 203 transfer of instrument rights acquired by transfer
UCC § 3-203 Transfer of Instrument; Rights Acquired by Transfer

(a) An 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.

--Transfer of the right to enforce it

(b) Transfer of an instrument . . . vests in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, but the transferee cannot acquire rights of a holder in due course by a transfer, directly or indirectly, from a holder in due course if the transferee engaged in fraud or illegality affecting the instrument.

Donald J. Weidner


Ucc 3 203 official comment
UCC § 3-203 Official Comment Transfer

  • . . . Under subsection (b) a holder in due course that transfers an instrument transfers those rights as a holder in due course to the purchaser. The policy is to assure the holder in due course a free market for the instrument.

    There is one exception to this rule stated in the concluding clause of subsection (b). A person who is party to fraud or illegality affecting the instrument is not permitted to wash the instrument clean by passing it into the hands of a holder in due course and then repurchasing it.

Donald J. Weidner


Ucc 3 203 official comment cont d
UCC § 3-203 Official Comment (Cont’d) Transfer

  • The operation of Section 3-203 is illustrated by the following cases. In each case Payee, by fraud, induced Maker to issue a note to Payee. The fraud is a defense to the obligation of Maker to pay the note under Section 3-305(a)(2).

    Case #1. Payee negotiated the note to X who took as a holder in due course. After the instrument became overdue X negotiated the note to Y who had notice of the fraud. Y succeeds to X's rights as a holder in due course and takes free of Maker's defense of fraud.

    In other words, an originator of a subprime note and mortgage may have engaged in consumer fraud. The originator can transfer the note to someone who takes as a HDC. That HDC can sell its right to HDC status even to someone who buys with notice of the originator’s fraud.

Donald J. Weidner


Ucc 3 203 official comment cont d1
UCC § 3-203 Official Comment (Cont’d) Transfer

There is an exception in the case of a fraudulent originator who subsequently reacquires the note:

Case #2. Payee (who induced the maker by fraud) negotiated the note to X who took as a holder in due course. Payee then repurchased the note from X. Payee does not succeed to X's rights as a holder in due course and is subject to Maker's defense of fraud.

Donald J. Weidner


Giorgi v pioneer title insurance co text p 477
Giorgi v. Pioneer Title Insurance Co. Transfer(Text p. 477)

  • Two couples (“Makers”) executed a Note and D/T. Note was payable to H, W.

  • Note was delivered to Pioneer, Trustee under the D/T, to hold in escrow for collection.

  • The D/T (as usual) directed the Trustee to collect on the note, disburse the proceeds to the payee named in the note and reconvey the property to the maker.

  • Payee H died, his interest passed to Payee W

  • Payee W assigned all her interest in the note and D/T to Giorgi before the note became due.

Donald J. Weidner


Giorgi v pioneer title insurance co cont d
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • Payee W did not physically transfer the note or the D/T to her assignee Giorgi, saying that she had lost both.

  • Georgi recorded the Assignment of the Note and D/T with the mortgages (and Ds/T)

  • Nevada statute said that recordation of an assignment of a beneficial interest under a D/T is constructive notice to all persons.

  • Giorgi gave Makers notice he was the assignee

  • Neither Giorgi nor the Makers gave the Trustee actual notice of the assignment.

Donald J. Weidner


Giorgi v pioneer title insurance co cont d1
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • Makers made Note payments to the Trustee

    • Even though Giorgi had told Makers he was the assignee

  • Trustee obeyed the trust instructions and:

    1. disbursed the money to original payee W (who took it even though she had assigned it to Giorgi) and

    2. reconveyed the property to Makers.

Donald J. Weidner


Giorgi v pioneer title insurance co cont d2
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • Giorgi sued both original payee-Assignor W [a clear wrongdoer] and the Trustee [who never had actual notice of the assignment (but not the Makers, who paid)

    • The suit against payee/assignor W was successful.

    • But NOT against the Trustee

Donald J. Weidner


Giorgi v pioneer title insurance co cont d3
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • Giorgi Argued: the statute says a recorded assignment of a D/T is constructive notice to the world, including the Trustee. Ct. REJECTED.

  • More generally, point #1: When there is a negotiable instrument secured by a D/T (or mortgage), the law of negotiable instruments prevails over mortgage law.

  • Assignee Giorgi never got physical possession of the note—never became its “holder”

    • The Maker is supposed to pay the Holder

Donald J. Weidner


Giorgi v pioneer title insurance co cont d4
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • “[T]he maker of a negotiable note secured by a mortgage or deed of trust cannot discharge his liability by payment to one not the holder or one not authorized by the holder to receive payment.”

  • Stated differently: “And a debtor is not justified as against an assignee of the security in making payments to a mortgagee or a beneficiary named in a deed of trust who does not have possession of the instrument.”

Donald J. Weidner


Giorgi v pioneer title insurance co cont d5
Giorgi v. Pioneer Title Insurance Co. (cont’d) Transfer

  • Point #2. Granted, it is hard to rationalize the law of notes with the law of mortgages. The law of mortgages should not be applied to interfere with “the mobility of the debt” and the mortgage is “a mere incident of the debt.”

  • Point #3. Trustees (or title companies) should not be required to keep searching the title before disbursing the payments they receive on the notes they hold for collection

    • Trustees can continue to disburse the payments to the trust beneficiary

Donald J. Weidner


Doyle v resolution trust corp text p 479
Doyle v. Resolution Trust Corp. Transfer(Text p. 479)

  • Doyle sued Trinity S & L for breach of contract and for fraud in connection with an adjustable rate note he signed.

    • RTC in 1990 became the receiver that got Trinity’s interest (par for the “S & L crisis” course)

  • Doyle later added FNMA, who purchased the note and mortgage, as a defendant.

  • The “gist” of Doyle’s complaint was that Trinity, without his consent, increased the interest rate on his note from 11% to 15% and forged his initials on the change.

Donald J. Weidner


Doyle v resolution trust corp cont d
Doyle v. Resolution Trust Corp. (cont’d) Transfer

  • Doyle sought actual and punitive damages and cancellation of the note and mortgage.

  • At trial, Doyle recovered both actual and punitive damages against wrongdoer Trinity S & L and cancellation of the note and mortgage held by FNMA.

  • The cancellation of the note and mortgage held by FNMA is the sole issue on appeal.

  • The note alteration was clearly material.

  • Court initially concluded that this particular note was not a negotiable instrument (and that therefore FNMA was not a HDC).

Donald J. Weidner


Doyle v resolution trust corp cont d1
Doyle v. Resolution Trust Corp. (cont’d) Transfer

  • An Oklahoma intermediate appellate court had said that the note was not a negotiable instrument: It was not for a “sum certain” because an external index, rather than the instrument itself, had to be consulted to determine the precise amount payable.

  • The Oklahoma S. Ct. reversed (reflecting the current rule under the U.C.C.).

  • Therefore, because the note was negotiable, a subsequent holder could be a HDC if it took the note for value, in good faith with no notice of its defect (the unauthorized alteration).

Donald J. Weidner


Doyle v resolution trust corp cont d2
Doyle v. Resolution Trust Corp. (cont’d) Transfer

Did FNMA have notice of the defect?

  • Under the UCC, one has notice of a fact when one has;

  • a) actual knowledge of it;

  • b) receives a notification of it; or

  • c) has reason to know it exists.

  • Absent a finding FNMA had notice of an unauthorized alteration, FNMA “could enforce the note, as originally executed, free from any claims or defenses Doyle might have against Trinity.”

Donald J. Weidner


Doyle v resolution trust corp cont d3
Doyle v. Resolution Trust Corp. (cont’d) Transfer

  • FNMA had actual knowledge that the interest rate was altered.

  • However, it had no knowledge that the alteration was unauthorized.

  • FNMA frequently purchased notes with altered interest rates, provided the maker’s initials appeared alongside the alteration.

  • FNMA was not required to dig further unless other factors called the alteration to FNMA’s attention (Trinity “had a fine reputation”)

Donald J. Weidner


Doyle v resolution trust corp cont d4
Doyle v. Resolution Trust Corp. (cont’d) Transfer

  • Court focused on U.C.C. 3-304(1):

    “The purchaser has notice of a claim or defense if

    (a) the instrument is so incomplete, bears such visible evidence of forgery or alteration, or is otherwise so irregular as to call into question its validity, terms or ownership or to create an ambiguity as to the party to pay.”

Donald J. Weidner


Doyle v resolution trust corp cont d5
Doyle v. Resolution Trust Corp. (cont’d) Transfer

Court upheld the trial court, stating:

---Whereas there is a subjective test to determine whether a holder takes in “good faith” (but see earlier—is both subjective and objective—”reasonable commercial standards of fair dealing”)

---There is an objective test to determine whether a holder has “notice of defenses”—the question is what a reasonable person in the holder’s position would know

--and that is a question of fact properly determined below

Donald J. Weidner


Doyle v resolution trust corp cont d6
Doyle v. Resolution Trust Corp. (cont’d) Transfer

  • The lower court also said

    • The originating lender was not FNMA’s agent; and

    • There was no other “close connectedness” between FNMA and the originating lender that, for example, would have put FNMA on notice of any bad practices of the originating lender .

      • Compare the apparent split in the cases (text p. 493) about whether the holder’s notice of the transferor’s shoddy business practices constitutes reason to know with respect to the transferred note.

Donald J. Weidner


Merscorp inc v romaine text p 485
MERSCORP, Inc. v. Romaine Transfer(Text p. 485)

  • In 1993, the Mortgage Electronic Registration System (“MERS”) was created by FNMA, GNMA, FHLMC, the Mortgage Bankers Association and other entities. Insurance companies, title companies and banks are also part of the system.

  • MERS was created to track transfers of ownership interests in residential mortgages.

  • Members pay annual fees to MERS.

Donald J. Weidner


Merscorp inc v romaine cont d
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Members appoint MERS to act as their common agent on all mortgages they register in the MERS system.

  • The initial MERS mortgage is recorded in the County Clerk’s office with MERS “named as the lender’s nominee or mortgagee of record on the instrument.”

  • Thereafter, there is no public recording of transfers of ownership interests in the mortgage, or of servicing rights among MERS members. The MERS system tracks those assignments privately and electronically.

Donald J. Weidner


Merscorp inc v romaine cont d1
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • In the MERS system, the mortgagor is notified of transfers of servicing rights pursuant to the Truth in Lending Act but not necessarily of assignments of the beneficial interest in the mortgage.

  • The County said that MERS, an entity that has no interest in the mortgage, is not a proper “mortgagee”, and the document listing it as the “nominee” for the lender is not a proper “conveyance” that can be recorded.

Donald J. Weidner


Merscorp inc v romaine cont d2
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • First, the Court of Appeals directed the County to record the “MERS mortgage.”

    • N.Y. statutes impose upon the clerk the “ministerial duty of recording and indexing instruments affecting real property.” There is no authority in the clerk to look beyond an instrument that otherwise satisfies the limited requirements of the recording statute.”

    • Court characterized the document as a “MERS mortgage”)

Donald J. Weidner


Merscorp inc v romaine cont d3
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Next, the Court of Appeals directed the County to record MERS assignments and discharges of mortgages.

    • Classically, each assignment in the chain of assignments was recorded

    • “As the nominee for the mortgagee of record or for the last assignee, MERS acknowledges the instrument”

      • Therefore, the County must record it

Donald J. Weidner


Merscorp inc v romaine cont d4
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Dissenting in Part, Chief Judge Kaye said the purpose of MERS was to eliminate the centuries’ old practice of preparing and recording “paper assignments of mortgages.”

  • The MERS system is less transparent.

  • MERS simply “appoints itself nominee, as mortgagee, for its members’ successors and assigns, thereby remaining nominal mortgagee of record no matter how many times loan servicing, or the mortgage itself, may be transferred.”

Donald J. Weidner


Merscorp inc v romaine cont d5
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Dissent agreed that the MERS mortgage must be recorded, given it shows the “actual lender” and indicates that MERS has been appointed the “mortgagee of record.”

    • NOTE: This 2006 case left open the validity of the instrument itself, in light of its failure to transfer a beneficial interest, and also left open whether MERS “has standing to foreclose on a mortgage”

Donald J. Weidner


Merscorp inc v romaine cont d6
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Dissent, however, did not agree that a MERS certificate of discharge must be recorded.

    • The County must examine all prior assignments

  • The County loses the fees that would have been paid when assignments are recorded (lenders instead simply pay MERS a “minimal” annual membership fee)

  • Although MERS makes assignments faster and cheaper for the lenders and notepurchasers, there is evidence it creates substantial disadvantages for home buyers and mortgagors.

Donald J. Weidner


Merscorp inc v romaine cont d7
MERSCORP, Inc. v. Romaine (cont’d) Transfer

  • Borrowers can access the name of the servicer but not the name of “the underlying lender.”

  • Making it harder for a borrower who wants to negotiate with or sue the lender.

  • And making it harder for anyone to study what is taking place in the mortgage markets, including predatory lending.

Donald J. Weidner


Associates home equity services inc v troup text p 427
Associates Home Equity Services, Inc. v. Troup Transfer(Text p. 427)

  • Classic type of civil rights case. This in N.J. in 2001.

  • Elderly, minority, inner-city resident Troup signed contract to purchase home improvements.

  • Home improvement company steered her to defendant originating lender to finance their contract.

  • In 1996, originating lender provide her a loan:

    • $46,500 amount

    • 11.6% interest (plus 4 points at closing)

    • 15 year term

    • $41,600 balloon (due at end of 15 years)

  • Originating lender sold her note and mortgage to defendant Associates Home Equity, who paid a premium for it because of its high interest rate.

Donald J. Weidner


Associates home equity cont d
Associates Home Equity Transfer(cont’d)

  • Borrower defaulted on the note.

  • Notepurchaser Associates (assignee of note and mortgage) filed an action to foreclose

  • Borrower asserted defenses against the foreclosure and counterclaimed on the basis of various statutes, including:

    • CFA, the Consumer Fraud Act

    • TILA, the Truth in Lending Act

    • FHA, the Fair Housing Act

    • CRA, the Civil Rights Act Sec. 1982

    • LAD, the Law Against Discrimination (New Jersey)

Donald J. Weidner


Associates home equity cont d1
Associates Home Equity Transfer(cont’d)

  • In short, the court allowed the case to move forward to the discovery stage.

  • Borrower is permitted to raise overlapping defenses to establish “equitable recoupment” in the foreclosure proceeding even if its claims would be time-barred as an independent matter.

  • Borrower asserted predatory lending, discriminatory lending and unconscionability.

  • Borrower asserted that notepurchaser either acted in concert with the originating lender or controlled its conduct.

Donald J. Weidner


Associates home equity cont d2
Associates Home Equity (cont’d) Transfer

  • Predatory lending was defined in terms of loans that are not suitable for the borrowers:

    • “In essence, the loan does not fit the borrower, either because [1] the borrower’s underlying needs for the loan are not being metor [2] the terms of the loan are so disadvantageous to that particular borrower that there is little likelihood that the borrower has the capacity to repay the loan.”

Donald J. Weidner


Associates home equity cont d3
Associates Home Equity (cont’d) Transfer

  • The borrower argued that the loan originator and notepurchaser were engaged in “reverse redlining”:

    • Recall that “redlining” refers to withholding financing from neighborhoods a lender disfavors

  • “Reverse redlining is the practice of extending crediton unfair terms” to specific geographic areas due to the income, race or ethnicity of the residents.

    • The focus is on communities that lack access to traditional lending institutions.

  • Reverse redlining has been held to violate the FHA (Federal Housing Act), the CRA (Civil Rights Act) and the LAD (New Jersey law against discrimination).

Donald J. Weidner


Associates home equity cont d4
Associates Home Equity Transfer(cont’d)

  • Racial or ethnic factors may be implicated in reverse redlining:

    • A plaintiff may establish a colorable claim of reverse redlining by demonstrating that “defendants’ lending practices and loan terms were ‘unfair’ and ‘predatory,’ and that the defendants either intentionally targeted on the basis or race or that there is a disparate impact on the basis of race.”

  • Discovery may reveal that notepurchaser’s guidelines are discriminatory.

Donald J. Weidner


Associates home equity cont d5
Associates Home Equity Transfer(cont’d)

  • Court rejected notepurchaser’s argument that recoupment is inapplicable because the foreclosure proceeding is not one to collect a debt.

  • A foreclosure action “is a quasi in rem procedure to determine not only the right to foreclose, but also the amount due on the mortgage.”

    • Borrower seeks to reduce the amount due

Donald J. Weidner


Associates home equity cont d6
Associates Home Equity Transfer(cont’d)

  • The Federal Trade Commission regulates “consumer credit contracts,” which must disclose:

    • “ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER . . . .”

  • The holder rule “strips the ultimate holder of the paper of its traditional status as a holder-in-due-course and subjects it to any potential defenses which the purchaser might have against the seller.”

  • A business may not so structure a consumer credit transaction to separate the consumer’s duty to pay from the seller’s duty to perform.

Donald J. Weidner


Associates home equity cont d7
Associates Home Equity Transfer(cont’d)

  • There was an issue whether the originator’s loan was a purchase money loan.

  • Under the FTC rule, a purchase money loan is a cash advance received be a consumer to purchase goods or services from a seller who:

    • 1. refers consumers to the creditor or

    • 2. is affiliated with the creditor by common control, contract or business arrangement.

  • There was also an issue whether the notepurchaser was affiliated with the originating lender or designated from the outset to be the notepurchaser.

Donald J. Weidner


Note 1 to associates home equity
Note 1 to Associates Home Equity Transfer

  • Nelson and Whitman, Real Estate Finance Law Sec. 5.30 (5th ed. 2007):

    • The FTC’s rule makes it an unfair trade practice for a seller of goods or services to finance a sale without including language that makes the lender subject to the consumer’s claims and defenses.

    • In the case of third-party financing, “the loan must have been made in connection with a sale of goods or services and a type of ‘close connectedness’ criterion must be satisfied”

      • “but it is much simpler and looser than the UCC’s.”

Donald J. Weidner


Note 1 to associates home equity cont d
Note 1 to TransferAssociates Home Equity (cont’d)

  • “The lender is brought within the rule’s ambit if the seller of the goods or services [1] refers consumers to the lender or [2] is affiliated with the creditor by [any] business arrangement.”

  • The FTC rule does not apply to financings or sales of interests in real estate—it only applies to sales of goods and services.

  • As of 2007, it only applied to purchases of $25,000 or less.

  • If the seller does not include the FTC notice in a note, its purchaser may qualify as a HDC.

    • Although Associates suggests that an assignee may be liable for a failure to include the required language.

Donald J. Weidner


Note 4 to associates home equity
Note 4 to TransferAssociates Home Equity

  • TILA, the Truth in Lending Act, subjects creditors to liability for violating its disclosure standards.

  • In certain loan transactions, debtors have a right of rescission.

  • Debtors may rescind by midnight of the third business day after the transaction for any reason.

  • The three-day “cooling off” period is extended if the creditor does not give the required disclosures.

Donald J. Weidner


Note 2 to merscorp inc v romaine p 493
Note 2 to TransferMerscorp Inc. v. Romaine (p. 493)

  • The Home Ownership and Equity Protection Act of 1994 amended TILA to address “high cost” home equity mortgage loans

    • Defenses that could be raised against the originator can be raised against the assignee of these high cost mortgages

    • Act does not apply to “residential mortgage transaction,” that is, a purchase money loan that enables a consumer to purchase a residence.

    • Special disclosures must be given

    • Certain terms are prohibited (negative amortization, certain balloons, etc.)

    • Certain conditions must be met to have a valid prepayment penalty

  • This is also an area of concern for the new Consumer Financial Protection Bureau.

Donald J. Weidner


West s f s a 701 04 701 04 cancellation of mortgages liens and judgments effective october 1 2007
West’s F.S.A. § 701.04 701.04. TransferCancellation of mortgages, liens, and judgments Effective: October 1, 2007

(1) Within 14 days after receipt of the written request of a mortgagor, the holder of a mortgage shall deliver to the mortgagor… an estoppel letter setting forth the unpaid balance of the loan secured by the mortgage, including principal, interest, and any other charges properly due under or secured by the mortgage . . . . Whenever the amount of money due on any mortgage, lien, or judgment shall be fully paid to the person or party entitled to the payment thereof, the mortgagee, creditor, or assignee… to whom such payment shall have been made, shall execute in writing an instrument acknowledging satisfaction of said mortgage, lien, or judgment and have the same . . . duly entered of record in the… proper county. Within 60 days of the date of receipt of the full payment of the mortgage, lien, or judgment, the person required to acknowledge satisfaction of the mortgage . . . shall send . . . the recorded satisfaction to the person who has made the full payment.