Why They Sue as Holder and Not as Holder in Due Course

Parties claiming a right to foreclose allege they are the “Holder” and do not allege they are the holder in due course (HDC) because they are ducking the issue of consideration required by both Article 3 and Article 9 of the UCC. So far their strategy of confusion is working. They are directly or impliedly claiming they are the holder of the NOTE. They cannot claim they are the holder of the MORTGAGE, because no such status exists — they either own the mortgage encumbrance because they paid for it or they didn’t. If they didn’t pay for it, they cannot enforce it even if they still can enforce the note.

The framers of the Uniform Commercial Code (UCC) had a plan they executed in Article 3 and Article 9 of the UCC, as adopted by 49 states (Louisiana, excepted). They had four (4) problems to solve.

Consider two possible fact patterns, to wit: first the payee (“lender”) did in fact fund the loan putting cash in the hands of the borrower or paying debts on the borrower’s behalf; second, the payee (“originator”) gets the borrower to sign the note but fails or refuses or never intended to fund the loan of money to the borrower. In the first instance the note is evidence of a real debt whereas in the second instance the note is not evidence of a real debt.

This issue has been obscured by the fact that SOMEONE (“investors”) did fund a loan. The questions posed here is whether the investors received the protection of a note and mortgage and if they didn’t, what is the effect of advancing funds for a loan without getting the required evidence of the loan (Promissory Note) and without getting the collateral (Mortgage) that would ordinarily apply.

The Four Goals

First, the UCC framers wanted to encourage the free flow of commerce by making certain instruments the equivalent of cash. The Payee should be able to use such instruments in trading for goods, services, or credit. This is the promissory note — a written instrument containing an unconditional promise to pay a certain amount. The timing of the payments, the amount, the terms, the method of payment must all be obvious from the face of the note without reference to any outside evidence (parol evidence) that could reduce or eliminate the value of the note. If there are questions or conditions apparent from the face of the instrument, it fails the test of a negotiable instrument or cash equivalent. That means that Article 3, UCC doesn’t apply.

Second they wanted to protect the issuer of the note (the payor) from the effects of fraud, improper lending practices and other deprive lending policies and practices from any false claims for payment on the note. If the Payor (homeowner, borrower) received no benefit from the Payee but was somehow induced to sign the note in anticipation of receiving the benefit, then the Payee should not be able to collect from the Payor. This goal conflicts with the first goal only when the note is sold to an innocent third party for value who had no notice of the defective nature of the origins of the note (Holder in Due Course -HDC).

Thus third, in order to maintain the status of cash equivalent paper, they had to provide a mechanism in which an innocent third party was protected when they advanced money for the purchase of the note without having any notice of the borrower’s defenses. This would allow the buyer to sue the payor (borrower, debtor) and collect free of any potential defenses. The burden of the borrower’s claims would then fall on the borrower to collect damages against the original payee for wrongful acts. (Article 3, UCC, Holder in Due Course -HDC).

And in order to allow all such notes to be enforceable regardless of the circumstances of their origin, any party holding the note (“Holder”) can enforce the note if they have physical possession of the note, even if they paid nothing for it, as long as it is endorsed to them. But if they are a HOLDER and not a HOLDER IN DUE COURSE then they sue subject to all of the borrower’s defenses. The central issue is whether the Holder has paid for the note, in which case they would be in HDC status or if they did not pay for the note, in which case they enforce subject to all borrower’s defenses — including the allegation that the original payee never made the loan.

Fourth was the issue of forfeiture of collateral. This is considered the most extreme remedy under commercial law, analogous to the death penalty in criminal cases. (Article 9, UCC — secured transactions). It is one thing to preserve liquidity in the marketplace by protecting the investment of innocent third parties who purchase negotiable instruments from defenses — and quite another to cause forfeiture of home or property. Here again, the language of Article 3 is used for an HDC — i.e., an assignment of the mortgage is enforceable ONLY if the Assignor paid for it and had no notice of borrower’s defenses.

So they devised a structure in which a bona fide purchaser of the paper without notice of the borrower’s defenses would be called a holder in due course. They could sue the borrower despite wrongful behavior by the original payee on the unconditional promise to pay (the note). In the event of fraud in the sale of the note, the new owner of the note could sue both the seller (Assignor, endorser or indorser).

Then they considered the possibility of wrongful behavior: the issuance of such commercial paper would be a claim, but not negotiable paper — but if it was sold anyway it would be subject to the borrower’s defenses. This allows outside evidence (parol evidence) — which is to say that in this fact pattern, the promise to pay was conditional on the value and effect of the borrower’s defenses. The HOLDER of this instrument need not pay for the sale of the note and need not be ignorant of the borrower’s defenses. This holder could sue both the payor (borrower, debtor) and the party who transferred the note — depending upon the agreement that accompanied the transfer of the note by delivery and indorsement.

The party who accepts indorsement without paying for the note or even knowing of potential borrower defenses can still enforce the note, but unlike the the HOLDER IN DUE COURSE, the Payor (Borrower) could raise all defenses to the original transaction. The UCC Article 3 calls this a holder. A holder need not purchase the note and may have actual knowledge of the borrower’s defenses but can still sue the payor (borrower) for the principal amount due on the unconditional promise to pay.

I have noticed that most judicial foreclosures are either in rem (foreclosures only) or the claim on the note is that the Plaintiff is a “holder.” If they have possession and it is indorsed, they are probably a holder entitled to enforce the note. But the Defendant can raise all available defenses just as he or she would do if the fight was with the originator of the note execution. And nothing is a better defense than the distinction between being the originator of the note execution and the originator of the loan. The confusion over the term “originator” has allowed millions of foreclosures to be completed despite the fact that the “holder” neither paid for the note nor could they claim they were ignorant of the borrower’s defenses.

This confusion has led most courts to look at Article 3, UCC, instead of Article 9, UCC. Neither allow the claimant to sue on either the note or the mortgage without having paid for the assignment of the mortgage or delivery of the note, if the holder has actual notice of borrower’s defenses. In most cases the claimant either has the knowledge of the fraud and predatory practices at closing or is a made to order controlled company of a real party who has such knowledge.

In conclusion, borrowers should prevail in foreclosure litigation in situations where the claimant is unable to prove the identity of the actual lender who advanced funds, or where the claimant has failed to purchase the mortgage.

Based upon vast quantities of information in the public domain including investor lawsuits, insurer lawsuits and government agency lawsuits (all alleging FRAUD and mismanagement of funds) against broker dealers who sold mortgage bonds, it seems highly likely that in the 96% of all loans between 2001-2009 that are subject to claims of securitization three things are true:

(1) the securitization plan was never followed in most cases thus making the investors direct lenders without benefit of a note or mortgage and

(2) none of the parties “holding” paper possess any of the qualities of a party who could have standing to foreclose and

(3) claims still exist on the notes, even though they were not supported by consideration but those claims are unsecured and subject to all defenses that could have been raised against the originator.

Neil F Garfield, Esq.

For further information call 520-405-1688, or 954-495-9867. Do not use the above information without consulting an attorney licensed in the jurisdiction in which your property is located and who knows all the facts of your case. The above article is a general description and may not apply to your case.

7 Responses

  1. […] Consider two possible fact patterns, to wit: first the payee (“lender”) did in fact fund the loan putting cash in the hands of the borrower or paying debts on the borrower’s behalf; second, the payee (“originator”) gets the borrower to sign the note but fails or refuses or never intended to fund the loan of money to the borrower. In the first instance the note is evidence of a real debt whereas in the second instance the note is not evidence of a real debt. READ MORE… […]

  2. NG is wrong on this. The loans are not table funded, they are transacted in the name of the agent-bank, which are primarily funded by advances / warehouse facilities made available through investment banks and the FHLB’s / GSE corporate side, (not the trust side of their business).

    The loans are conveyed to the corridor through flow agreements, short term paper, fhlb advances etc… and the Depositor pays off these lines on the closing date of the pool in return for the collateral file.

    What everyone misses is – the depositor does not create the trust, and than pick the loans from the pool. The tranches are populated from the pool of available loans, the swap agreements, insurance etc.. are established via term sheets and the cash flow from the loans are finalized prior to the Trust being created.

    On the closing date, they light up the Trust, have the printer forward the certificates to the Depositor / Underwriter / Investment Bank, who fills firm orders acquired through investors that relied on the base prospectus (not the supplement prospectus, which typically amends the base prospectus and the PSA) for the benefit of the Master Servicer and Depositor.

    Meaning, the assets of the trust were chosen and conveyed prior to the creation of the trust. The entire trust was populated and than transferred to the Trustee for the benefit of the certificateholders.

    The payment for the assets are never made by the Trust, payment is made by the Depositor.

    I say we sue the printing companies. Had they not printed the certificates, none of this would have occurred.

    Get the point!

  3. and Gene, how about when the funding instrument is a fake cashier’s check from a foreign national bank on a purchase money mortgage?

  4. I would like to hear Gene’s response to Hman’s comments as well.

    Also, I would like to hear about those of us with refis. My loan was a refinance that “paid” off a loan with Citimortgage in 2004, the latter who “owned” the loan due to a merger with First Nationwide (I think that is the name of the former bank). Is it the experience of lawyers following the money trail that there was ever any consideration for even paying off the original loan in the situation of a refinance? This same refi “lender” “sold” the note to Freddie Mac a few months later, which was not recorded with the county (backdated, it appears 10 years later) until I stated in my complaint that no FC can occur in my state where all of the assignments have not been duly recorded.

    What about the refis? What are people discovering? Neil? Anyone?

  5. Gene,

    Question about your comment, “The regs tate thatt he table funder is the lender of record”. What reg are you referring to? I’ve searched high and low to see if table funding was legal. I believe under contract law that there must be a “meeting of the minds”. Isn’t that one of the essential elements of a contract to make it valid and binding? This would contradict that table funding was “legal”.

    Furthermore, I don’t think that equitable tolling period would start if the contract wasn’t valid to start. I think you would have a TILA claim since there was never a meeting of the minds.

    Please explain further as I am interested in knowing this info.

    thank you,

  6. NG does it again…..He writes “In conclusion, borrowers should prevail in foreclosure litigation in situations where the claimant is unable to prove the identity of the actual lender who advanced funds, or where the claimant has failed to purchase the mortgage.”

    All that is needed to defeat his claims is to present Fed Commentary regarding TILA and RESPA and table funded loans. The regs state that the Table Funder is the lender of record.

    But you will never hear him admit this…

  7. this is what you all need to read..

    Securitization Accounting under FASB 140
    The Standard Formerly Known as FASB 125, 2001

    this will explain all, no one can foreclose . no way no how

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