The Heirs of Karl Lleywellyn: the PEB Report, Green Cheese, and the...

As I noted in the previous posts on this thread (here and here), I think the Permanent Editorial Board for the UCC's report on the enforceability of mortgage notes is simply irrelevant because it deals with negotiable notes, and virtually all mortgage notes today are not negotiable. But even if the notes were negotiable, there are still some further flaws in the report itself.

I'm not going to attempt a complete catalogue. But I will point out some two highlights:  the failure to address the interaction of the UCC with other law, such as real property law and trust law and agency law; and the failure to address the evidentiary issues that are at the heart of the foreclosure documentation problems.  

(1) Failure to Address the Interaction of the UCC with Other Law. The report puports to deal with the enforceability of the negotiable mortgage note under the UCC. While that is the extent of the PEB’s mandate, it is also sort of ridiculous, which is one reason why the report should never have been issued. Courts are never dealing with the enforcement of the note just under the UCC. Instead, the question is the foreclosure of the mortgage, which may require reference to the enforceability of the note (it’s actually done as an in rem action in Delaware, without reference to the note), but there are many other areas of law that also come into play, including agency and trust law. The outcome might by X under the UCC alone, but when the UCC interacts with other areas of law, the outcome might be completely different. The result is a fundamentally misleading report (on an irrelevant topic). 

The report is also very selective in what it discusses and doesn’t. It discusses the parts of the UCC and official commentary (which is not law, but should at least bind the PEB) that it likes in order to get the “and therefore the banks should win” outcome. For example, the report makes a big deal out of the ability of a transferee who is not a holder (because there is no endorsement) to enforce a note. The point of the report is that lack of endorsements aren’t fatal. Maybe not under Article 3 of the UCC, but they are if a pooling and servicing agreement (PSA) supplements or supplants the UCC, as it is permitted to do per UCC 1-102(3) (current version)/ UCC 1-302 (revised version). No mention of this little problem, however. By framing the issue in UCC-only terms the PEB is able to engineer the desired outcome. But that's highly misleading as the real world outcomes depend on other areas of law as well as the banks' ability to meet the requisite evidentiary showings. 

(2) Evidentiary Issues.  The report doesn’t address what’s really the nub of the matter when enforcing mortgage notes (negotiable or otherwise)—the evidentiary problems. The issues in courts aren’t so much confusion about what the law is, but that the banks are dancing around the law because they don’t have the evidentiary basis to prevail on any of the grounds that the PEB sets forth. All the law in the world won’t help if you don’t have the facts on your side.

If the foreclosing banks were “holders” in the UCC Article 3 sense (which would require the notes to be negotiable, btw), there’d be no issue here. The problem is that the foreclosing banks are generally are not holders or at least not able to show that they are. Instead, they have to rely on other statuses to enforce the notes—lost note status (the dog ate my note!) or nonholder with rights of a holder. I’ll spare you my comments on the lost note issue. But there’s an important point to make about the nonholder with the rights of a holder. The PEB report conveniently fails to mention a line in the official comment 2 to UCC 3-203 about the ability of a transferee who is not a "holder" to enforce a negotiable note: 

Because the transferee's rights are derivative of the transferor's rights, those rights must be proved. Because the transferee is not a holder there is no presumption under Section 3-308 that the transferee, by producing the instrument is entitled to payment. (emphasis mine.)

So what does this mean as an evidentiary matter? The transferee needs to prove (1) that the transferor was a holder at the time of the transfer and (2) that the transferor delivered the note to the transferee and (3) that the transfer was for the purpose of giving the transferee the right to enforce the instrument. I have never seen a case in which a foreclosing party claims to be a nonholder in possession of the note and even attempts to prove (1) or (3). Proving (2) without proving both (1) and (3) doesn't do anything. In other words, 3-203 is requiring that the chain of title, including the timing of the transfer. Good luck showing that. No discussion of this in the PEB report—wouldn’t want to signal to courts that the UCC actually sets up some real evidentiary roadblocks to note enforcement if taken seriously. So we have two levels of deception. First, the pretense that the law of negotiable notes is what matters and second that the law of negotiable notes is simply "banks win" rather than bank wins if it meets the evidentiary requirements of law. 

Similarly, with the discussion of the ability to transfer a note under Article 9 of the UCC, the report glosses over some huge evidentiary hurdles: to prove a transfer under Article 9, you have to prove that value was given (should be easy enough), that there is an authenticated sale agreement (a problem in the Ibanez case in the Massachusetts Supreme Judicial Court), that it describes the collateral (query what sort of description is needed, again a problem in Ibanez), and that the seller has rights in the collateral.

I think this last point is actually a huge problem because if there has been a chain of transfers depending on Article 9, rather than Article 3 endorsement, the last party in the chain has to prove up the title of all of the prior transferors. It’s not clear to me how easily that can be done, especially if some of the prior transferors have gone bankrupt, etc. The biggest and often overlooked benefit of negotiation is an evidentiary benefit. The zipless Article 9 process loses that benefit.

And that zipless Article 9 process will be the subject of our next post.