Monday, August 5, 2013

Another Ch. 7 Bankruptcy Trustee Successfully 'Strong-Arms' Lender Out Of Rights Under Homeowner's Mortgage Where Lack Of Proper Indorsement Rendered Promissory Note Unenforceable


  • A chapter 7 trustee sought to use his “strong arm” powers as a hypothetical judgment lien creditor, arguing that a mortgage could be avoided because the mortgagee (which was an assignee of the original mortgagee) was not entitled to enforce the note secured by the mortgage. Although the bankruptcy court did not avoid the mortgage lien, it did conclude that the trustee could sell the mortgaged property free of any claim by the mortgagee assignee.

    The debtors (the Dorseys) executed a note in favor of Popular Financial Services, LLC (PFS) that was secured by a mortgage given to Mortgage Electronic Registration Systems, Inc. (MERS) as nominee for PFS. The debtors executed an Affidavit of Conversion of Real Estate so that the mobile home encumbered by the mortgage was treated as real estate, and the mortgage properly perfected the lien on the mobile home.

    A couple of years later Vanderbilt Mortgage & Finance, Inc. (Vanderbilt) acquired certain installment loan agreements pursuant to a purchase agreement with the parent and an affiliate of PFS to purchase.  The schedule of contracts attached to the purchase agreement included a contract with one of the Dorseys, and the Dorsey note was identified as one of the notes that was transferred.

    Vanderbilt obtained possession of the Dorsey note, and MERS’ assignment of the Dorsey mortgage to Vanderbilt was recorded. However, unfortunately for Vanderbilt, there was no indorsement of the note from PFS to Vanderbilt, and PFS was not a party to the purchase agreement.
  • [I]n this case there was no dispute that the mortgage was valid and perfected. Rather the only challenge was to Vanderbilt’s right to enforce the note secured by the mortgage.
  • When asked for evidence that it had a right to enforce the note, Vanderbilt argued that the assignment of the mortgage and the purchase agreement were sufficient.
  • The assignment of the mortgage [] did not cure the problem. In this case the mortgage was granted to MERS as nominee for PFS. When it assigned the mortgage, it could only assign the rights granted by the mortgage, and could not transfer any right with respect to the note.

    In sum, Vanderbilt was not able to establish that it had a right to enforce the note, and therefore the mortgage. Consequently, the court concluded that the trustee was entitled to an order authorizing the sale of the property free and clear of any interests of Vanderbilt under the note and/or the mortgage.

    The court specifically did not determine that the mortgage was not perfected, “which means that it is a lien against the Real Property pending sale free and clear of liens, with liens to attach to the proceeds, pursuant to 11 U.S.C. 363(b) and (f).” It is not at all clear what this will mean when it comes time to distribute proceeds.

    PFS remained the only entity entitled to enforce payment of the note. However, it had assigned its rights under the mortgage. And in any event, the court noted in a footnote that the trustee had already obtained a default judgment against PFS holding that the bankruptcy estate had priority over the interests if any of PFS.

    Once again, the importance of paying attention to detail is brought home with a vengeance. The failure to include PFS as a seller under on the purchase agreement (and/or to indorse the Dorsey note to its parent or affiliate before the sale) caused Vanderbilt to lose all rights with respect to the note and the mortgage.

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