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Legal Issues On Enforcement Of Promissory Notes

The foreclosure fraud debacle raises a number of legal issues, ranging from perjury to consumer fraud. All of the issues revolve around one central legal issue. Who has the right to foreclose? I address the basic law, and then offer an example to explain why it matters.


Let’s assume a couple buys a house with a down payment a loan from Argent Mortgage Co. The borrowing is evidenced by a promissory note, and the promissory note is secured by a mortgage on the home. State law governs promissory notes. Article 3 of the Uniform Commercial Code is the basic law. Every state has adopted Article 3, some with minor variations. The citations vary from state to state, but generally track the UCC sections. References are to model UCC provisions. This link gives you Article 3.

Basic Negotiable Instrument Law

§ 3-301 says that the person entitled to enforce a note is (a)(1) the holder, (a)(2) a nonholder in possession of the note who has the rights of a holder, or (a)(3) a person not in possession but who has the right to enforce because the note is missing (§3-309) or another section which isn’t likely to apply.

§ 3-201 defines negotiation as transfer of possession to a person other than the issuer of the note. The transferee is a holder. If a note is payable to a specific person, negotiation requires both transfer of possession and indorsement by the named person. If the instrument is payable to bearer, transfer of possession is enough.

A note is payable to bearer if it is made out to bearer, or if it is indorsed in blank. In our example, the couple signed the note, making it payable to Argent Mortgage Co. When Argent Mortgage Co. transfers the note, it might endorse it as follows:

Pay to Bank of America, N.A.
Argent Mortgage Co.

Its: [title of authorized person]

In this example, Bank of America is an identified payee, so to transfer the note, Bank of America has to indorse the note as well as transfer possession.

The note could have been endorsed:

Pay to:____________________
Argent Mortgage Co.

Its: [title of authorized person]

That is an indorsement in blank, and the note can be negotiated by transfer of possession.

With this background, we can see who is entitled to enforce the note. In the first case, only Bank of America can enforce the note. In the second case, any person in possession of the note can enforce it.

That covers the provisions of § 3-301(a)(1).

Turning to § 3-301(a)(2), there is no definition of a “nonholder in possession of the instrument”. In fact, that looks like a contradiction. We get the answer in the Official Comment to § 3-301:

A nonholder in possession of an instrument includes a person that acquired rights of a holder by subrogation or under section 3-203(a). It also includes any other person who under applicable law is a successor to the holder or otherwise acquires the holder’s rights.

Subrogation is not likely to be applicable. However, §3-203(a) is likely to be applicable, and here are relevant parts.


(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.

(b) Transfer of an instrument, whether or not the transfer is a negotiation, 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.

(c) Unless otherwise agreed, if an instrument is transferred for value and the transferee does not become a holder because of lack of indorsement by the transferor, the transferee has a specifically enforceable right to the unqualified indorsement of the transferor, but negotiation of the instrument does not occur until the indorsement is made.

Suppose there is a note with a named payee, in our example, the note payable to Bank of America. Bank of America transfers the note to Deutsche Bank, Trustee for RMBS 1234, but doesn’t endorse it. Deutsche Bank, Trustee is not a holder. However, under the provisions of § 3-203(c), Deutsche Bank, Trustee is entitled to get an endorsement from Bank of America (unless the parties agreed otherwise, which didn’t happen). In the mean time, Deutsche Bank, Trustee, is entitled to enforce it by virtue of § 3-203(b), so long as it can produce the actual note.

Why this matters

When promissory notes are securitized, it would be a disaster if the makers of the notes, the homeowners, were able to assert defenses against the new owner. For our example, suppose that the borrowing from Argent Mortgage was founded on consumer fraud. The RMBS doesn’t want to get into a lawsuit over consumer fraud. To protect themselves, securitizers structure transfers to insure that the trust holds notes as a holder in due course. That way, the trust is not exposed to claims of the homeowner.

Holder in due course status is governed by § 3-302. A transferee obtains that status only if the promissory note a) is negotiated to a person who b) takes for value, in good faith, and without knowledge of the defenses of a party.

In the last case above, Deutsche Bank, Trustee, is not a holder in due course, because the note has not been negotiated, merely transferred. § 3-302 says that a person can only be a holder in due course if at the time the note is negotiated, the transferee has no notice of defenses of any party to the note.

Suppose Deutsche Bank, Trustee, tries to enforce the note. The homeowners respond by asserting that Argent Mortgage cheated them in some way into doing the deal, and demanding that Deutsche Bank, Trustee, produce the note.

Deutsche Bank, Trustee, suddenly realizes that this note has only been transferred, not negotiated. It rushes to Bank of America, and demands an indorsement, which Bank of America provides. That is the negotiation of the note. However, at the time of negotiation, Deutsche Bank, Trustee, takes the note with notice of the defense to the note, and cannot be a holder in due course. The homeowners can pursue their claims against Deutsche Bank, Trustee the same way they could against Argent Mortgage.

Suppose that Argent Mortgage didn’t endorse the note to Bank of America, but merely transferred it. Bank of America can’t negotiate the note without the signature of Argent Mortgage. However, if Argent Mortgage is out of business, there is no one who can indorse. No one is a holder in due course, and the homeowner has all defenses against both Bank of America and Deutsche Bank, Trustee.


Banksters say it doesn’t matter, because someone owes money. Legal rights matter. HUD Secretary Shaun Donovan) thinks it’s enough for the banksters to "fix" the problem, presumably by reconstructing paperwork as David Axelrod put it. Whose side is the Administration on?

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