The Promissory Note Defense, Research Paper Example

Background

Before discussing the “produce the note” defense, it should be made clear exactly what the “note” is. It is a promissory note and is pretty much exactly what it sounds like: the promise to pay a certain amount of money; a rate of interest (if any); exactly how the note should be paid if specific steps are required; and the consequences for failure to pay (to default, as on a mortgage). Although the note is a negotiable instrument, payment is not negotiable. By contrast, a non-negotiable promissory note means that the holder (any holder) may not be in a position to collect money due if the terms of the note were not kept by the payee. In other words, a non-negotiated note is a contract (Missouri). Note as well that a promissory note is not an “IOU” either, which typically is not a negotiable instrument, stating only what is owed without conditions.

The key point that makes a negotiable instrument like a promissory note (or bill of exchange[1]) especially useful for mortgages is that it can be transferred to a holder in due course without the knowledge of the payor, although the terms of such a transferal may be set out as part of the note itself. Negotiation is the term for that transferal. There are two modes of negotiation reflecting the two basic kinds of promissory notes: bearer and on demand. In the former case, whoever hasthe note owns the note. By contrast, on-demand notes are transferred by endorsement, like a check. So one can see that promissory notes have a basic legal and practical similarity to cash and credit, checks being themselves a kind of credit.

The ability to transfer a note while retaining its financial obligation is what makes such notes and bills useful substitutes for money. They were used as such throughout much of the pre–Civil War west (Billings), and were, as one might imagine, the instrument for much abuse in the “flush times” of that era (Baldwin) — and also in the even more flush times of our own era; specifically the mortgage-bubble begun in the Clinton administration, which mandated loans to subprime borrowers; and that ended during the last months of the George W. Bush presidency.

The Defense

In the mortgage field, when a promissory note is used as security for a household mortgage, it is often taken for granted that the note will be sold to a third party, pooled, and sold off to investors, a process called securitization. The bank collects a fee and is free of default-risk. It might be thought that for someone expecting to live in the purchased property indefinitely and to eventually pay the mortgage off, it would make little difference who held the note. However, in the bust of the post-2008 years, many legitimate debtors, struggling in a major recession to keep paying off their debt by renegotiating the terms of the mortgage (to reflect the new post-bubble value of their property) such an assumption proved to be incorrect. Banks began to call in their debts wholesale, a bit like the way a human body, going into shock following trauma, drains blood from its extremities in order to keep as much blood as possible available for the vital organs. Good debtors often found themselves lumped in with the bad ones.

With the wave of foreclosures that began to take effect after 2008, the “produce the note” defense became vital for more and more homeowners facing loss of housing they had borrowed money to buy (and increasingly, as the housing bubble began to rise, to flip for a quick profit). However, a mortgage is not a promissory note, as many who take out mortgages more or less assume. Instead, the mortgage is the security behind the note. This is more than a technicality: if the note cannot be paid off, then the security — the house or land — is claimed by the lender. But if the mortgage has been bottom-dealt to other holders for a fee, the promissory note itself can (and sometimes does) get lost in the shuffle. After 2008 this began to happen often enough to provide some hope for homeowners facing abrupt foreclosure, particularly in states like Florida where mortgage-shuffling was pervasive.[2] It should be noted that state laws tend to govern such matters as promissory notes, so the state of residence will be one of the most important of factors bearing on a homeowner’s decision to contest a foreclosure using a produce-the-note defense. (Representative Marcy Kaptur (D-OH) introduced the federal-level Produce the Note Act of 2013, however it is apparently stuck in committee (Kaptur)).

Whether a homeowner will want to use a produce-the-note defense will probably depend on whether the mortgage holder is suing the homeowner, or whether the homeowner is considering such a lawsuit against the mortgage holder. The legal terms are judicial foreclosure, which takes place when the holder (probably an institution) sues the homeowner to force payment or begin foreclosure. Non-judicial foreclosure takes place when a lawsuit to obtain foreclosure is unnecessary (Nolo.com). In such cases, the “mortgage” may be a deed of trust, in which a third party — a title company — acts as escrow. Presumably in exchange for the risk, deeds of trust provide a right of redemption, allowing a foreclosed homeowner a window of opportunity to pay off the debt and reclaim the house. (That window may be as short — or long — as a year.) In such non-judicial mortgages, however, the homeowner must take the initiative to sue to defend title and stop foreclosure. In case of judicial foreclosure, a produce-the-note defense should certainly be considered. (There would seem to be little reason not to use it if there is any reasonable doubt that the mortgage holder may not in fact hold the note.) However, it should be understood that possession of the note itself is not always required. A certified or at least clearly untampered-with photocopy of the note may suffice, as might a lost note affidavit, in which the foreclosing party swears that the note has been lost, etc., and that they are in fact the true and rightful owner of the note. None of these alternatives are guaranteed, however, and that works both ways: if the homeowner is considering a lawsuit (in the case of a non-judicial foreclosure), then the chances of succeeding must be weighed along with the cost of legal fees incurred in the course of the lawsuit. Courts will not grant a favorable outcome where the lost note defense is seen as a last-ditch effort that has the effect of wasting the court’s time and money. A homeowner facing foreclosure must confront the question as to whether there really is any legitimate doubt as to rightful ownership of the note. If your mortgage was granted as part of an assembly-line liar loan that has since been sold-off as part of a securitized investment and you actually do not have the financial ability to pay — if you “bought” the property in order to flip it and would have flipped it had the economy not tanked — then walking away from the property might be the wiser option. If your mortgage was legitimate, and you do now in fact have the resources to pay and you have reasonable expectation of keeping those resources — usually as represented by a steady job, either yours or your spouse’s — that is another matter entirely. In such a case, if the bank in fact does not have proof of ownership, a full-court press may be justified. There have been many such instances and more will probably come to light, fueling yet more reform legislation (Corkery) that the financial system will eventually circumvent.

Before buying a residential property, learn whether the deal is governed by a deed of trust or a mortgage and whether it will be sold off. Then learn whether you can afford it.

Works Cited

Baldwin, Joseph. Bartleby.com: Flush Times of Alabama and Mississippi, 1853. Website. 8 May 2014.

Billings, Roger. Abraham Lincoln, Esq.: The Legal Career of America’s Greatest President. Lexington: The University Press of Kentucky, 2010. Book.

Bouvier, John. A Law Dictionary. 1856. Website. 3 May 2014.

Corkery, Michael. Dealbook. 14 April 2014. Website. 2 May 2014.

Missouri, U. “http://www.law.missouri.edu/.” 5 May 2013. Freyermuth/ref/spring2013/presentations2013/class26.pdf.Website. 7 May 2014.

[1] From a nineteenth century book entitled A Law Dictionary: “Most of the rules applicable to bills of exchange, equally affect promissory notes. No particular form is requisite to these instruments; a promise to deliver the money, or to be accountable for it, or that the payee shall have it, is sufficient” (Bouvier).

[2] As of 2013, Florida requires increased levels of documentation before a foreclosure will be granted.