In contrast to other recent well-publicized decisions, a New Jersey state court has held that, in order to seek foreclosure of a mortgage that has been securitized, a lender need not demonstrate actual physical possession of the note memorializing the underlying debt. In Bank of America, NA v. Alvarado, BER-F-47941-08 (N.J. Super. Ct. Ch. Div. Jan. 7, 2011), the court held that the plaintiff was entitled to summary judgment striking the borrower's answer, dismissing her counterclaim and entering default, even though the plaintiff's predecessor, which was the original lender, had lost the note before transferring its interests to the plaintiff. The court found that this result was compelled by the doctrines of equitable/common law assignment and unjust enrichment.
The Alvarado decision marks a departure from prior holdings over the past year in which courts throughout the nation have been unwilling to allow lenders to enforce their security interests absent a demonstration of actual physical possession of the note. In Alvarado, the mortgagor acknowledged that she had executed a note and mortgage in favor of Washington Mutual Bank ("Washington Mutual") and had defaulted on the loan in 2008. She challenged the right of the plaintiff, Bank of America, NA ("B of A"), to foreclose, however, because Washington Mutual had lost the original note before transferring its interests. Notably, Washington Mutual had executed an Affidavit of Lost Note in 2006.
The court in Alvarado, like the courts in prior New Jersey decisions, Raftogianis and Kemp, started its analysis with the Uniform Commercial Code ("UCC"), as adopted in New Jersey. Specifically, the court looked to N.J.S.A. 12A:3-301, regarding persons entitled to enforce negotiable instruments. That provision sets forth that the following three categories of persons are entitled to enforcement: (1) the holder of the instrument; (2) a non-holder in possession who has the rights of the holder (i.e., one who has physical possession as the result of a legitimate transfer, but to whom the note has not been indorsed); and (3) a person not in possession of the note, but who was in possession of and entitled to enforce the note when the loss of possession occurred. The court in Alvarado acknowledged the Kemp decision, but found that the bankruptcy court had not considered the merits of the lost-note claim.
Though the UCC was amended in 2002 to eliminate the requirement that a lost note could be enforced only by one who had been in possession at the time of the loss, New Jersey never adopted that amendment. Accordingly, the court in Alvarado looked to pre-amendment cases interpreting section 3-301, which were divided in their analysis. Ultimately, the court found that to allow the borrower to prevail would lead to the inequitable result that no one was entitled to enforce the note and that the borrower would receive a windfall.
The court thus looked to decisions from courts outside of New Jersey that had found that a lost note could be enforced by one other than the party that had lost it. The UCC provides that, where it is silent on an issue, courts may look to common law principles to supplement the UCC. N.J.S.A. 12A:1-103. The UCC is silent on the issue of assignability of rights arising under a lost promissory note. Accordingly, courts finding that a successor was entitled to enforce a lost note relied on either the common law doctrine of assignment or the doctrine of unjust enrichment. The court in Alvarado relied upon both.
The court noted that the defendant had received the benefit of the loan from Washington Mutual and that to allow her to go without repaying it would constitute unjust enrichment. The court also noted that B of A was the assignee of Washington Mutual's rights and that Washington Mutual had intended to transfer all its rights to enforce and collect the debt and debt instruments. Even though there was a colorable argument that the provisions of the UCC did, in fact, preclude the "legal remedy of assignment," the court found that New Jersey courts will recognize an "equitable assignment when the equities of a circumstance so compel."
Finally, the court addressed the UCC requirement that, to find a lost note enforceable by a particular plaintiff, the court must determine that the defendant is adequately protected from future claims of enforceability by other parties. The court determined that defendant Alvarado was adequately protected, given the amount of time since the loss of the original note (which had occurred in 2006), the fact that it was lost almost immediately after execution, and the fact that no other person had stepped forward to make a claim on the note. In any event, the court opined that should such a situation arise, B of A was obligated to intervene and defend so that the borrower would not be held liable twice on the same obligation.
The Alvarado decision marks an important step in New Jersey courts' recognition of the rights of lenders not in possession of an original note. Lenders should recognize, however, that Alvarado addressed the specific circumstance of a lender seeking to enforce a note that was lost by the original lender. Accordingly, the decision (and the UCC provision it interprets) may be narrowly construed by courts going forward. It follows that the best practice in New Jersey is still to secure actual physical possession of an indorsed note prior to filing a foreclosure complaint. Should the note not be available, lenders should hope that other courts will follow the example of the Alvarado court.
Day Pitney Partner Joy Harmon Sperling will present on a panel entitled "How to Navigate Debt Collection Restrictions, Manage Liquidity Challenges, and Reconcile Opposing Demands from Consumers and Investors as a Servicer," at the 27th American Conference Institute National Forum on Residential Mortgage Regulatory Enforcement and Litigation.
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