The Naked Truth

by Sal

It is all about standing you see, the plaintiff must have standing.

§ 104.10(b) Negotiability.

§ 104.10(b)(1) The Implications of Negotiability.

A note can be negotiable or non-negotiable, but this has nothing to do with whether the lender can sell (or assign) the note. Notes and mortgages are presumed saleable absent explicit language to the contrary.

This may strike borrowers as unfair because their right to assign their mortgage debt is usually hemmed in by a due-on-sale clause. Yet, the lender’s right to sell the loan isn’t subject to the borrower’s prior approval. The crucial difference between the debtor’s and creditor’s positions is that the creditor is assigning the right to receive money. The debtor is assigning the obligation to pay back a loan. Most creditors legitimately question a substitution of one debtor for another while few debtors care who pockets their monthly payments.

”Negotiability” means that the note can pass from the original creditor to a ”holder in due course” free of certain defenses the debtor may have had against the original creditor. ”To take free of a mortgagor’s defenses, the assignee must win on both issues. He must both hold a negotiable note and be a holder in due course.”n230 The theory is that negotiable notes are like money and should be freely transferable; loan purchasers shouldn’t have to worry about the possible invalidity of the paper.

The lost defenses are ”personal” ones, not ”real.” The ”real” ones survive the note being negotiated.

The Uniform Commercial Code lists some of the ”real” defenses.n231 They include, among others, infancy, duress, illegality of the transaction, and ”fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms.”n232 Among the ”personal” defenses: The original lender never actually made its promised loan or the debtor actually paid off the loan before her lender sold the note. The buyer of a negotiable note takes free of all ”personal” defenses.

The distinction between ”real” and ”personal” defenses parallels the difference between contracts that are voidable and those that are void. A void contract is really no contract at all — because of a forgery, for instance, or some other defense amounting to illegality or a lack of mutual assent to form a contract. A voidable contract is one which a party can elect to invalidate because, say, she was induced to sign it by a misrepresentation or because of a failure of consideration — the original creditor never disbursed all the loan funds the debtor is now being sued to repay.

In almost all states the holder in due course of a negotiable note secured by a mortgage takes the mortgage as well as the note free from defenses that the mortgagor would have had against the original mortgagee.n233 Lenders have generally carried the day in establishing legal protection for mortgages identical to that of the note. If the note is negotiable, so is the accompanying mortgage.

You can see how the consequences of negotiability can be harsh to the borrower. If the borrower never got the loan proceeds, or paid off the loan after the lender had sold the note to a ”holder in due course,” the borrower would still be liable for the face amount of the note. Moreover, generally speaking, the mortgage ”follows” the note so the present holder of the note can foreclose if the borrower doesn’t pay.n234 Like bankruptcy and limited liability for corporations, negotiability sacrifices a few deceived innocents for the sake of the many in the marketplace.

In the case of home loans, the benefits of negotiability can be measurable. Two authors compared the price of adjustable rate loans in Chicago, where they are held to be non-negotiable, with comparable adjustable rate loans in the District of Columbia, where they are legally negotiable. They found that the Chicago rates were higher and attributed the differential to the non-negotiability feature, concluding that borrowers are best served, too, by negotiability.n235

What can borrowers do to protect themselves? They could insist on seeing the note before making each payment and demand its return after making their final payment. Individual lenders might be able to comply with this request, but institutional lenders probably wouldn’t. They often store notes in remote locations and don’t record each payment on the back of the note as they did in days of yore. Because borrowers usually pay by check or by authorized bank account withdrawal, any borrower who asked to see the note each month would be regarded as an extremely odd duck.

Lenders sometimes ask borrowers to sign duplicate notes because they ”lost” the original. Borrowers should be wary of these requests. The lender could sell the note to someone who didn’t realize it was a duplicate and the borrower could end up having to pay the same debt twice if the original note was never destroyed.

Mortgage purchasers can protect themselves against unknown infirmities between the mortgagor and the original mortgagee by obtaining a statement signed by the mortgagor stating that he has no defenses to the enforcement of the mortgage. This document is variously called a waiver of defenses, estoppel certificate, no set-off certificate, or declaration of no defenses.n236 A certificate offers better protection than the holder-in-due-course doctrine because it protects the mortgage purchaser against both real and personal defenses.

An estoppel certificate signed by the maker of the note doesn’t protect the note purchaser against defenses or claims belonging to third parties. But the purchaser of the note may prevail against some third party claims if he has no notice of them and the note is non-negotiable for reasons other than the way it was negotiated.n237