Technology and Professional Responsibility: NewTrak and Required Due Diligence -“Plausible Deniability” collides with reality

The Judge authored a 58 page opinion ”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” Opinion, p. 30.

where, as here, the debtor contests the relief sought, the flaws in the automated process become apparent. At this juncture, an attorney must cease processing files and act like a lawyer. That means she must become personally engaged, conferring with the client directly and abandoning her reliance on computer screens as an expression of her client’s will. This did not happen in this case until the Court became involved. It should not have taken judicial intervention to bring the Claim Objection to its conclusion.
Opinion, p. 32 (emphasis added).


Here follows a summary and analysis of the Judge Sigmund opinion by Texas Bankruptcy Attorney Stephen Sather

SUNDAY, APRIL 26, 2009

Pennsylvania Judge Writes Epic Opinion on Technology and Professional Responsibility

Technology has dramatically changed the practice of law. Thanks to Westlaw and Lexis, it is no longer necessary to keep large expensive libraries. PACER and ECF have made court filings and filing documents available 24/7. I recently observed a case where the parties used GoToMeeting to handle thousands of pages of exhibits electronically. All of these developments have made the practice of law more efficient. However, a recent opinion from Judge Diane Weiss Sigmund highlights that professionals must be masters of the technology rather than being mastered by it. In re Taylor, No. 07-15385 (Bankr. E.D. Pa. 4/15/09).

The Taylor case started with a simple question that comes up frequently in consumer bankruptcy cases: Why couldn’t the creditor’s lawyer get a payment history? The answer given to this question prompted Judge Sigmund to launch a one year investigation into the technology behind the case and how it was being used and to award some very creative sanctions. The Judge authored a 58 page opinion ”to share my education with participants in the bankruptcy system who may be similarly unfamiliar with the extent that a third party intermediary drives the Chapter 13 process.” Opinion, p. 30.

What Happened

Taylor involved a chapter 13 filing to try to keep a house. Two firms appeared on behalf of HSBC, the mortgage holder. A national firm filed a proof of claim, while a local firm filed a motion for relief from stay and responded to an objection to claim. All three documents were defective. The proof of claim attached the wrong mortgage and listed the wrong payment amount. The motion for relief from stay recited that the debtors had failed to make their post-petition payments for three months, when in fact they had been making the payments, but at a lower amount due to a dispute over flood insurance. According to the Court, “at the time the Stay Motion was filed, the Debtors were short $360 for payments more than 60-days overdue, a fact not clear from the canned pleading prepared by a paralegal from New Trak screens. The Debtors were charged $800 for the cost of the motion.” Opinion, p. 14. The motion also recited that the debtors had no equity in the property which the attorney later attributed to being part of a boilerplate form. The response to the objection to claim said that the claim was just fine when it was not.

The Debtor’s attorney did not do much better. She filed a late response, which incorrectly stated that the debtors had made all of their payments but they had been returned by HSBC. The Debtor’s attorney also failed to respond to requests for admission tendered with the motion, incorrectly believing that her response to the motion was sufficient.

Upon receiving the Debtor’s attorney’s response, HSBC’s local counsel continued the hearing for further investigation. The Debtor’s lawyer then filed an amended response, which included copies of the checks for the months of September through January with both front and back and the checks for February and March with just the front. The amended response alleged that the payments for September through March had all been made. As it turns out, the reason that there were only copies of the front side of the February and March payments was because the Debtor’s counsel was still in possession of these checks which had not yet been tendered. Debtor’s counsel erroneously mailed these checks to the person at HSBC’s attorney’s office who handled Sheriff’s Sales rather than to the Bankruptcy Department. The person in the Sheriff’s Sale department sat on the checks and did not inform the Bankruptcy Department that they had been received. The Debtor’s counsel also requested a payment history.

On May 1, a young associate appeared for HSBC and insisted on prosecuting the motion even though he had been provided with proof of payments. The young attorney sought to proceed based on the deemed admissions even though he knew they were not accurate. The court denied the motion and instructed the debtor to escrow the disputed flood insurance premiums while the parties worked through the issue.

One month later, the parties appeared on the claims objection and things rapidly escalated. The young associate (he had been licensed a few months at the time) stated that he could not get a payment history from his client. He explained that he had submitted a request for a payment history through an electronic system, but that he was forbidden to speak directly with the client. This statement caused the Court to issue a show cause order.

In response to the Court’s Show Cause Order, HSBC retained new counsel and the problem with the claim was quickly settled. As noted by the Court, “What could not be accomplished for six months through the use of electronic communication was finalized in an hour the old way, by people sitting down with all relevant information and talking to each other.” Opinion, p. 19.

While the contested matters were quickly settled, the Court was not satisfied. It launched an inquiry which brought the technology center stage.

The Technology and Professional Responsibility

The technology involved was the NewTrak system developed and operated by Lender Processing Services, Inc. f/k/a Fidelity Information Services, Inc. To its credit, LPS was “extremely cooperative” with the court’s inquiry and “provided a detailed demonstration of how NewTrak works in a hypothetical case.” Opinion, p. 9, n. 15. As a result, the Court had a substantial knowledge base to draw on when writing her opinion.

NewTrak is an automation system which allows lenders and attorneys to communicate with each other. The lender uploads its information onto the system which then generates a referral to an attorney on the approved list. The attorney receives the information and generates the proof of claim, motion for relief from automatic stay or other pleading. The system also allows the attorney to request information from the client by opening an issue on the system. Another system called the mortgage servicing platform handles routine mortgage servicing. According to LPS, it was used by 39 of the 50 largest banks in 2007 and processed approximately 50% of the loans in the United States.

While NewTrak provides a flow of information between attorney and client, it is not meant to prohibit direct contact between the parties. The Default Services Agreement specifically provides that “The Firm will never be prohibited from directly contacting any client where, in the professional opinion of the Firm such contact is necessary.” Opinion, p. 34, n. 45. As a result, the agreement contemplates that the Firm will exercise professional judgment. However, the Court found that when an attorney mechanically uses the system “the attorney abandons any pretense of independent judgment to the greater goal of expeditious and economical client service.” Opinion, p. 31.

The Court contrasted the benefits of using the technology with its pitfalls when a matter is not routine.

It is a regrettable reality, especially in this economic climate, that many homeowners are defaulting on their mortgages. While bankruptcy affords an opportunity to save the family home through a Chapter 13 plan that stretches the payments of mortgage arrears, it also requires debtors to maintain current payment on their mortgages. (citation omitted). This obligation is beyond the capability of many debtors who use a bankruptcy to forestall the inevitable. It seems reasonable that a mortgage lender should be able to avail itself of economic and expeditious means of collecting defaulted loans through the use of technology and delegation of tasks to lower cost labor. In many cases, the motions are granted by default, the debtors, or often more accurately their attorneys, filing no answer or making no appearance, where there is simply no defense to the relief sought. However, where, as here, the debtor contests the relief sought, the flaws in the automated process become apparent. At this juncture, an attorney must cease processing files and act like a lawyer. That means she must become personally engaged, conferring with the client directly and abandoning her reliance on computer screens as an expression of her client’s will. This did not happen in this case until the Court became involved. It should not have taken judicial intervention to bring the Claim Objection to its conclusion.
Opinion, p. 32 (emphasis added).

In this case, the court found that professional judgment was not used.
The attorney for the national firm which filed the proof of claim testified that he reviewed only a representative sample of 10% of the claims which were electronically signed with his name. He did not review the specific claim in this case and as a result, did not find the mistakes in it.

The president of the local firm which utilized NewTrak testified that he delegated the administrative aspects of the firm’s practice and was unaware of how NewTrak worked.

The head of the bankruptcy section of the firm electronically signed all of the pleadings in the matter, but delegated all of the court appearances to an attorney who had been licensed for only one month when the initial pleading was filed. The court found that the head of the bankruptcy section failed to supervise the young attorney and asked the rhetorical question, “Could it be with ten lawyers and 130 paralegals and processors, a young attorney is expected to figure it out himself?” Opinion, p. 42.

The Court also found that the client had restricted the firm’s authority.

The Udren Firm’s authority from HSBC allowed them to take only three actions: (1) seek a continuance; (2) settle with Motion with an agreement for a six month maximum cure of the mortgage arrears with an agreement for stay relief upon certification of default of any future payment; and failing either of the foregoing; (3) press the motion. (citation omitted). No consultation with HSBC was expected nor occurred during the pendency of the contested matter.
Opinion, p. 37, n. 49.

Sanctions

The Court found that several parties to the case had violated their obligations under Rule 9011, including the obligation to make reasonable inquiry. However, the Court was also mindful that sanctions should be “limited to what is sufficient to deter a repetition of such conduct or comparable conduct by others similarly situated.” Rule 9011(c)(2). As a result, the Court granted some very creative relief.

As to the Udren Firm, which acted as local counsel, the Court found that the expense of having to hire counsel and defend itself and the productive time lost in attending to the matter was punishment enough. However, the Court devoted additional attention to the specific lawyers from the firm.

The Court found that the head of the Udren Firm’s bankruptcy section “may be so enmeshed in the assembly line of managing the bankruptcy department’s volume mortgage practice that she has lost sight of her duty to the court and has compromised her ethical obligations.” Opinion, p. 52. The Court ordered her to obtain 3 credits of CLE in professional responsibility/ethics in addition to her regular requirements.

The court declined to award sanctions against the young associate, finding that “I believe these proceedings have been very hard on this young lawyer and while lack of experience is not a defense to a Rule 9011 violation, I suspect that he has learned all that he needs to learn without protracting this unfortunate time in his nascent career.” Opinion, p. 52.

The Court found that the head of the firm “sets the tone and establishes its culture. He notes his firm’s reliance on NewTrak and other such aids as essential to the economic structure of the law practice. However, he had little familiarity with the actual operation of NewTrak and did not appear to get involved in the ‘weeds’ of the bankruptcy practice.” Opinion, pp. 52-53. The Court found this lack of involvement to be troubling and ordered relief accordingly.

Mr. Udren may not be aware of the questionable practices imposed by his firm’s acquiescence to NewTrak and how little legal judgment is employed as a result or he may be aware and find it acceptable. To examine these practices in light of extant ethical obligations, I will direct him to obtain training in NewTrak and spend a day observing his bankruptcy attorneys, paralegals, managers and processors as they handle referrals. Since policy emanates from the top, I will also order Udren and (the head of the bankruptcy section) to conduct a training session for all members of the bankruptcy department in the appropriate use of the escalation procedure and the requirements of Rule 9011 with respect to pre-filing due diligence.
Opinion, p. 53.

The Court did not award sanctions against the national firm which prepared the proof of claim, but not because she found their conduct appropriate. The Court found that the record had not been fully developed with regard to this party, that the practices were national in scope and that the U.S. Trustee was investigating the firm. As a result, the Court left it to another day and another court to address these issues.

The Court found that some of the problems in the case resulted from the Udren firm’s reluctance to contact its client directly and found that other firms used by HSBC might be under the same impression. As a result, the Court ordered HSBC “to prepare and transmit by mail and e-mail a letter to all the Network Firms outlining the escalation policy and encourage its use consistent with the Rules of Professional Conduct. HSBC should also advise the Network Firms that use of direct contact will not reflect adversely on the firm.” Opinion, p. 55.

The Court did not sanction LPS.

Based on the record, I find that sactions against LPS are not warranted. While it does appear from the limited screens that have been introduced in this case, that LPS’ involvement goes beyond passing data through their automatic system, I cannot conclude that it imposed restrictions on the Udren Firm’s handling of this case. (citation omitted). The Udren Firm entered into a contract with Fidelity which it viewed as advantageous to the business relationships with its mortgage lender clients and presumably its bottom line. As attorneys, the Udren Firm understood an attorney’s obligations under Rule 9011 to investigate and took a lesser approach. While NewTrak prescribed that approach, LPS did not dictate how they would handle cases referred to them when problems with the procedure were apparent. By misusing the resources made available to them, the Udren Firm, not LPS, was responsible for the Rule 9011 deficiencies in this case.
Opinion, pp. 55-56.

CONCLUSION

Judge Sigmund’s remarkable opinion demonstrates that she is no Luddite. Her opinion focuses on the need to exercise professional judgment in conjunction with technology rather than mindlessly bashing the technology itself. In her conclusion, she stated:

My research has disclosed no other published opinion that explains the NewTrak process that is utilized by so many consumer mortgage lenders seeking relief in bankruptcy cases. I have attempted to share my education in this Opinion. Finally, it is my hope that by bringing the NewTrak process to the light of day in a published opinion, system changes will be made by the attorneys and lenders who employ the system or at least help courts formulate the right questions when they have not. While NewTrak has many features that make a volume business process more efficient, the users may not abandon their responsibility for fairness and accuracy to the seduction of electronic communication. The escalation procedures in place at HSBC and the Udren Firm existed on paper only. When an attorney appears in a matter, it is assumed he or she brings not only substantive knowledge of the law but judgment. The competition for business cannot be an impediment to the use of these capabilities. The attorney, as opposed to a processor, knows when a contest does not fit the cookie cutter forms employed by paralegals. At that juncture, the use of technology and automated queries must yield to hand-carried justice. The client must be advised, questioned and consulted. Young lawyers must be trained to make those judgments as opposed to merely following the form manual. Until they are capable of doing so they should be supported and not left to sink or swim alone in an effort for the firm to be more profitable by leveraging the cheapest labor.

At issue in these cases are the homes of poor and unfortunate debtors, more and more of whom are threatened with foreclosure due to the historic job loss and housing crisis in this country. Congress, in its wisdom, has fashioned a bankruptcy law which balances the rights and duties of debtors and creditors. Chapter 13 is a rehabilitative process with a goal of saving the family home. The thoughtless mechanical employment of computer-driven models and communications to inexpensively traverse the path to foreclosure offends the integrity of our American bankruptcy system. It is for those involved in the process to step back and assess how they can fulfill their professional obligations and responsibly reap the benefits of technology. Nothing less should be tolerated.
Opinion, pp. 57-58 (emphasis added).

POSTED BY STEVE SATHER AT 10:35 AM

4 Responses

  1. I am going through something similar in my case. I filed a complaint on April 3, 2009 against 2 lenders, MERS, and the Trustee. The parties were almost all served by April 15, 2009. On April 22, 2009, an attorney claimimg to represent one of the lenders filed an unlawful detainer and served us on April 26, 2009.

    I filed for an Ex Parte TRO which was and served that lenders attorney and the TRO was heard on April 30, 2009. A rent an attorney showed up and said he was there representing the law firm in the unlawful detainer and not the lender. An order to show cause was scheduled for May 15, 2009 and the lender was deemed served in open court.

    A lawfirm filed an opposition to the Show Cause order for a Preliminary Injunction and c;aimed that their firm represented all of the Defendants in the case.

    A lawyer for that law firm appeared by phone on May 15, 2009. That same date, a law firm claiming to represent one of the lenders filed a Demurrer to the complaint served on them 30 days prior. A few days later, a law firm for the Trustee made an appearance in the case. Today, another law firm contacted me requesting additional time to respond to the complaint and was representing the other lawfirm served.

    So who is the original law firm that filed the opposition to the Preliminary Injunction actuall representing?

    Who is the attorney of record for any and all of these Defendants and who do I serve motion notices to, the first law firm, or all of them?

  2. Here is some notes on article 9

    by John C. Murray and Dena Cruz
    © 2003. All rights reserved.

    Effective July 1, 2001, the rules regarding interests in promissory notes under the Uniform Commercial Code (“UCC”) dramatically changed. This was done in an attempt to accommodate asset securitization; the asset-based commercial-paper market currently holds $708 billion in assets (up from $517 billion in 1999), and is by far the most rapidly growing segment of the U.S. credit markets.

    Former Article 9 of the Uniform Commercial Code classified a promissory note as an instrument, and the sale of an instrument was outside the scope of Article 9. In 2001, revised Article 9 (“Revised Article 9”) of the UCC was enacted into law in every state. Revised Article 9 expressly includes the sale of promissory notes within its scope. See UCC sec. 9-109(a)(3). However, there are some limitations:

    1. Sales of promissory notes as part of the business from which they arose;
    2. Assignments of promissory notes for collection only; and
    3. Assignments of promissory notes to an assignee in satisfaction of indebtedness

    These exclusions typically do not effect securitization transactions.

    Sec. 109(b) of Revised Article 9 provides (as did Former Article 9) that “[t]he application of this article to a security interest in a secured obligation is not affected by the fact that the obligation is itself secured by a transaction or interest to which this article does not apply.” However, Comment 7 to this section makes clear the views of the drafters that a recorded assignment of a mortgage has no bearing on whether a security interest in the mortgage is created or perfected and that any cases to the contrary are overruled. According to Comment 7, “an attempt to obtain or perfect a security interest in a secured obligation by complying with non-Article 9 law, as by an assignment of record of a real-property mortgage, would be ineffective . . . [O]ne cannot obtain a security interest in a lien, such as a mortgage on real property, that is not also coupled with an equally effective security interest in the secured obligation.”

    A buyer of an interest in a promissory note should enjoy automatic perfection under Revised Article 9, but should also file a UCC-1 Financing Statement in case the seller/originator’s bankruptcy trustee subsequently alleges that the transaction was really a loan and not a sale. Methods of perfection can create problems for the escrow holder and the borrower/debtor. The method of perfection of a security interest in a promissory note depends on whether the transaction involves a “sale” of that type of property or a “loan” secured by that type of property. To perfect an interest in the note, the buyer/lender should, if the interest is a:

    a. “Loan secured by interest in promissory note”: Perfect by possession or filing. See UCC secs. 9-312(a) and 9-313(a). Since possession of the note is not always practical, in many instances filing of a UCC-1 may be only way to perfect. A bona fide purchaser in possession will prime perfection by filing!

    b. “True Sale” of an interest in a promissory note: Be aware that neither filing nor possession is necessary or effective to perfect the security interest. Perfection is automatic upon attachment if the “security interest” results from the sale of the promissory note. See UCC sec. 9-309(4). Once perfected, the security interest takes priority over the interest of a subsequent lien creditor and the originator/debtor’s bankruptcy trustee. See UCC sec. 9-317(a)(2); 11 USC sec. 544(a)(1).
    In addition, to accommodate the practice of warehouse lending, Revised Article 9 provides that a secured party does not relinquish possession of the mortgage if a mortgage warehouse lender delivers the original note to prospective purchasers. It need only instruct the third party that it is to hold for the benefit of the secured party, and to re-deliver the collateral to the secured party. See UCC sec. 9-313(h), cmt. 9.

    Because perfection can be done without filing, and possession of the instrument is not determinative of ownership, and because UCC sec. 9-203(g) states that the mortgage follows the note, the original maker of the note and an escrow holder cannot rely on the public records to determine who owns the note and who can sign a reconveyance or release of the mortgage. Revised Article 9 does not protect the original maker, nor provide advice on how to determine whom to pay. Revised Article 9 simply states that the “issues are determined by real-property law”. The Comments to UCC Sec. 9-109 of Revised Article 9 also state that any attempt to obtain or perfect a security interest in a mortgage by complying with non-Article 9 law (such as recording a collateral assignment of the beneficial interest) would be ineffective. Purchasers of interests in promissory notes and the underlying debtors must rely on representations and the financial stability of originators/sellers to determine who really owns the interest. See UCC sec. 9-308, cmt. 6.

    Some commentators, viewing this phenomenon from the maker/account debtor’s perspective, refer to this set of facts as an “invisible lender scenario” because the debtor under the mortgage-secured note will not be able to ascertain what has occurred through examination of the public records (including who has the right to execute a reconveyance or release of the mortgage).

    If the maker of the note cannot determine whom to pay, and recording of a collateral assignment of the beneficial interest is ineffective and not indicative of ownership, failure to rely on the public records by the escrow holder should not be the basis of a breach of fiduciary duty cause of action. Reliance on the public records would be foolhardy and may even be actionable negligence.

    As noted above, an absolute assignment of a promissory note carries with it the securing mortgage without the requirement of physical delivery of either the note or mortgage. Attachment of a security interest in a promissory note (which automatically includes the attachment of a security interest in the securing mortgage) requires either a security agreement authenticated by the debtor or possession of the collateral by the secured party pursuant to an agreement. See UCC secs. 9-309(4) and 9-203. Under the “principal/incident” view of the note/mortgage relationship, UCC secs. 9-203(g) and 9-308(e) provide that attachment of a security interest in a promissory note is also attachment of a security interest in a securing mortgage, and the perfection of a security interest in a promissory note is also perfection of a security interest in a securing mortgage.

    It should be noted that Revised Article 9 ostensibly makes it easier for a secured party with a security interest in a promissory note to foreclose a mortgage securing the note. After the debtor/mortgagee’s default, the secured party may exercise the debtor/mortgagee’s rights with respect to any property that secures the debtor/mortgagee’s obligations. See U.C.C. sec. 9-607(a)(3).

    The secured party does not have to foreclose on the promissory note in order to foreclose on the mortgage. Of course, the secured party cannot foreclose or exercise the debtor/mortgagee’s foreclosure or other remedies unless the debtor/mortgagee is entitled to do so under the mortgage. This raises the possibility that the debtor/mortgagee may not be in default under its obligation to the secured party, but the obligor/mortgagor is in default under its note to the debtor/mortgagee. If the debtor/mortgagee is not in default, the secured party cannot foreclose on the mortgage. (The agreement between the debtor/mortgagee and the secured party should address this situation).

    Title insurers may have some concerns with respect to these particular revisions to Article 9. For the secured party to have insurable title following a foreclosure, the secured party will need to have a good chain of title to the mortgage. (In some states, a secured party cannot foreclose unless it has a recorded chain of title). This is why the secured party will usually require that an assignment of the mortgage from the debtor/mortgagee to the secured party be properly recorded in the applicable land records at the time of the grant of the security interest in the note to the secured party. If this has not occurred, the debtor/mortgagee may subsequently be unwilling to cooperate in the secured party’s request for an assignment to assist the secured party (especially if the debtor/mortgagee is in default under the security agreement or other loan documents).

    Sec. 9-607(b) of Revised Article 9 provides a way for the secured party to document its interest in the mortgage in the land records without the debtor/mortgagee’s involvement. Under this section, the secured party is authorized to file in the land records a copy of the security agreement and a sworn affidavit, which states that a default has occurred and that the secured party is entitled to foreclose non-judicially. However, some problems exist with respect to this procedure: (1) a conflict may arise with state laws that require an acknowledgment or other conditions to recording a document in the land records (which provisions are usually not found in a security agreement); (2) Neither revised Article 9 nor the Official Comments provide that a memorandum of the security agreement (as opposed to the entire agreement) is sufficient for recording, and there is uncertainty as to whether other loan documents referenced in the security agreement must also be recorded (most debtor/mortgagees would not want the entire document(s) recorded); (3) a filed security agreement will only (as noted above) establish a chain of title if the debtor named in the security agreement is in fact the mortgagee in the mortgage and the secured party named in the security agreement is the secured party that proposes to foreclose. If there have been further assignments of the note, these further assignments also would have to be documented. See UCC Sec. 9-619 (explaining the transfer statement). As one commentator recently stated, “Title insurance companies presumably will develop underwriting guidelines for determining when a foreclosure by a secured party that has established its chain of title by filing its security agreement is enforceable”; (4) this procedure does not appear to be available in those states that do not permit nonjudicial foreclosure proceedings. See W. Rodney Clement and Baxter Dunaway, “Revised Article 9 and Real Property,” 36 REAL PROP. PROB. & TR. J. 511 (Fall 2001).

    Sec. 9-109(d)(11) of Revised Article 9 continues to exclude from its coverage “the creation or transfer of an interest in or lien on real property,” with certain limited exceptions. This language, but for the exceptions (which don’t affect this analysis), is identical to Former Article 9. However, this language is not entirely accurate because, as noted above, Revised Article 9 does provide for transfers of mortgages (which clearly are “liens on real property”).

    If there was intent to transfer a promissory note when an assignment of mortgage was executed, the plaintiff/ lender should prevail. See UCC sec. 3-110(a) (“The person to whom an instrument is initially payable is determined by the intent of the person, whether or not authorized, signing as, or in the name or behalf of, the issuer of the instrument”). Revised Article 9 and Article 3 of the UCC (Negotiable Instruments) allow enforcement when the note has been lost, before or after the transfer to an assignee, or is simply unavailable. See UCC sec. 3-301(iii) (stating that a “Person entitled to enforce” an instrument” includes “a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3-309 or 3-418(d). A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument”). Section 3-109(a) provides that a person not in possession of an instrument is nonetheless entitled to enforce it if the instrument was destroyed, lost, or is in the wrongful possession of an unknown person. However, under Sec. 3-309(b) the person seeking enforcement, if not the holder of the note, must prove the terms of the instrument and the person’s right to enforcement, and also must provide “adequate protection” (by “any reasonable means”) to the debtor/borrower to prevent the debtor/borrower from paying the same debt twice. If there was no intent to transfer, and the assignee of the mortgage was simply a “servicer”/ agent for the holder of the note (which is common in connection with securitized loan transactions), general agency law may still protect the lender. See also UCC sec. 3-110(c)(2)(ii) (providing that if an instrument is payable to “a person described as agent or similar representative of a named or identified person, the instrument is payable to the represented person, the representative, or a successor of the representative”).

    In a recent decision by the South Carolina Court of Appeals, Swindler v. Swindler, 2003 S.C. App. LEXIS 104 (July 7, 2003), the court dealt with an issue involving the interplay between Article 3 and Article 9. While acknowledging that the UCC excludes from its application the creation or transfer of an interest in or lien on real estate, the court held that Article 3 clearly applies to negotiable instruments and that the negotiability of a note is not altered by the execution of a related real estate mortgage. The court noted that Article 3 does not distinguish an unsecured note from a note secured by a real estate mortgage and that Article 9 does not exclude a note secured by a real estate mortgage from the application of Article 3. According to the court, “nothing in Article 9 provides a limitation on the applicability of Article 3 to notes secured by mortgages on real estate.” Id. at *10. The court stated further that, “Article 9 controls over Article 3 only where some conflict between the applicable provisions of Article 3 and Article 9 exists. Here, no conflict exists because Article 9 does not address the underlying indebtedness of a security interest.” Id. at *11.

    To summarize, under the UCC possession is not an indication of ownership of the note. Recording of collateral assignments is not required under Revised Article 9. Enforcement of the debt without the note is allowable under Article 3. Equitable arguments are available to prevent a borrower from benefiting from the industry’s inability to keep track of its documents.

  3. Do you have a PDF of the opinion?

  4. Great Article. It reminded me of a quote uttered by a speaker at a CLE seminar I attended early in my career – before computers took over. The speaker was a Judge so I paid close attention to what he said to us young attorneys: “You may not be able to win all your cases but you can at least READ THE FILE!” It is in human nature to always look for shortcuts. It’s when we fail to engage ourselves in the matter that we run into trouble. Relying on technology to do our thinking, even in some of the most mundane tasks simply adds to the risk of greater inefficiencies – and injustice.

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