UCC § 3-205. SPECIAL INDORSEMENT; BLANK INDORSEMENT; ANOMALOUS INDORSEMENT.
UCC 3-205 deals with special indorsements, blank indorsements, and anomalous indorsements and states as follows: (a) If an indorsement is made by the holder of an instrument, whether payable to an identified person or payable to bearer, and the indorsement identifies a person to whom it makes the instrument payable, it is a “special indorsement.” When specially indorsed, an instrument becomes payable to the identified person and may be negotiated only by the indorsement of that person. The principles stated in Section 3-110 apply to special indorsements.
(b) If an indorsement is made by the holder of an instrument and it is not a special indorsement, it is a “blank indorsement.” When indorsed in blank, an instrument becomes payable to bearer and may be negotiated by transfer of possession alone until specially indorsed.
(c) The holder may convert a blank indorsement that consists only of a signature into a special indorsement by writing, above the signature of the indorser, words identifying the person to whom the instrument is made payable.
(d) “Anomalous indorsement” means an indorsement made by a person who is not the holder of the instrument. An anomalous indorsement does not affect the manner in which the instrument may be negotiated.
Explaining UCC §3-104 NEGOTIABLE INSTRUMENT
For negotiable notes, UCC 3 governs how these notes may be transferred, the effect of the transfer of ownership of the notes on the ownership of the mortgages securing those notes, and the right of the transferee, under certain circumstances, to record its interest in the mortgage in the applicable real estate office.
- Who is the person entitled to enforce a mortgage note and to whom the obligation to pay the note is owed?
If the note is a negotiable instrument , Article 3 determines who may enforce those obligations and to whom these obligations are owed. If the note is non-negotiable, contract law governs.
First, identify the “person entitled to enforce” the note. The owner is not synonymous with person entitled to enforce, a person need not be the owner to be entitled to enforce. The reason it is necessary to identify the “PETE” is that
- the maker’s obligation is to pay the amount of the note to PETE;
ii. the maker’s payment to PETE results in discharge of the maker’s obligation; and
iii. the maker’s failure to pay; when due, the amount of the note to PETE constitutes dishonor of the note.
UCC 3-301 provides only three ways in which a person may qualify as a PETE, two of which require the person to be in possession of the note (which may include possession by a third party as an agent. (See UCC §§3-1-103(b), UCC § 3-402.) “Delivery” of a NI (negotiable instrument) is defined as “a voluntary transfer of possession.” UCC 1-201(b)(15).
The first way a person may qualify as a PETE is to be its “holder”. UCC § 1-201(b) (21) (A), requires that the person be in possession of the note and either the note is payable to that person or (ii) the note is payable to bearer. This requires examination of the note and any subsequent endorsements.
The second way that a person may be a PETE is to be a “nonholder in possession of the note who has the rights of a holder.” A nonholder may have the rights of a holder if the delivery of the note to that person constitutes a “transfer” as defined in Article 3 because transfer of a note “vests in the transferee any right of the transfer or to enforce the instrument.” UCC 3-203(b). If a payee delivers the note to an assignee without indorsing it, the assignee will NOT BE a holder because the note is still payable to the payee. The person in possession of the note must also demonstrate the purpose of the delivery of the note in order to qualify as the PETE.
The third method does not require possession of the note but is limited because it applies only in cases in which “the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process.” UCC §3-309(a)(iii). In such cases, a person qualifies as a PETE if he demonstrates not only that one of the circumstances is present but also that the person was formerly in possession of the note and entitled to enforce it when the loss of possession occurred and that the loss of possession was not a result of transfer or lawful seizure. If the person proves those facts as well as the terms of the note, the person may enforce the note but the court may not enter judgment in favor of the person unless the court finds that the maker is adequately protected against loss that might occur if the note subsequently appears.
Explaining UCC §3-104 NEGOTIABLE INSTRUMENT Continued
- What steps must be taken for the owner of a mortgage note to transfer ownership of the note to another person or use the note as collateral for an obligation?
A note is owned by the payee to whom it was issued. If the payee seeks either to use the note as collateral or sell the note outright, Article 3 governs that transaction and determines whether the creditor or buyer has obtained a property right in the note. Article 9 governs transactions in which property is used as collateral for an obligation. UCC §9-109(a)(1).
Three criteria must be fulfilled in order for the owner of a mortgage note to effectively create a “security interest.”
- Value must be given;
2. Debtor/seller must have rights in the note; and
3. Either the debtor must “authenticate” a “security agreement” that describes the note or the secured party must take possession of it pursuant to the debtor’s security agreement .
Satisfaction of these three criteria of § 9-203(b) results in the secured party obtaining a property right whether outright ownership or a security interest to secure an obligation in the note from the debtor, including a seller of the note.
The sale of a mortgage note not accompanied by a separate conveyance of the mortgage securing the note does not result in a separation of the mortgage from the note. §9-203 official comment. “Subsection (g) codifies the common-law rule that a transfer of an obligation secured by a security interest or other lien on personal or real property also transfers the security interest or lien.”
- In general terms, the mortgage follows the note but the note does not follow the mortgage. “The note and mortgage are inseparable; the former as essential, the latter as incident. An assignment of the note carries the mortgage with it, while assignment of the latter alone is a nullity. Carpenter v. Longan, 16 Wall 271, 83 U.S. 271, 274, 21 L.Ed. 313 (1872).
Each state has its own statutory requirements regarding enforcement of Negotiable Instrument but in general, they follow the dictates of the Uniform Commercial Code. Each state also codified requirements for the proper recordation of mortgages to be effective as notice of lien to subsequent purchasers of real property.
Securitization and Separation of Intangible Payment Obligation and the Tangible Promissory Note
In brief, these unsecured intangible payment streams were pooled and used as a Real Estate Mortgage Investment Conduit herein referred to as (REMIC). The lender would pool the asset, i.e. Intangible Payment Obligation, with other loans and sell fractional ownership as one would sell stock in a company. Although the REMIC was allegedly backed by a properly secured Mortgage Instrument, in reality the Security Instrument did not follow the Tangible Promissory note, as the tangible promissory note was no longer properly secured.
A copy of the of the homeowner Tangible Promissory Note and Security Instrument is created electronically, executed electronically, transferred electronically and stored electronically. This is known as an eNote and an eMortgage aka the paperless mortgage. A Transferable Record is not a Negotiable Instrument and pertains to Personal Property and not Real Property. It is the transfer of the Transferable Records and Servicing rights that are tracked within the Mortgage Electronic Systems Registry, Inc. herein referred to as (MERS). The failure to transfer the entire instrument opens a whole myriad of security violations under the Securities Act of 1933 and the Securities Exchange Act of 1934, most notably violation of Rule 10(b) and 10(b)(5).
Securitization – Separation of Note from Mortgage
In brief, most of the sub-prime loans were pooled and used as an investment backed security. The lender would pool the asset, i.e. principle and interest with other loans and sell fractional ownership as one would sell stock in a company. Although the security was allegedly backed by the mortgage (Mortgage Backed Security) in reality the mortgage did not follow the original note but was held by MERS instead who at all times was not a beneficiary to the original note.
The failure to transfer the mortgage along with the note when pooled and sold as a security opens a whole myriad of security violations under the Securities Act of 1933 and the Securities Exchange Act of 1934 most notably violation of Rule 10(b) and 10(b)(5). This however is a story for another day.
The problem for the lender but a potential windfall for those who can exploit this separation of the note and the mortgage is that although the underlying obligation to pay the lender still exists, it is no longer secured by the real property originally encumbered by the mortgage.
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