Legal Question in Real Estate Law in California

I researched this once, more than a year ago. To the best of my recollection, there were a couple of problems with using the foreclosing lender's inability to produce the original promissory note as a defense to a foreclosure. One of them is that in order to deny the existence of the note, the borrower would have to commit perjury. Another is that, I believe, California law allows the foreclosing lender to put up a bond to protect against some third party later coming in and claiming to be the true holder of the note. Further, the statutory provisions for how private (non-judicial) foreclosures are to be handled are set forth in their entirety in the Civil Code, sections 2924, 2924a, etc., and there is no reference anywhere in the code to any necessity for the foreclosing lender or its representative to produce the original note.

Most foreclosures are handled nonjudicially (outside of court) where there is no need to "produce the note." However, the original note for your mortgage is probably missing, and some attorneys have been successful in what is called the "bankruptcy litigation model." This involves filing for BK and then challenging the creditor's standing to enforce the debt in bankruptcy court (because they do not have possession of the note). Recent bankruptcy court rulings have upheld these strategies. However, very few consumer attorneys in this area have the skill and knowledge to successfully litigate a case in this manner.

As a general rule, the foreclosure process begins with a demand on the trustee by the beneficiary that the trustee commence the foreclosure. The trustee usually requires that the beneficiary deliver to the trustee the original note, the deed of trust, any assignment of the note, a �statement of condition� that describes the terms of the note or secured contract, the unpaid principal balance, the defaults by the trustor, and a written request that the trustee commence foreclosure. It is not critical, however, that the beneficiary actually physically deliver these documents to the trustee to lawfully commence a nonjudicial foreclosure. Manual delivery is not necessary, symbolic delivery has been held to be sufficient. �As to the first alleged irregularity, it is our conclusion that manual delivery of the note and deed of trust was not necessary--symbolic delivery was sufficient.� (California Trust. Co. v. Smead Inv. Co. (2nd Dist. 1935) 6 Cal.App.2d 432, 434-435.)

A lot of discussion has been circulating on the Internet regarding the �lost note� defense. It must be made clear that the loss of the note will not prevent a nonjudicial foreclosure by private sale. The defense has had merit in several situations, not related to nonjudicial foreclosure.

First, the defense is used in states where the promissory note is secured by a mortgage, rather than a deed of trust. A mortgage is different, in that it usually does not contain a power of sale. A lender whose promissory note is secured by a mortgage that does not contain a power of sale is limited to the remedy of filing a lawsuit to judicially foreclose the mortgage, and cannot conduct a private trustee�s sale. Because the foreclosure of the mortgage requires an actual lawsuit, the lender must prove that there was a written contract, and that the written contract was secured. If the lender cannot prove this, because the documents are missing, the lender�s claim fail

Second, the issue of a lost promissory note is significant when the debt has been assigned to someone else. A lender who wants to assign a debt simply does so by assigning the promissory note, which usually involves an endorsement and a physical transfer of the original promissory note. By operation of law, the security is deemed to follow the promissory note. �The assignment of a debt secured by a mortgage carries with it the security.� (Civ. Code, � 2936.) By case law, this provision has also been made applicable to deeds of trust. (Domarad v. Fisher & Burke, Inc. (1st Dist. 1969) 270 Cal.App.2d 543, 553.)

A security interest, whether a mortgage or a deed of trust, cannot be separately transferred and a transfer of the debt expressly without the security interest constitutes a waiver of the security. (Kelley v. Upshaw (1952) 39 Cal.2d 179, 192.)

Again, the �lost note� defense arises in litigation. When the assignee files an action, they must prove the assignment. �The burden of proving an assignment falls upon the party asserting rights thereunder � In an action by an assignee to enforce an assigned right, the evidence must not only be sufficient to establish the fact of assignment when that fact is in issue �, but the measure of sufficiency requires that the evidence of assignment be clear and positive to protect an obligor from any further claim by the primary obligee.� (Cockerell v. Title Insurance & Trust Co. (1954) 42 Cal.2d 284.)(Internal citations omitted.)

Third, the issue of the lost promissory note arises when the underlying debt has been paid, and the trustee has been requested to execute a deed of reconveyance. �When a trustee improperly reconveys a deed of trust to the trustor before the secured obligation is satisfied, and the trustor subsequently conveys the property to a bona fide purchaser, the grantee receives his title free and clear of the lien �. In such cases, the beneficiaries� interests in the property are terminated and their recourse is limited to the collection of an unsecured debt from the trustor and/or damages against the trustee for the loss of the security�. Knowing the note has been paid and is not in the hands of a bona fide purchaser for value is, therefore, essential to keep the trustee free of liability�. Standard practice established by the record in this case and noted by text writers generally is for the trustee to require the presentation of the original note.� (Huckell v. Matranga (4th Dist. 1979) 99 Cal.App.3d 471, 478.)

The fourth and final situation involving a �lost note� has arisen in bankruptcy. This arose in California when the trustor under the deed of trust filed for protection under the bankruptcy code. Secured lenders who wish to continue or institute nonjudicial foreclosure proceedings are required by existing bankruptcy law to file a motion for relief from the automatic stay. One company in particular, Mortgage Electronic Registration Service, Inc. (MERS), ran into problems because they were filing motions to lift the automatic stay, without proving that they were the holders of the original promissory note, when the trustor/ debtor had executed the promissory note and deed of trust in favor of someone else. MERS also complicated matters because it officially disclaims having any interest in the promissory note, but claims that it is an agent for the foreclosing lender. MERS lack of interest and lack of possession of the promissory note caused several bankruptcy judges to rule that it did not have standing as an assignee to foreclose on the properties subject to the automatic stay.