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Modernizing Mortgage Foreclosure Law: A Call for Transparency and an End to the Payment Rule
Quinnipiac Law Review (2014)
  • Matthew M. Heekin, Charlotte School of Law

The global financial crisis--which arose in great measure from millions of bundled mortgage loans which randomly commingled arrays of toxic subprime mortgages with soundly underwritten “normal” loans and marketed securities derived from these bundles—led directly to the foreclosure epidemic we continue to face. The bursting of the derivatives bubble which spawned this epidemic has now revealed a major legal pitfall in mortgage foreclosure laws.

A traditional legal rule forces the foreclosing lender to produce the original signed mortgage note to prove that it holds the legal right to foreclose or otherwise enforce remedies on the defaulted debt. This is the so-called “payment rule” of negotiable instruments law. But because of the bundling, securitization, and global remarketing of mortgage-backed securities (“MBS”) the normal chain of current ownership of any particular mortgage debt is now often unable to be traced. However, if the modern mortgage industry is to survive—and many believe that its survival is an essential goal of society—while protecting the rights of all involved in mortgage enforcement cases, there needs to be a solution to this problem. This timely article demonstrates how the nation’s courts have struggled to put a bandage on the problem.

In the course of that struggle our courts have given disparate, even self-contradictory treatment to the “payment rule.” The Court of Appeals of North Carolina is one of many such courts, handing down two schizophrenic holdings regarding the “payment rule” within weeks of one another. This article examines these inconsistent holdings, their implications for mortgage enforcement law, and presents various proposed solutions. The article offers a new fair and balanced solution the problem, which meets the three essential goals: (1) public transparency in harmony with policy underlying nearly two centuries of states’ recording acts; (2) fairness to individual mortgage debtors; (3) promoting the certainty and efficiency of the financial industry’s ability to enforce borrowers’ obligations by foreclosure.

Regarding the solutions available, some are fatally complex or politically impossible, but some are more readily at hand. This article spotlights how the adoption of the Uniform Commercial Code’s revised Section 3-602 could alleviate the problem but state legislatures may continue to balk at this step. In the years since 2002 only 10 state legislatures have adopted this sensible solution, illustrating the political problem. This otherwise sensible solution would likely be blocked by intense lobbying from the lending industry as it seeks to avoid notice and filing delays in bundling and transferring of MBS.

Some national commentators propose removing mortgages from the realm of negotiable instruments law altogether, the two laws being mutually irrelevant. Although removing mortgages from the realm of negotiability has some minor impact on Holder in Due Course rules, it does not render them untransferrable. Such a change merely requires reasonable notice to the note debtor of each such transfer.

This article concludes that instead of trying to motivate the Legislature to eliminate negotiability from all mortgage notes, the optimal solution is to encourage legislators to enact the revised U.C.C. Section 3-602, which would eliminate the double payment threat embodied in the payment rule

Regardless of the political outcome—pro or con—of a UCC reform, state legislatures should take the minimal step of mandating that notice of transfer of mortgage notes must be accomplished by mail to the borrower and recording of that notice in the land records of the county where the mortgage itself is recorded. In accord with the best national thinking on the matter, this will give the mortgage ownership status much needed transparency. Moreover, recording all such transfers would provide notice of the transfer and give much needed transparency to mortgage note ownership, thereby preventing the “lost in the MBS bundling” that has created our present crisis.

Publication Date
Citation Information
Matthew M. Heekin. "Modernizing Mortgage Foreclosure Law: A Call for Transparency and an End to the Payment Rule" Quinnipiac Law Review Vol. 33 (2014)
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