Banks fear courts' ruling on negotiability of promissory notes

The following article was written and authored by Roy Oppenheim for The South Florida Law Blog.

There’s been a lot of discussion over the last year or so about the negotiability of Fannie Mae and Freddie Mac promissory notes. The banking industry has been trying to convince courts that these notes, which total about $7 trillion in commercial paper, are a negotiable instrument.

Why is this so important to the banking industry? The bottom line is that if banks can’t convince the courts that these types of notes are negotiable, then it will be a lot more difficult for them to foreclose on a home and this is what they fear.

The history of negotiability goes back even further into the history books – which trace it to the Florentines and Venetians in the 12th and 13th century.

Like the charlatan weavers who tried to persuade the emperor he was wearing beautiful new clothing in Hans Christian Andersen’s famous tale, banks have spun a wonderful story about the negotiability of these notes. But their argument has begun to wear thin and that has the banking industry very concerned. So concerned that they have started to lobby supreme courts around the country.

Our legal system has been discussing the negotiability of a note since the time the nation was formed.

Ironically, many of the terms and conditions in the standard Fannie Mae and Freddie Mac promissory note have been deemed non-negotiable in other types of instances, whether it’s car loans, consumer loans, solar panel loans, or hot water heater loans. Why should banks be any different?

First, a little background: A negotiable instrument is a piece of paper that includes a promise to pay a certain amount of money to the bearer. It can be freely transferred without the need to notify the person from whom it originated.

Examples of negotiable instruments include cash, which is your purest form of negotiable paper.

Your next form of negotiable paper is a check. If it’s paid to cash, then it’s negotiable, (unless your name is “Cash”) or if you just leave the name blank, then whomever holds that check can go to the bank with it –if it’s signed — and ask for cash. A blank check is the second most pure form of negotiable paper.

The third most pure form of negotiable paper is a promissory note, otherwise known as an IOU. It says payable to the order of “blank” on a certain date, at a certain time. Those are what promissory notes are and they are freely negotiated by endorsement.

A non-negotiable instrument, on the other hand, cannot, by definition, be transferred freely from one person to another, but rather needs another document called an assignment.

A mortgage generally can’t be foreclosed upon unless the creditor possesses the properly negotiated original promissory note (or can swear he lost it). If a promissory note has been properly transferred, the endorsements on a promissory note will show a chain of ownership leading from the bank that originated the loan to the foreclosing bank.

However, if the bank cannot show a proper chain or produce the original note, then the foreclosure suit can be dismissed for failure of the lender to verify that it has the right to sue.

With so many banks transferring so many mortgages during the height of the home buying frenzy in 2007 – 2009, the proper chain of title often was often lost or broken.

It’s not as if the banks can’t transfer the note, they just must use a different mechanism to transfer it. They must assign the promissory note; they can’t just endorse it. Endorsement is a simple statement on the back of the note “payable to the order of” just like a check. Or if it’s a bearer note, then someone must posses it – just like if you possessed a $100 bill.

Oppenheim Law’s, Roy Oppenheim recently was interviewed by banking, legislation, regulatory policy, and litigation publisher Bloomberg BNA on a number of legal topics including the non-negotiability of promissory notes.

Oppenheim told Bloomberg BNA that banks are trying to make sure that these promissory notes are deemed a negotiable instrument.

“The irony is, of course, that in our review of case law in all 50 states, we found similar provisions in other types of notes such as consumer transactions for the purchase of a car or solar heater, where the court found that such a note was not negotiable,” Oppenheim law told Bloomberg BNA.

“This finding was made based on provisions in these notes which required additional conduct to occur, additional notifications to occur, or additional obligations to occur, and which are nearly identical to many provisions in the Freddie/Fannie promissory notes.

And the law is that if you have any of those extra requirements, then the note becomes a loan, rather than commercial paper and cannot be transferred as a negotiable instrument by endorsement. Which means you simply can’t just sign ‘pay to the order of’ on the back of it and negotiate it in the marketplace in the context of commercial paper.”

Oppenheim went on to tell BNA: … “These notes, by any analysis, are just so obviously non-negotiable that everyone wants to pretend that they are.

Now, to the extent that they are not, it means that they can be transferred but they don’t get transferred by a stamp. They get transferred pursuant to assignment the way other assets – both hard assets as well as intangible assets – typically get transferred, and they get transferred via assignment, not via negotiability.”

While the question of negotiability has been out there for a while, because many more of these foreclosures have come home to roost; there is a real sense of panic in the banking industry.

From a foreclosure defense perspective, the banks have no business being in court. The only person who has the right to foreclose is the party that transferred the promissory note to the trust, and frankly with all of the transferring going on at the height of the real estate boom, knowing just who that is can often be next to impossible.

So what’s the takeaway: As long as banks continue to argue that a promissory note is negotiable, Oppenheim Law will continue to make sure that banks substantiate chains of transferability for promissory notes because if there are any serious questions about those chains the courts can nullify a lender’s ability to foreclose.

Real estate and foreclosure defense attorney, Roy Oppenheim left Wall Street for Main Street, founding Oppenheim Law along with his wife Ellen in 1989 in Fort Lauderdale, Florida. He also is vice president of Weston Title and creator of the South Florida Law Blog, named the best business and technology blog by the South Florida Sun-Sentinel. Follow Roy on Twitter at @OpLaw or like Oppenheim Law on Facebook