Federal Bankruptcy Appellate Court Makes Astonishing Decision on "Produce the Note"

A federal bankruptcy judge has ruled that a lender must prove that it has the original note in order to receive relief from the automatic stay in bankruptcy and proceed against the real estate.  This has potentially HUGE repercussions in all forclosures and certainly all foreclosures in bankruptcy.

The "produce the note" affirmative defense in one in which a home owner in foreclosure alleges as a defense to the foreclosure lawsuit that the lender does not have the legal right to sue ("standing") because they cannot prove that they have the original note.  Many courts (in my experience it is about 50/50) will dismiss a foreclosure lawsuit when a bank cannot produce the original note.  There was a lot of publicity last year about banks alleging that they had the original note when in fact they did not. In legal parlance that is referred to as a misrepresentation. In my world it is called a lie!! LOL 

In bankruptcy, the minute a petition is filed, all assets are under the exclusive jurisdiction of the bankruptcy court (judge and/or trustee).  Lenders routinely seek relief from the automatic stay in order for them to proceed against the actual real estate under the collateral (mortgage or deed of trust).  Courts routinely grant relief from the stay because as a matter of law, the lender is entitled to pursue relief against the asset. However, this decision now requires that a lender prove that they have standing - prove that they do have the original note.  This will be a problem in a significant number of cases and it will certainly slow the process down.


The ruling will have an impact on all foreclosures as attorneys will cite the bankruptcy case in furtherance of the affirmative defense of "produce the note". Trust me, this decision has far broader implications than many believe.

I will relate a bizarre outcome that I had in the OTHER Orange county..Orange County Florida. I had an investor client that owned two condominium units in the same complex. Same price, same lender, purchased at the same time.  Both went into foreclosure at the same time. naturally, two separate actions had to be filed and two different judges were assigned. In both cases, the lender (Wells Fargo) could not find the original notes and we pleaded the affirmative defense that the bank did not have standing to sue because they could not prove that they held the note.


I filed Motions to Dismiss once Wells Fargo admitted that they could not produce the original notes. Same brief field, identical facts. You can guess what happened. Judge A granted the Motion to Dismiss and threw out the foreclosure suit and Judge B denied the Motion to Dismiss. This is how it is folks....both decisions are legally supportable.


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Comment by Paddy Deighan, JD PhD on July 3, 2011 at 5:00pm
Sally, the underlying financial obligation and the security interest are two separate things. If the note is invalidated, the borrower still has title, but there still is a mortgage on the property.  This would only be an issue if & when the borrower sells the property and their is going to be a HUGE argument over the payoff...on one hand it would be zero since the note was invalidated, and on the other hand, there would be accrued interest etc.  The Lis Pendens might not get dismissed (although it should). I will be blogging soon about what to do at this point
Comment by Sally Rackey on July 3, 2011 at 12:22pm

Paddy:  To follow up, if the bank can't produce the note, and the lis pendens has been dismissed, can the homeowner then file a suit to quiet title and would this action then remove the security interest?

Comment by Paddy Deighan, JD PhD on July 3, 2011 at 3:17am
Steven....to summarize...if the lender cannot produce the original note, it cannot foreclose in a lawsuit or file a proof of claim in bankruptcy.  Some courts may allow them to do it; others will not. The law is clear that they should not be able to foreclose because they do not have standing to sue.There are a lot of complex legal issues but in theory and in many, many courts, once the lender is proven to not have the original note, they can no longer foreclose...ever. It is not a title issue. Title, at all times is still in the borrower's name. The note may no longer be legally enforceable if the original note is not produced, but the mortgage (or deed of trust) is still in place and the security interest is valid. Theoretically, a home owner could stay in a home forever and never pay the note. However, if they ever went to sell, the payoff would be astronomically high because of accrued interest but the home owner would argue that there is no accrued interest because there was not note!!
Comment by Steven Pawera on July 2, 2011 at 11:26pm

"..if a lender cannot produce the original note.." then my nonlawyer opinion is, the lien on title is not fully supported, so..  a quiet title action?  I'm ok with an unsecured note.

But thinking even that through, suddenly the homeowner would have lots of equity.  If I were the lender, I'd probably like to sue for judgment on my unsecured debt and attached my judgment to the equity.

If the lender couldn't foreclose when they thought they had a secured debt, what can they do with the same lacking paperwork on an unsecured debt?

Comment by Paddy Deighan, JD PhD on July 2, 2011 at 7:04pm
Sally, in the produce the note scenario, the underlying note is invalid and yes, the home owner will be able to stay in the home without paying since the lender cannot foreclose etc, HOWEVER, when they go to SELL the home, the mortgage is still in effect and the payoff will be whatever it would have been unless the borrower took the additional step to invalidate the mortgage as well and also the rationale of the Veal case would limit what the lender could collect to the value of the home
Comment by Paddy Deighan, JD PhD on July 2, 2011 at 7:02pm
Steve, the rationale of this decision applies to more than just bankruptcy.....if a lender cannot produce the original note it does not have standing to sue in foreclosure or present a proof of claim in bankruptcy. If/when this happens, the lender cannot foreclose or take action against the real estate and this should enable a borrower to get loan modification or short sale relief...possibly a Deed in Lieu as well
Comment by Paddy Deighan, JD PhD on June 30, 2011 at 9:24pm
this decision has far ore reaching consequences than borrowers in bankruptcy...a bit complicated to discuss via blog or comment.  this should help with short sales, loan mods, forgiveness of debt, etc
Comment by Nora Hunt on June 29, 2011 at 5:12pm
Just when you thought the mortgage banking industry couldn't get any worse!  Ugh!  I believe the "birth Pains" have only begun!
Comment by Steven Pawera on June 29, 2011 at 3:43pm

This is freakin HUGE! 

This means the borrower will get to keep the dogs of foreclosure at bay LONGER in the BK. 

And if the borrower is sharp, then it follows that,

1) if the lender couldn't prduce the original note for the BK judge,

2) they probably can't present the note if the borrower challenges the foreclosure in court.

Paddy - not that it makes a big difference here, but are you an attorney, or another bright JD who can't afford to take the bar exam?  :)

Have you seen anything to answer this question I've been carrying:

If only a holder in interest can foreclose on a property, can a note that has been securitized, sliced and diced into tranches, sold to mutual funds, who then sell shares to shareholders,

obviously the 'holder in interest' for any specific mortgage note can't stand up in court.  It's probably doubtful you could even complile an accurate and timely list of ALL the holders in interest and their exact % of interest.  Can that loan EVER be foreclosed upon if the borrower is represented by a skilled and knowledgeable attorney?

I heard Congress is working on legislation to fix this very problem for the banking industry?


Comment by Eleanor Cheffer on June 29, 2011 at 3:28pm
Thank you for this post!


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