By Alan L. Hill & Nickolas Karavolas, originally published in Law360 on 1/25/17.
A Note on Mortgage Assignments in New York
The U.S. District Court for the Western District of New York recently ruled that, under New York law, a party may enforce a note and mortgage where the note is a negotiable instrument, and that party obtained its interest in the note and mortgage through a written assignment as opposed to delivery and indorsement. In Arnold v. First Citizens National Bank (In re Cornerstone Homes Inc.), Chief Judge Frank P. Geraci Jr. of the U.S. District Court for the Western District of New York affirmed the decision of Judge Paul R. Warren of the U.S. Bankruptcy Court for the Western District of New York and held that Section 3-201 of the New York Uniform Commercial Code allows for transfer of a party’s interest in a note and mortgage to be made by written assignment, as opposed to by delivery and indorsement under Section 3-202 of the NY UCC. No.16-CV-6012, (W.D.N.Y. Nov. 18, 2016).
Mortgage Assignments in New York
In New York, mortgage assignments are common because the assignment of a mortgage results in the waiver of a portion of tax imposed for recording such mortgage. While New York state imposes a tax on the recordation of all mortgages related to properties in New York, local counties typically impose an additional mortgage recording tax. Such taxes can be quite onerous. For example, depending on the type of property secured by the mortgage, residents of New York City can pay up to 2.8 percent of the amount of the mortgage being recorded. If the resident takes out a mortgage loan of $500,000, for instance, the local mortgage recording tax alone can add an additional $14,000 to the homeowner’s closing costs.
To reduce a homeowner’s closing costs, often a new mortgage lender will take an existing mortgage by assignment, rather than effectuating a payoff of the existing loan. In such a case, the homeowner is only responsible for paying mortgage recording taxes on that amount of the mortgage loan that exceeds the principal amount of the prior mortgage.
In Cornerstone Homes, prior to its bankruptcy filing, the debtor purchased and renovated single-family homes in New York, subsequently selling or renting the renovated homes to high-risk borrowers. The debtor obtained financing from numerous individuals and issued a promissory note to each individual evidencing the debt. To secure the indebtedness, the debtor granted each individual a mortgage on the respective real property.
Between 2006 and 2007, the debtor sought to refinance its obligations by obtaining financing from institutional lenders. As part of the refinancing, certain individual lenders agreed to assign their mortgages to the new lenders and deliver a written assignment of the note and mortgage. However, the individual lenders did not indorse or deliver the existing promissory notes to the new lenders. Instead, Cornerstone issued a new promissory note to each of the new lenders.
Ultimately, the debtor was unable to satisfy its numerous debt obligations and filed for Chapter 11 bankruptcy relief on July 15, 2013. During the debtor’s bankruptcy case, a Chapter 11 trustee was appointed and commenced an action against the new lenders seeking a declaratory judgment that the new lenders were not entitled to enforce the assigned notes and mortgages, notwithstanding the existence of new enforceable promissory notes, because the assigned notes and mortgages were not indorsed and delivered by the individual lenders.
The Bankruptcy Court Decision
On Dec. 23, 2015, the bankruptcy court issued a decision dismissing the trustee’s complaint against the new lenders. In its decision, the bankruptcy court applied a long-standing principle of New York case law that a plaintiff has standing to bring a mortgage foreclosure action where it is either the holder or the assignee of both the subject mortgage and the underlying note at the time the action was commenced.
Because the bankruptcy court found that the new lenders were the assignees of the mortgages, and because the mortgage assignments included language that unambiguously assigned the underlying debt, the court dismissed the trustee’s action, holding that the new lenders had standing to enforce the new notes and mortgages. The trustee appealed the bankruptcy court decision.
The District Court Decision
On appeal, the district court affirmed the decision of the bankruptcy court. As an initial matter, the district court held that Section 3-202 is not the only method by which a third party can obtain the right to enforce a negotiable instrument. Specifically, the court analyzed the language of Section 3-201(1) of the New York UCC, which provides that the “[t]ransfer of an instrument vests in the transferee such rights as the transferor has therein.” N.Y. U.C.C. Law § 3-201 (1) (Westlaw through L.2016 chs. 1 to 503).
The court then analyzed what the New York Legislature intended by use of the word “transfer” for purposes of New York UCC § 3-201(1). The court interpreted the line of New York cases conveying standing upon an assignee by written assignment to supplement the provisions of the New York UCC. Accordingly, the district court held that a written assignment is a valid form of “transfer” under New York UCC Section 3-201.
Further, the court was persuaded by the fact that the New York Legislature refused to adopt a proposed revision to the Uniform Commercial Code (adopted by every other state) that requires delivery to satisfy the “transfer” prerequisite. Finally, the court held that the requirement that an instrument be delivered makes sense in situations where the debtor is unaware of the assignment, and, thus, there is a risk that multiple parties will seek payment on account of the same debt obligations. In the Cornerstone Homes case, however, the debtor was well aware of the assignment and specifically used the assignment structure to satisfy its own refinancing objectives. Additionally, the debtor had issued a new negotiable instrument to the new lenders on account of the same debt obligation.
Assigning a note and mortgage to refinancing lenders is an effective tool to minimize closing costs. Even though the district court in Cornerstone Homes held that a party who is assigned a note and mortgage by written assignment may enforce the note and mortgage, the assignee may still have to pay certain mortgage recording taxes associated with the transaction.
The district court in Cornerstone Homes ultimately held that the written assignment, without delivery and indorsement, transferred rights to enforce the notes and mortgages to the new lenders. Nonetheless, a new lender should ensure that the note is properly indorsed and delivered to it in connection with any refinancing transaction. In Cornerstone Homes, the district court left open the possibility that an assignment of the note and mortgage may not be effective in the event that the debtor is unaware of the assignment. Ensuring that your lender client receives proper indorsement of the instrument and maintains the instrument in a secure location remains the best method for guaranteeing enforceability of the instrument.
DISCLOSURE: Phillips Lytle represents First Citizens National Bank, a defendant in the action discussed.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
Allan L. Hill is a partner in the Rochester, New York, office of Phillips Lytle LLP. Nickolas Karavolas is a senior associate in the firm’s New York City office.