In and of Itself

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James A. Knowlton — Sun, 25 Oct 2026 00:00:00 GMT

The real estate prices are going crazy!

How do I know this?

Because they are.

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Some more random text. to be honest.

And that's it. Click here to learn more.

Board Responsibilities for Non-profit Organizations

James A. Knowlton — Fri, 09 May 2025 00:00:00 GMT

Fiduciary Duty

The IRS gives charitable organizations special status to encourage charitable donations. Contributions to 501(c)(3) non-profit organization reduce taxable income of the donor and potentially taxes. To qualify non-profit organizations must follow rules such conducting business under a higher level of scrutiny referred to as a fiduciary duty and not becoming involved in politics. To be successful, non-profit organizations must insure donor confidence.

Donor Confidence

Donors need and deserve confidence that non-profit organization they are supporting will use their money for the charitable purpose they promote. There are approximately 260 non-profit organizations in the upper Roaring Fork Valley competing for donor dollars. This competition makes it even more important that nonprofits present themselves in the best possible light to engender confidence and sustain financial and volunteer support.

Subscribing to accepted standards of conduct or policies and procedures help non-profit organizations maintain their tax exempt status and attract financial support for their designated purpose.

The law requires that a non-profit organization’s board members conduct the organization’s business with a higher duty of care and loyalty commonly referred to as a “fiduciary duty.” Fiduciary duty means that a board of directors must prioritize the organization's best interests over personal or other affiliations (duty of loyalty) and make decisions based on each member’s independent, good faith judgment (duty of care).

Requirements for Board responsibilities are summarized as follows:

Be organized and operate exclusively for exempt purposes.
None of its earnings may inure to any private shareholder or individual.
Maintain a nonprofit structure.
Ensure that the organization’s activities align with its stated purpose.
Comply with financial reporting requirements.
The board acts as one body in the best interest of the organization.

These requirements translate into the organization’s policies and rules:

Bylaws that establish a clear and consistent basis of operating;
Noticed Board meetings with Agenda to allow each board member to contribute their independent, best judgement on important decisions; and
Approved minutes of Board meetings to document the decision making process.

This open, documented process shows the public and donors that the board is acting as one body in the best interest of the organization and not for the benefit of any one person or organization. The process is also a written record of the Board fulfilling its fiduciary duties.

Committees

Directors and staff lack individual authority; all major decisions are made by the full board. The independent opinions of each board member contribute to forming a transparent consensus that best serves the interests of the organization. To help with board responsibilities, the board can delegate separate duties or responsibilities to committees consisting of less than all the members of board. These committees normally follow the same procedures as the board and report back to the full Board with their recommendations. The full board then makes the major decision in noticed meetings and records them with written minutes.

Conflict of Interest Policy

The collective strength of a non-profit board is, in part, due to individual strengths and expertise of board members to provide necessary expertise and services. Conflicts are unavoidable and therefore the reason for having a strong conflict of interest policy.

Board actions that serve personal interest or have the perception of serving personal interest erode the confidence of donors and threaten non-profit status. A conflict of interest policy protects donor confidence and an organization’s tax-exempt status with full disclosure of any actual or perceived conflict and a board vote to approve or disapprove of a transaction or arrangement with a board member who has a conflict.

A director breaches their fiduciary duty if they act based on personal interest rather than in good faith. Under a conflict of interest policy, the board member with the conflict recuses themselves from voting. The board then makes a decision based on the organization's best interests. Even if a board member benefits from an action or service, the process discloses the conflict and focuses on the organization's best interests, not the individuals.

With a conflict of interest policy the Board and its directors have the flexibility to provide the services that an organization needs for its operation.

Board and Staff Boundary

Directors of nonprofit organizations typically do not receive income due to potential conflicts of interest. The 990 Form filed by all non-profits will show a conflict of interest if any board of director receives income. This is one reason executive directors are not usually on the Board. Executive directors and staff are paid employees of the organization and that status as an employee means that board decisions affect their employment with the organization. If an executive director were on the board, potentially all the major decisions would personally impact the Executive directors which would necessitate their having to recuse themselves from most important decisions. Not an efficient way to operate a non-profit organization.

Executive directors and other paid personnel wield considerable influence within a non-profit organization. They are appointed by the Board of Directors and bear the responsibility of reporting the operational status back to the Board. In fact, an executive director’s influence may be more powerful outside the stricter rules required of board members. They have been hired for their expertise to run the organization upon which the board relies. A board’s main function is to make major policy decisions and not to micro-manage the executive director as they manages the day to day operation of the non-profit enterprise.

Summary

Being a board member of a non-profit organization is more than identifying with and supporting a charitable cause. A board member assumes responsibility to know how to operate a non-profit organization to maintain its non-profit status. Policies and procedures are typically in place to guide directors. To play an integral role in sustaining and growing a charitable purpose, understanding how to curate donor support is taking a bigger view of the charity within a larger community context.

PRESUMPTIONS IN ADVERSE POSSESSION AND PRESCRIPTIVE EASEMENT CASES

James A. Knowlton — Wed, 09 Aug 2023 00:00:00 GMT

By James Knowltonⁱ

The 2008 amendment to Colorado’s adverse possession statuteⁱⁱ and the recent Colorado Supreme Court decision in Lo Viento Blanco, LLC v. Woodbridge Condominium Association, Inc.ⁱⁱⁱ challenge longstanding assumptions about presumptions in adverse possession and prescriptive easement cases. In this article we will explore the far reaching implications of these developments and examine the competing policies that are driving the evolution of the law in this area.

PRESUMPTIONS GENERALLY

Presumptions are not evidence. Presumptions are evidentiary rules of convenience based upon experience or public policy to help decide cases.^iv Legislatures and courts create presumptions when certain fact patterns assist in uncovering the truth.^v Some examples include: the husband in a marriage is presumed to be the father of the child of the marriage; a stamped letter placed in the mail is presumed to be delivered to the person to which it is addressed; a person is presumed dead after being absent for 7 years; and the record title owner of real property is deemed to be the owner of the land to which she has title. In each instance, the result seems obvious unless facts are introduced to show the presumption is not true.

A presumption imposes the burden of going forward with evidence but does not shift the burden of proof.^vi Burden of proof is the degree of certainty needed to convince a jury or judge to decide a question in your favor based on the facts presented. In most civil cases the burden of proof is by a preponderance of evidence.^vii The 2008 amendment to Colorado’s adverse possession statute increased the burden of proof for adverse possession claims to clear and convincing evidence. The burden of proof for prescriptive easement claims remains by a preponderance of evidence.^viii

Presumptions are rebuttable.^ix Once a presumed fact is introduced by its proponent the opposing party has the burden of presenting evidence to disprove the presumed fact. If the presumed fact is disproved, the presumption disappears but if not disproved, the presumed fact is confirmed as a matter of law.^x The weight or strength of the evidence introduced to rebut a presumption is a question for the trial court, not a question of fact for the jury.^xi And must be measured on a case-by-case basis.^xii

Because a rebuttable presumption does not shift the burden of proof, the challenging party is not required to persuade the jury of her position, only required to offer evidence “legally sufficient” to meet the burden of going forward.^xiii If met, the presumed fact remains in dispute and the burden of proving the facts supporting the underlying the claim returns to the proponent.^xiv

In Krueger v. Ary, the Colorado Supreme Court explained “legally sufficient” in the context of the presumption of “undue influence and unfairness” of a caretaker who becomes a beneficiary in a will of the person she was caring for. The Court found that the estate successfully rebutted the presumption of “undue influence and unfairness” of the caretaker by producing a letter from the deceased to the caretaker with a check for $5,000, which was to be used if the conveyance to the caretaker was contested by the deceased’s daughters.^xv As a result, the presumption disappeared but a permissible inference of the presumed fact remained.^xvi

PRESUMPTIONS OF ADVERSITY IN PROPERTY LAW

Adversity is a common element for both adverse possession and prescriptive easement claims^xvii and means without permission or authority.^xviii In order to give permission - or not - the landowner needs to have notice of the particular possession or use taking place.^xix Notice for adverse possession is determined by actual and exclusive possession "sufficiently open and obvious to apprise the true owner, in the exercise of reasonable diligence, of an intention to claim adversely”^xx and for prescriptive easements is determined by the “open and notorious” element defined as a use “sufficiently obvious to apprise the owner of the servient estate, in the exercise of reasonable diligence, that another is making use of the burdened land so that the owner may object."^xxi Actual knowledge by the owner is not necessary if the use is open,^xxii it is implied.

Presumptions of adversity for adverse possession^xxiii and prescriptive easement^xxiv claims are also similar. The presumption helps resolve cases when there is little direct evidence of parties intention on how they possess or use land.^xxv After 18 years, parties may not be available or their memories may have waned and documentary evidence may be scarce. Possession provides the best circumstantial evidence whether the possession or use is adverse or permissive.^xxvi Presumptions, based on length and nature of possession or use, allow fact finders to resolve property disputes and clean up real property titles for transfer.^xxvii

With the introduction of the presumption of adversity in Trueblood v. Pierce,^xxviii a prescriptive easement case, and Vade v. Sickler,^xxix an adverse possession case, Colorado courts shifted to the length and nature of possession and use of property to determine whether the possession or use was sufficient to alert the landowner to take steps to protect their property rights. This focus on notice and fairness to the landowner is important when loss of property rights is threatened.^xxx

Prior to this shift in the late 1940s, possession, alone, could not extinguish property rights because possession or use of real property was presumed permissive.^xxxi The first case to interpret Colorado’s 1893 adverse possession statute, Evans v. Welch,^xxxii captures the importance of this early policy of sanctity of title with a ruling requiring Ms. Evans to move her home, which had encroached on a neighbor’s lot by a few feet for 17 years - one year short of the 18 years needed to succeed on an adverse possession claim.

Colorado history helps explain this shift away from possession being presumed permissive toward the presumption that possession is adverse if continued unexplained for 18 years.

The Colorado legislature passed the original adverse possession statute limiting claims for adverse possession until 20 years had passed in 1893.^xxxiii Prior to 1893, there was little need for presumptions^xxxiv because Colorado, as a newly admitted state (as of August 1, 1876), was encouraging possession of land to settle the frontier. Beginning with the 1893 Act and its interpretation by Evans, the legislature and courts worked toward the same goal of securing title to property.^xxxv Beginning in 1947, Colorado courts, faced with boundary, access and water rights issues, turned to presumptions of adversity to help resolve these property disputes.

The results have been confusing.^xxxvi The Colorado Supreme Court in Lobato v. Taylor tackled the confusion when it adopted a way to obtain a prescriptive easement without proving adversity.^xxxvii In explaining the need for a new theory to resolve cases involving common drives, boundary and party wall disputes the Court noted the 'convoluted explanations' used by courts to explain how a permitted use was actually hostile to meet the adversity requirement or in some Colorado cases where courts "simply glossed over the adversity requirement without comment."^xxxviii

Colorado courts have also identified certain fact situations which overcome the presumption of adversity creating a counter presumption that the initial use is permissive.^xxxix When parties share a driveway,^xl or when the others use a passageway constructed by the landowner^xli or when the land involved is “vacant, unenclosed, and unoccupied”^xlii there is a presumption that the possession is permissive and continues permissive unless and until notice or explicit disclaimer of subservience is given to the owner by the claimant.^xliii

Underlying public policy and political forces add to the confusion.

DUALING POLICIES

Beginning with the 1893 Act, the legislature balanced two policies - one protecting property ownership^xliv and the other acknowledging productive use of land.^xlv The legislature applied a statute of limitations approach to protect property ownership by giving the landowner 18 years to protect their ownership and rewarded the adverse claimant for making productive use of the property if the owner did not object during the same time period.^xlvi

With the shift by Trueblood and Vade, the policy favoring the sanctity of title established in Evans with its presumption of permissiveness was now contending with a new public policy favoring productive use of land with the presumption of adversity.^xlvii

Recent Colorado Supreme court cases dealing with prescriptive easements give context to these two polices: one giving effect to the idea that long-continued possession and uses create expectations of entitlement;^xlviii and the other honoring private property rights with predictable and clears laws.^xlix

The Court in Lobato deployed the equitable tools of implied rights (prescriptive easement, easement by estoppel and easement by necessity) to validate grazing and foraging rights created in 1863 on Taylor Ranch located near the Sangre de Cristo mountains in southern Colorado.^l The Court invoked Colorado’s strong policy of recognizing its unique history and geography to justify judicial recognition of these implied rights over a mountainous region on this 77,000 acre tract of land.^li The reference to history and geography calls to mind the settlement of Colorado, mentioned above, when protecting possession with legal title was necessary for settling Colorado’s frontier. But different from Evans, the equitable appeal of long term possession and use prevailed over the protection of recorded title by statute and common law.^lii

In Matoush v. Lovingood,^liii the Court supported the record title owner of an express easement over an adverse possession claim by the servient landowner.^liv The Court determined something more was necessary to show adversity than the "incompatible or irreconcilable" use significant enough to give notice that the easement was under threat because it was difficult to know what use is adverse to an easement holder’s rights.^lv The Court held that an adverse possession claim for an express easement does not begin until “the easement holder needs to use the easement, demands to use it, and is denied the right to use it.”^lvi In effect, the Court required actual notice to divest a recorded property right. Diverging from Lobato, the Court supported recorded property rights over possession and the law over equity.

Aside from courts juggling equitable and legal principles and competing policies for over 100 years in applying the 1893 adverse possession statute, political pressure to change the statute is a reminder that the legislature is the final arbiter of Colorado law.

“As the [U.S.] Supreme Court has noted, "it is indisputable that the general welfare of society is involved in the security of the titles to real estate and in the public registry of such titles, it is obvious that the power to legislate as to such subjects inheres in the very nature of government."^lvii

LEGISLATIVE INVOLVEMENT

The 2008 amendment to the adverse possession statute fixes the presumption of adversity in adverse possession cases to prioritize the sanctity of title and protect property rights.

The Legislature made it more difficult to succeed on an adverse possession claim by raising the standard of proof for all elements of adverse possession from “preponderance of the evidence” to “clear and convincing” evidence, added a good faith requirement and gave judges discretion to award damages to the landowner for the loss of property.^lviii

The amendment was in response to a large public outcry at the perceived abuse of adverse possession law that would allow a past mayor and retired judge and his attorney wife in Boulder, Colorado to claim title to a portion of a neighbor’s lot based on their use of a path, tending a garden and building a rock wall for more than 18 years.^lix The case settled with a smaller easement that would allow the neighbors to sell their property.^lx

The requirement that all elements of adverse possession be proven by clear and convincing evidence and made in good faith raises the question of whether possession can give rise to a presumption of adversity with its shifting burden requiring the landowner to come forward with evidence to rebut the presumption.^lxi In theory, the presumption of adversity, which is not evidence but a way of dealing with evidence,^lxii no longer applies. As a result, sanctity of title regained its stature with the return of the presumption of permissiveness to protect ownership.^lxiii

Ostensibly, the Legislature fulfilled its role of watching over the general welfare of Colorado by weakening, if not undoing, the codification of the presumption of adversity in the adverse possession statute to secure title to property.^lxiv

COMMON LAW PRESCRIPTIVE EASEMENTS

The Colorado Supreme Court took a different approach with prescriptive easements. Lo Viento Blanco strengthened the presumption of adversity by making it more difficult for landowners to challenge the use of property giving rise to the presumption.

In Lo Viento Blanco, the adverse claimant, Woodbridge, offered to buy the owner’s property after asking for permission and receiving permission, albeit with conditions, to landscape the property before the 18-year prescriptive period had lapsed. The Court found this evidence did not rebut the presumption of adversity and declined to overturn a lower court’s decision granting an exclusive prescriptive easement over the majority of the undeveloped property for visual appearance, skiing and maintenance of property bordering a condominium complex.^lxv

The Court decided that Woodbridge’s letter asking for the owner’s permission to landscape the property did not interrupt the presumption of adversity^lxvi because the owner responded by giving its permission with conditions which Woodbridge did not accept.^lxvii

On its face an adverse claimant asking a landowner for permission to landscape the landowner’s property is not notice to the landowner of an adverse use and as a result fails to meet the “open and notorious” element for prescriptive easements.^lxviii A claimant asking permission to landscape the same property that they are maintaining does not create a cause of action for “trespass, nuisance or interference” as the Restatement (Third) of Properties (Servitudes)(2000) defines adversity.^lxix Ownership of the property is acknowledged or recognized when a claimant asks the owner for permission to use their property.^lxx

The general concept that acknowledging or recognizing the title of the owner during the prescriptive period interrupts a presumption of adversity originated with the Colorado Supreme Court in Segelke v. Atkins,^lxxi an adverse possession case. Pagel v. Reyman^lxxii and Trask v Nozisko^lxxiii applied this concept to prescriptive easement cases.

In Pagel, an agreement to move mobile homes over the owner’s property represented an acknowledgment of owner’s title because the owner could withdraw his permission to use the right of way and precluded a prescriptive easement.^lxxiv In Trask, a prescriptive easement for parking was granted because the adverse claimant told the owner that she did not believe he owned the property.^lxxv Since the adverse claimant did not acknowledge or recognize the owner’s title, her use was not permissive but adverse and supported a prescriptive easement. In both cases, acknowledging or recognizing title in the owner addressed the issue whether the adverse claimant’s use of the property was permissive or adverse.

The Lo Viento Blanco Court followed a different line of reasoning: acknowledging or recognizing title in the owner applies to the “hostile” element (claim to exclusive ownership) of adverse possession and not to whether a use is permissive or adverse^lxxvi for prescriptive easements. By making the istinction that recognizing or acknowledging title only applies to adverse possession cases and not prescriptive easement cases, the Court determined that asking an owner for permission to use property or offering to buy property does not rebut a presumption of adversity or prove adverse claimant’s use is subordinate^lxxvii or permissive. In so doing, the Court overruled Trask with the comment that the lower court “did not appear to recognize the above-described distinction.”^lxxviii

It is not clear why asking for permission to use or offering to buy the owner’s property would not also be evidence to prove a use was permissive or in subordination of the landowner. The Colorado Supreme Court in Smith v Hayden^lxxix used the same evidence to determine both the “hostile” and “adverse” elements for adverse possession. At the very least, one would assume that the letters exchanged by the owner and Woodbridge are actual evidence that would be legally sufficient to rebut a presumption of adversity implied by possession during the prescriptive period.

As certiorari was granted on whether acknowledging or recognizing landowner’s title by an adverse claimant during the prescriptive period defeats the presumption of adversity and the Court decided it did not, the Court’s additional decision to require an actual agreement to prove permissiveness and rebut the presumption of adversity reaffirms the importance of possession and the presumption of adversity in Colorado prescriptive easement cases going forward.

Prior to Lo Viento Blanco, Colorado law did not require an “actual agreement” to show permissiveness.^lxxx A landowner could interrupt an adverse possession claim^lxxxi or prescriptive easement claim^lxxxii by giving permission. Acceptance of landowner’s permission was not necessary to rebut a presumption of adversity.

“When a landowner gives another person permission to use a road, whether the other person believes he needs such permission or not is immaterial in determining whether the other's use is permissive when the permission is given. By granting permission, the owner has exercised dominion over the property in a way which necessarily renders the other's use of the road permissive rather than adverse.”^lxxxiii

After the decision,** a landowner’s grant of permission during the prescriptive period does not interrupt a prescriptive easement claim unless it is accepted by the adverse claimant.^lxxxiv The decision tacitly adopts, as new law, Restatement (Third) Properties (Servitudes) § 2.17 cmt. j which states: “Nor does the grant of permission to the prescriptive user work an interruption unless the user submits to the title of the landowner by accepting the license offered.”^lxxxv

Moving forward after Lo Viento Blanco, presumptions of adversity in prescriptive easement cases will be more difficult to overcome. Adverse claimants can rely on mere possession while landowners will bear the heavier burden of overcoming the presumption of adversity based on such possession. From a policy perspective, Colorado may benefit from judicial support for beneficial use of land but the countervailing effect is the uncertainty and the higher cost of land ownership.^lxxxvi

CONCLUSION

The treatment of presumptions in adverse possession and prescriptive easement cases has taken divergent paths in Colorado with the legislature providing more protection for property ownership while the courts prioritize the productive use of property. The 2008 amendment to C.R.S. §38-41-101 et seq. weakened the presumption of adversity in adverse possession cases, while the recent Colorado Supreme Court Decision in Lo Viento Blanco v. Woodbridge Condominium Association allowed an exclusive prescriptive easement over the majority of the undeveloped property, potentially expanding the boundaries of prescriptive easements into territory formerly claimed by adverse possession.

This conflicting approach can be partly explained by the different interests at state – the whole bundle of property rights versus just a few sticks – and the desire to simplify an otherwise complex area of the law. The legislature has clarified the evidence required to succeed on an adverse possession or prescriptive easement claim, while the courts have narrowed the evidence needed to rebut a presumption of adversity, giving more weight to possession and the implication of an unexplained use.

As society’s values and needs evolve, it is likely that the direction of Colorado’s prescriptive rights will continue to change in response. The legislature will continue to make policy decisions but not with the agility the judiciary has demonstrated in its ability to adapt to the needs of a modern, congested and sophisticated society. Property law practitioners will be better able to serve their clients with the understanding that it is important to be proactive in protecting property rights and to combine prescriptive easement claims with adverse ones in the event of litigation.

Notes

i
Author represented Lo Viento Blanco LLC in the litigation discussed in this article. ↩︎
ii
Colo. Rev. Stat. §38-41-101(3)-(5) (2022 Edition). ↩︎
iii
Lo Viento Blanco, LLC v. Woodbridge Condominium. Association, Inc., 489 P.3d 735 (Colo. 2021). ↩︎
iv
Rome v. HEI Res., Inc., 411 P.3d 851, 859 (Colo. App. 2014). ↩︎
v
Vititoe v. Rocky Mountain Pavement Maint., Inc., 412 P.3d 767, 783 (Colo. App. 2015). ↩︎
vi
CRE 301. ”In all civil actions and proceedings not otherwise provided for by statute or by these rules, a presumption imposes upon the party against whom it is directed the burden of going forward with evidence to rebut or meet the presumption but does not shift to such party the burden of proof in the sense of the risk of non-persuasion, which remains throughout the trial upon the party on whom it was originally cast.” ↩︎
vii
Gerner v. Sullivan, 768 P2d 701, 702 (Colo. 1989) (Colorado Supreme Court reduced the burden of proof in adverse possession cases from “clear and convincing” to “preponderance” in order to comply with a legislative mandate for a “preponderance” burden in civil cases in C.R.S. §13-25-127(1)). ↩︎
viii
Colo. Rev. Stat. §38-41-101(4). ↩︎
ix
Supra nt. 6. ↩︎
x
Krueger v. Ary, 205 P.3d 1150, 1156 (Colo. 2009). ↩︎
xi
Id. at 1154. ↩︎
xii
Rome, 411 P.3d at 859. ↩︎
xiii
Krueger, 205 P.3d at 1154. ↩︎
xiv
Id. at 1156. ↩︎
xv
Id. at 1153. ↩︎
xvi
Id. at 1156. ↩︎
xvii
LR Smith Invs., LLC v. Butler, 378 P.3d 743, 747 (Colo. App. 2014) (citing "Lobato v. Taylor, 71 P.3d 938, 970–71 (Colo.2002) (Kourlis, J., dissenting); see also 2 Cathy Stricklin Krendl, Colorado Practice Series: Methods of Practice § 65:5(3.1) (2014) (“By modern decisions, prescription is recognized as a doctrine analogous to the doctrine of adverse possession.”). ↩︎
xviii
McIntyre v. Board of County Com’rs, 86 P.3d 402, 418 (Colo. 2004) ("'Adverse use' is defined as 'use without license or permission.' Black's Law Dictionary 53 (6th ed.1990)." See also Restatement (Third) of Property (Servitudes) §2.16 cmt. b. (Am. Law Inst. 2000). ↩︎
xix
Connell v Clifford, 39 Colo. 121, 125 (1907) (“One cannot waive or acquiesce in a wrong while ignorant that it has been committed.”). ↩︎
xx
Smith v. Hayden, 772 P.2d 47, 52 (Colo. 1989). ↩︎
xxi
Olson v. Hillside Community Church Sbc, 124 P.3d 874, 880 (Colo. App. 2005). ↩︎
xxii
Id. See also Restatement at § 2.17 cmt. h (“An openly visible and apparent use satisfies the requirement even if the neighbors have no actual knowledge of it.”). ↩︎
xxiii
See Smith, 772 P.2d at 52. ↩︎
xxiv
LR Smith Investments, 378 P.3d at 747. ↩︎
xxv
Restatement at § 2.16 cmt. g. ↩︎
xxvi
Restatement at § 2.17 cmt. c (“use for the prescriptive period provides sufficient substitute proof of the parties' intent to create a servitude.”). ↩︎
xxvii
Lobato, 71 P.3d at 964-965 (“Our legislature adopted a thorough statutory regime intended to ensure titles to real property are secure and marketable… This court, over the decades, has consistently required conveyances to comply with such laws at the time of the document's creation to give full effect to the goal of security and marketability of real property titles.”). ↩︎
xxviii
Trueblood v. Pierce, 179 P.2d 671, 677 (Colo. 1947). ↩︎
xxix
Vade v. Sickler, 195 P.2d 390, 391 (Colo. 1948). ↩︎
xxx
Restatement at § 4.1 cmt. h. ↩︎
xxxi
Cox v. Godec, 108 P.2d 876, 879 (1940) ("There is no presumption arising from mere possession, however long it may continue, that the holding is adverse."). ↩︎
xxxii
Evans v. Welch, 68 P. 776, 778 (Colo. 1902) (“possession of property is in consonance or harmony with the rights of the owner and any entry onto the land was presumed to be with the permission of the landowner”). ↩︎
xxxiii
Edelstein v. Carlile, 78 P. 680 (Colo. 1904). ↩︎
xxxiv
Latta v. Clifford, 45 F. 108, 109 (C.C.D. Colo. 1891) (“This is a new country, in which presumptions as to title are as yet not much needed.”). ↩︎
xxxv
See Supra nt. 27. ↩︎
xxxvi
This confusion is not unique to Colorado. See Lobato, 71 P.3d at 953 n. 11. ↩︎
xxxvii
Lobato, 71 P. 3d at 954 ("a use that is made pursuant to the terms of an intended but imperfectly created servitude.). ↩︎
xxxviii
Id. citing Restatement at § 2.16 cmt a (“To avoid these convoluted explanations and the errors that follow literal applications of the terms “adverse” and “hostile,” this section adopts a definition of prescriptive uses that straightforwardly recognizes the two types of uses that can lead to prescriptive rights.”). ↩︎
xxxix
Restatement at § 2.16 cmt. g. ↩︎
xl
Trueblood 179 P.2d at 678. ↩︎
xli
Allen v First Nat. Bank of Arvada, 208 P.2d 935, 940 (1949). ↩︎
xlii
Durbin v. Bonanza Corp., 716 P.2d 1124, 1129 (Colo. App. 1986). Simon v. Pettit, 651 P.2d 418 (Colo.App.1982), aff'd, 687 P.2d 1299 (Colo.1984). ↩︎
xliii
LR Smith Investments, 378 P.3d at 747 (citing Cox, 108 P.2d at 879). ↩︎
xliv
See Supra nt. 27. ↩︎
xlv
Cielo Vista Ranch I, LLC v. Alire, 433 P.3d 596, 621 (Colo. App. 2018) (citing at Restatement at § 4.10 cmt. b ("'In resolving conflicts among the parties to servitudes, the public policy favoring socially productive use of land generally leads to striking a balance that maximizes the aggregate utility of the servitude beneficiary and the servient estate.') ↩︎
xlvi
Restatement at § 2.17 cmt. b (“Acquisitive-prescription theory is reflected in the view that use for the prescriptive period does more than bar the possessor's right to legal relief. It also creates a property right--a servitude--in the prescriptive user.”). ↩︎
xlvii
Restatement at § 2.17 cmt. c.** ↩︎
xlviii
Restatement at § 2.16 cmt. g.** ↩︎
xlix
See Supra nt. 27. ↩︎
l
Lobato, 71 P.3d at 953, ↩︎
li
Id. ↩︎
lii
Id.. ↩︎
liii
Matoush v. Lovingood, 177 P.3d 1262 (Colo. 2008). ↩︎
liv
Id. at 1265. ↩︎
lv
Id. at 1270-1271. ↩︎
lvi
Id. at 1265. ↩︎
lvii
Lobato,71 P.3d at 964 (citing Am. Land Co. v. Zeiss, 219 U.S. 47, 60, 31 S. Ct. 200, 55 L. Ed. 82 (1911) and BFP v. Resolution Trust Corp., 511 U.S. 531, 544, 114 S. Ct. 1757, 128 L.Ed.2d 556 (1994). ↩︎
lviii
CRS § 38-41-101(3). ↩︎
lix
McLean and Stevens v. DK Trust and Kirlin, Boulder District Court Case No. 06 CV 982 (filed Oct. 4, 2006). ↩︎
lx
https://www.dailycamera.com/2009/08/14/boulders-infamous-land-grab-case-settled. ↩︎
lxi
Geoffrey P. Anderson, David M. Pittinos, Adverse Possession After House Bill 1148, , 37 Colo. Law. 73, 77 (November 2008). ↩︎
lxii
Fed. R. Civ. P. Rule 301. Notes of Committee on the Judiciary, Senate Report No. 93–1277. ↩︎
lxiii
See William G. Ackerman & Shane T. Johnson, Comment, Outlaws of the Past: A Western Perspective on Prescription and Adverse Possession, 31 Land & Water L. Rev. 79, 94-95 (1996) (taking someone else’s property without paying for it is in “contravention of the ideals set forth in the U. S. Constitution of protecting life, liberty and property.). ↩︎
lxiv
C.R.S. § 38-41-101(1) ("Eighteen years' adverse possession of any land shall be conclusive evidence of absolute ownership."). ↩︎
lxv
Woodbridge Condo. Ass’n, Inc. v. Lo Viento Blanco, LLC, 490 P.3d 598, 611 (Colo. App. 2020). ↩︎
lxvi
Lo Viento Blanco, 489 P.3d at 742 (“the mere fact that Woodbridge sought permission (which it did not ultimately receive) to landscape the disputed parcel did not interrupt its adverse (i.e., nonpermissive) use.”) ↩︎
lxvii
Id. (“the owner responded it would give permission if Woodbridge would agree to certain conditions (including relinquishing any claim to rights in the easement) and that Woodbridge did not accept those conditions and continued using the property as its own."). ↩︎
lxviii
Olson, 124 P.3d at 880. ↩︎
lxix
Restatement at § 2.16 cmt. f. ↩︎
lxx
Trask v Nozisko, 134 P. 3d 544, 553 (Colo. App. 2006). ↩︎
lxxi
Segelke v. Atkins, 357 P.2d 636, 638 (Colo. 1960) (Parties lease was acknowledgment of title). See also Hunter v Mansell, 240 P.3d 469, 475 (Colo. App. 2010) ( 2006 affidavit of wives describing oral agreement between their deceased husbands in 1976 acknowledging owner’s title to land where neighbor built a shed showed permissive use.). ↩︎
lxxii
Pagel v. Reyman, 628 P.2d 166, 168 (Colo.App.1981). ↩︎
lxxiii
Trask, 134 P. 3d at 553. ↩︎
lxxiv
Pagel, 628 P.2d at 168. ↩︎
lxxv
Trask, 134 P. 3d at 553. ↩︎
lxxvi
Lo Viento Blanco, 489 P.3d at 741. ↩︎
lxxvii
“Subordination” and “permissive” express the same concept. “To express the idea that an adverse use cannot be in subordination to the rights of the owner, it is frequently said that the use must be made under claim of right.” Restatement at § 2.16 cmt. f. McIntyre, 86 P.3d at 417 (Colo. 2004) ("[T]he terms 'use under a claim of right' and 'adverse use' are synonymous." (Martinez, J., dissenting)) ↩︎
lxxviii
Lo Viento Blanco, 489 P.3d. at 743. ↩︎
lxxix
See Smith, 772 P.2d at 55-56 (“Hayden bases this argument on the same conversations and facts she relied on above to argue that the Smiths' use was permissive. That is, Hayden asserts that Smith's conversations with Chace and Hayden amounted to a recognition by the Smiths that they were not the record owners of the property.”). ↩︎
lxxx
LR Smith Investments, LLC, 378 P.3d at 748 ("an erroneous requirement that only “an actual agreement” between the parties demonstrates permission."). ↩︎
lxxxi
McKenzie v. Pope, 33 P.3d 1277, 1280 (Colo. App. 2001) (“permission to use the property is granted to the adverse possessor by the true owner during the statutory period.”). ↩︎
lxxxii
Brown v. Faatz, 197 P.3d 245, 250 (Colo.App. 2008). ↩︎
lxxxiii
Id. (Owner’s installation of a gate is generally deemed to make public’s use of a road permissive). ↩︎
lxxxiv
Lo Viento Blanco, 489 P.3d at 742 ("Woodbridge did not accept those conditions and continued using the property as its own."). ↩︎
lxxxv
Cf. Restatement at § 2:16 cmt. f (“When a property owner gives permission to use property, the law implies that a license was intended.”). ↩︎
lxxxvi
Restatement at § 2:17 cmt. c (“On the negative side, it discourages neighborly conduct and accommodation. Landowners are required either to formalize permissive arrangements, or to prevent use by others to avoid the risk that rights will be established by prescription. Prescription tends to increase the costs of land ownership by creating a need for periodic monitoring to detect adverse uses.”). ↩︎

Toni Morrison Nobel Lecture 1993

James A. Knowlton — Tue, 13 Aug 2019 00:00:00 GMT

The vitality of language lies in its ability to limn the actual, imagined and possible lives of its speakers, readers, writers. Although its poise is sometimes in displacing experience it is not a substitute for it. It arcs toward the place where meaning may lie.

From Toni Morrison's Nobel Lecture, 1993.

Homeowner Associations and Emotional Support Animals

James A. Knowlton — Wed, 26 Sep 2018 00:00:00 GMT

Homeowner Associations, (“HOA”) are increasingly coming under attack for not making “reasonable accommodations” for individuals with disabilities. Specifically, HOAs, through their boards, are open for claims of discrimination under the Fair Housing Act (42 U.S.C. §§ 3601 – 3619) (“FHA”) and Colorado Unfair Housing Practices Act (C.R.S. § 24-34-502.2) (“CUHPA”) for not making an exception to their “no dog policy” when an individual with a disability shows a need for a dog in order to live in a unit governed by the HOA.

The Fair Housing Act (42 U.S.C. §§ 3601 – 3619) (“Act”) and the Colorado Unfair Housing Practices Act (C.R.S. § 24-34-502.2) make it illegal to discriminate against individuals with a disability who want to own or rent housing. A disability can be as obvious as a blind individual with a seeing-eye dog or as obscure as an individual who suffers from chronic anxiety.

The range of disabilities derives from the definition of a “disability” under the FHA: “A physical or mental impairment that substantially limits one or more of the major life activities of such individual”. 29 CFR 1630.2 (g). A mental impairment is “[A]ny mental or psychological disorder, such as an intellectual disability (formerly termed “mental retardation”), organic brain syndrome, emotional or mental illness, and specific learning disabilities. 29 CFR 1630.2 (h). A “major life activity” is defined as “caring for oneself, performing manual tasks, seeing, hearing, eating, sleeping, walking, standing, sitting, reaching, lifting, bending, speaking, breathing, learning, reading, concentrating, thinking, communicating, interacting with others, and working”. 29 CFR 1630.2 (i). And “substantially limits” shall be construed broadly in favor of expansive coverage, to the maximum extent permitted by the terms of the ADA. 29 CFR 1630.2 (j).

If the disability is obvious, a HOA cannot ask for proof of the disability and must allow the person with the disability to have a “service dog” as a “reasonable accommodation” necessary for the disabled person to live in the housing. The definition of a “service dog” is any dog trained to do work or perform tasks for an individual with a disability. Problems rarely arise when the dog is a “service animal” and when they do it is because the animal is dangerous.

Problems occur when the disability is not obvious and the “reasonable accommodation” is to waive enforcement of the HOA “no dog policy” for an “assistance animal” or “emotional support animal.” While there is a difference between “service animals” which are actually trained and “emotional support” animals which are not, both are considered “assistance animals” for purposes of claims of discrimination under the Fair Housing Act (FHA). Assistance animals are usually dogs and some small horses.

The FHA and ADA adopted the broader definition of “assistance animals”, which includes “service dogs”, because these animals provide emotional support, well-being, comfort, or companionship for individuals with disabilities. “Service Animals and Assistance Animals for People with Disabilities in Housing and HUD-Funded Programs” HUD FHEO Notice: FHEO-201-01, April 25, 2013. (Replaced by FHEO 2020-01 on January 28, 2020)

For instance, individuals with chronic anxiety will benefit from an “assistance animal” because it provides “emotional support” in the form of companionship which allows the individual to live in housing the same way as an individual without a disability. Since an “assistance animal” or “emotional support animal” does not need special training most any dog is an “emotional support” animal or “assistance animal” under Federal law. And if supported by “reliable documentation”, the HOA must allow the individual to have the “assistance animal” by making a reasonable accommodation in the form of waiving its “no dog policy.”

60% of all FHA complaints involve the denial of reasonable accommodations and disability access. FHEO 2020-01, p. 4. One reason is that there has been no clear guidance from HUD on what information an HOA may rely on to show a person as a disability and that a service animal would be helpful with the disability.

Unlike individuals with obvious disabilities, HOAs can ask an individual requesting “reasonable accommodation” for “reliable documentation of the disability and the need for a disability-related animal.” “The duty to make a reasonable accommodation does not simply arise from fact that the handicapped person wants such an accommodation made.” Arnal v Aspen View Condominium Association, Inc., 226 F. Supp. 3d 1177, 1186 (D. Colo. 2016). See “Joint Statement of The Department of Housing and Urban Development and the Department of Justice, Reasonable Accommodation under the Fair Housing Act”, issued May 2004 at page 13.

The question becomes what constitutes “reliable documentation”. The Colorado legislature attempted to provides guidance. Colorado law provides only physicians, nurses and mental health providers (“licensees”) are qualified to respond to requests by “patients seeking an assistance animal as a reasonable accommodation in housing”. C.R.S. § 12-36-142, nurses, C.R.S. § 12-38-132.5 and health care providers, C.R.S. § 12-43-226.5. Federal law allows states to supplement the Fair Housing Act. 42 U.S. Code § 3615.

FHEO 2020-01 provides “Guidance on Documentation an Individual’s Need for an Assistance Animal” to which all HOA must refer and direct anyone requesting a “reasonable accommodation” to assess the reliability of proof of a disability and the need for an assistance animal. HUD’s promulgation of this most recent Memo highlights the fact the federal government was not excited about the Colorado legislature stepping in to help clarify the obvious ambiguity of what is “reliable” information. HUD’s own guidance is similar to the Colorado’s guidance but now more persuasive, I guess.

The requirements for the physicians, nurses and mental health care providers are the same. They “shall either: a) Make a written finding regarding whether the patient has a disability and, if a disability is found, a separate finding regarding whether the need for the animal is related to that disability; or b) Make a written finding that there is insufficient information available to make a finding regarding disability or the disability-related need for the animal.” C.R.S. § 12-36-142(1). In order to make a written finding, the “licensee” shall meet with the patient in person; (b) become familiar with the patient and the disability; and (c) is legally and professionally qualified to make the determination.” C.R.S. § 12-36-142(3).

The HOA can inquire into the species but not the breed, size or weight of the assistance animal. U.S. Department of Housing and Urban Development: Service Animals and Assistance Animals for People with Disabilities in Housing and HUD funded Programs, FHEO -2013-10 (“HUD Statement”) at 3. The issue is not the dog but the person with a disability. The HOA cannot collect fees associated with having pets because “emotional support” animals are not considered pets.

The HOA board’s responsibility to uphold its “no dog policy” often creates tension with homeowners because the federal mandate to protect individuals who need a dog because of their disability takes precedence over the majority of homeowners who do not want dogs.

The HOA board’s responsibility to uphold an HOA “no dog policy” requires it to confirm an individual’s disability and verify that the “assistance animal” does assist with the individual’s disability. HOA boards can rely on medical professional and in doing so comply with standards of conduct for non- profit board members to act in “good faith” under Colorado law. C.R.S §7-128-401. The HOA cannot inquire into the details of the disability.

Since a disability under the Act covers a wide range of conditions, which HOA boards are not qualified to assess, they may rely on medical experts to confirm an individual has a disability and separately that an “assistance animal” will help with the disability. In practice, however, a physician may determine there is a disability as defined in the FHA but refers a determination on the need for an “assistance animal” to a mental health provider. Since the Colorado statutes is new it is unclear whether a determination of disability and a determination whether an “assistance animals” will help with the disability can be divided up among medical professionals.

It is important to note that a separate claim for coercion, intimidation, threats or interference may be lodge against a HOA by persons with a disability or by a person trying to help a person with a disability, if fines are levied and an attempt to collect on them has been made. 42 U.S.C. § 3617. This claim can be raised even though a claim for failure to make a “reasonable accommodation” has not been raised. Arnal, 226 F. Supp. 3d. Therefore, it is not advisable to assess fines during the process of obtaining “reliable documentation” of a request for “reasonable accommodation” for an assistance animal.

UCC Article 3 and Mortgage Backed Securities

James A. Knowlton — Mon, 07 May 2012 00:00:00 GMT

Borrowing money to buy a home used to be straightforward. Nowadays, the promise to pay back the borrowed money (Note) is transferred into securities, known as mortgage-backed securities (MBS), and pieces of this MBS are sold in the form of certificates to investors all over the world. The Deed of Trust, which secures the promise to pay with the home, also known as a mortgage, lives in a virtual world somewhere between your home and the investors in the security holding your Note.

UNIFORM COMMERCIAL CODE

The transfer of the Note into securities is governed by the Uniform Commercial Code (“UCC”)¹. The UCC is a set of laws adopted by most states to maintain uniformity in commercial transactions. The sale and transfer of promissory notes are commercial transactions governed by the UCC. UCC Article 3 and Article 9 are the substantive provision applying to the transfer of promissory notes and their status once inside a MBS.² C.R.S. 38-38-101 et seq. are the procedural laws governing foreclosure under Allen v. Bailey, 91 Colo. 260, 14 P.2d 1087 (Colo. 1932). Article 9 governs if there is conflict with Article 3.³

Article 3 applies to “negotiable” instruments. Article 9 applies to “security interests”. Promissory notes can be both “negotiable instrument” and “security interests”. While there is some discussion whether Notes are negotiable and therefore the applicability of Article 3⁴, Article 9 specifically identifies the “sale of a promissory note” (Note) as a commercial transaction covered by Article 9.⁵

ARTICLE 3

Article 3 lays out the requirements that allow Notes to travel from one owner to another.⁶ Think of checks you write as “instruments” showing your promise to pay a sum of money. Article 3 uses the terms “transfer” or “negotiation” to define the type of travel. The minimum requirement for transferring a Note is an indorsement.⁷ An indorsement can be made out “to order” of a specific person or “to bearer”.⁸ For example a check made out to a specific person is “to order” and a check made out in blank can be cashed by anyone who has possession.

With limited exceptions, possession of the Note with an indorsement is required to enforce the Note and it does not matter if coming into possession is “wrongful”. A person in possession of the Note with an indorsement is considered a “holder” of the Note with the right to enforce the Note.⁹

The reason for focusing on possession of a Note to enforce it, regardless of how one comes into possession, is the premium placed on keeping commercial activity moving. Commercial activity moves when the one obligated to pay a sum of money knows who to pay. Possession is the best way to identify who to pay. And, to complete the symmetry, the only way to discharge a debt is to pay the one who has the power to enforce it¹⁰ or simply the one in possession.

ARTICLE 9

Prior to 2001 Article 9 applied only to personal property. In 2001 Article 9 was changed to apply to the sale of promissory notes.¹¹ Under Article 9, the Note takes on a legal significance different from a “negotiable instrument” under Article 3. The Note becomes security for its underlying obligation to pay a certain sum of money. The Note does not lose its identity as a promise to pay because it is transferred into a MBS.¹² A Note, once lodged in a MBS, is both a promise to pay and a security interest for the promise to pay.

The concept that a Note becomes the security for itself is a strange concept when compared to the original structure of a home loan in which the home secures the promise to pay with a deed of trust or mortgage.

The concept is less strange when one understands that the reason for allowing Notes to lodge in mortgage backed securities is to provide more money in order that more homes can be bought.

Article 3 and Article 9 are similar in their requirements that a promissory note signed by a homeowner to purchase a home and sold into the stream of commerce must be in possession of the person or entity enforcing the Note after a default.

A person or entity comes into possession of a “promissory note”¹³ through a sale and is a considered “secured party”¹⁴ with a right to “enforce” the note if three requirements are met:

Value is given,( which means any consideration that would support a simple contract) ;
Debtor has rights in the collateral or power to transfer the collateral; and
Collateral is in possession of the Debtor pursuant to debtor’s security agreement.¹⁵

A person or entity in possession¹⁶ of a promissory note has the right to enforce the Note by any judicial procedure, including “foreclosure”.¹⁷ Article 9 helps with foreclosure by specifically providing that the deed of trust follows the note,¹⁸ a concept reaffirmed by the Colorado Supreme Court in Columbus Investment v. Lewis, 48 P.3d 1222 (Colo. 2002).¹⁹

If one were to challenge the standing of a trustee of a MBS to bring a foreclosure on a Note within a MBS, a challenge might focus on whether “value” was given or whether the MBS ever obtained possession of the Note.

As “value”²⁰ is defined as any consideration to support a simple contract, the consideration of transferring a Note into a MBS would not be hard to find. The MBS buys the Note at a discount and assumes the right and obligation to collect the monthly mortgage payments and disperse these monthly payments minus administrative and other deductions to investors in the MBS. Either the money or the assumption of responsibility for holding the Note constitute consideration to satisfy the requirement of “value”.

POSSESSION

Possession of a security interest would necessarily follow the Pooling and Service Agreement of the MBS as mandated by securities regulations and explored in an earlier post, titled PSA Defense.

A difference between Article 9 and Article 3 is whether the Trustee of a MBS must prove its right to enforce the Note by filing an affidavit in the public land records pursuant to UCC 4-9-607.²¹ Colorado’s non-judicial foreclosure statute provides for the filing of this affidavit with the Public Trustee at the same time as it is filed with County Clerk and Recorder.²² It is not clear if any foreclosures comply with this requirement. A reason for not complying with this voluntary recording is the penalty provisions of C.R.S. § 38-35-109(3) for filing a knowingly false document.²³

Another difference between Article 9 and Article 3 is that there appears to be no corollary requirement for an indorsement.²⁴ Indorsements insure the person or entity enforcing the Note has rightful possession of the Note. If the Note is not covered by Article 3 because it is not negotiable, the only way to insure that the Note is in possession of the person or entity entitled to enforce the Note is that the person or entity has actual possession of the Note.

But does possession alone show that the one in possession is entitled to enforce the Note through a foreclosure? UCC § 4-9-203 states that possession is “pursuant to a security agreement”. A “security agreement” is defined as “an agreement that creates a security interest.”²⁵ A security interest is defined as an interest of a buyer of “a promissory note in a transaction that is subject to article 9 of this title.”²⁶ Comment 4 to UCC § 4-9-203 states that: “In the unlikely event that possession is obtained without the debtor's agreement, possession would not suffice as a substitute for an authenticated security agreement.” Therefore the only agreement that qualifies as a debtor security agreement would be the Note itself.

Promissory notes contain language similar to: “I understand that he Lender may transfer this Note. The Lender or anyone who takes this Note by transfer and who is entitled to receive payments under this Note is called the “Note Holder”. “Transfer” is defined in C.R.S. § 4-3-203 (a): “An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.”

According to the above traverse of the UCC, it appears that no indorsement is necessary to show that the person or entity trying to foreclose is entitled to foreclose under Article 3 but is necessary for Article 9. All the more reason to insist on production of the original note in a foreclosure.

Notes

1
“UCC” in this Blog refers to Colorado statutes adopting the UCC at C.R.S. §4-1-101 et seq. ↩︎
2
UCC 4-3-104 and UCC 4-1-201(35) ↩︎
3
UCC 4-3-102 ↩︎
4
“Mortgage Documentation Issues Close to (my) Home” by Jean Braucher, Credit Slips, October 28, 2011, http://www.creditslips.org/creditslips/2011/10/mortgage-documentation-issues-close-to-my-home.html#more ↩︎
5
UCC 4-9-109 Comment 7: Security Interest in Obligation Secured by Non-Article 9 Transaction. Subsection (b) is unchanged in substance from former Section 9-102(3). The following example provides an illustration. O borrows $10,000 from M and secures its repayment obligation, evidenced by a promissory note, by granting to M a mortgage on O's land. This Article does not apply to the creation of the real-property mortgage. However, if M sells the promissory note to X or gives a security interest in the note to secure M's own obligation to X, this Article applies to the security interest thereby created in favor of X. The security interest in the promissory note is covered by this Article even though the note is secured by a real-property mortgage. Also, X's security interest in the note gives X an attached security interest in the mortgage lien that secures the note and, if the security interest in the note is perfected, the security interest in the mortgage lien likewise is perfected. See Sections 9-203, 9-308. ↩︎
6
UCC 4-3-104 Negotiable instrument(a) Except as provided in subsections (c) and (d) of this section, “negotiable instrument” means an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it: (1) Is payable to bearer or to order at the time it is issued or first comes into possession of a holder; (2) Is payable on demand or at a definite time; and (3) Does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor. ↩︎
7
UCC 4-3-204 (a) “Indorsement” means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument…” ↩︎
8
UCC 4-3-109 ↩︎
9
UCC 4-3-301. Person entitled to enforce instrument: “Person entitled to enforce” an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to section 4-3-309or 4-3-418(d). A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument. ↩︎
10
Comment 2 to UCC 4-3-102. “The issuer of a negotiable instrument, on the other hand, may discharge its obligation to pay the instrument only by paying a person entitled to enforce under Section 3-301.” ↩︎
11
UCC 4-1-201 (35) “Security interest” means an interest in personal property or fixtures that secures payment or performance of an obligation. The term also includes any interest of a consignor and a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to article 9 of this title. ↩︎
12
Be aware of any outfit who says differently. Mortgage Securitization reports or analysis are not legal documents. ↩︎
13
UCC 4-9-102 (68) “Promissory note” means an instrument that evidences a promise to pay a monetary obligation …” ↩︎
14
UCC 4-9-102(75) “Secured party” means: (D) A person to which accounts, chattel paper, payment intangibles, or promissory notes have been sold;” ↩︎
15
UCC 4-9-203. Attachment and enforceability of security interest; proceeds; supporting obligations; formal requisites(a) A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment.(b) Except as otherwise provided in subsections (c) to (i) of this section, a security interest is enforceable against the debtor and third parties with respect to the collateral only if: (1) Value has been given; (2) The debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) One of the following conditions is met: (A) The debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned; (B) The collateral is not a certificated security and is in the possession of the secured party under section 4-9-313 pursuant to the debtor's security agreement; ↩︎
16
UCC 4-9-313. When possession by or delivery to secured party perfects security interest without filing (a) Except as otherwise provided in subsection (b) of this section, a secured party may perfect a security interest in tangible negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession of the collateral. ↩︎
17
UCC 4-9-601(a) After default, a secured party has the rights provided in this part 6 and, except as otherwise provided in section 4-9-602, those provided by agreement of the parties. A secured party: (1) May reduce a claim to judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure; ↩︎
18
UCC 4-9-203 (g) The attachment of a security interest in a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest in the security interest, mortgage, or other lien. ↩︎
19
Curious that this case, with a rather harsh result, applied Article 9 prior to its amendment adding promissory notes as a “secured interest”. ↩︎
20
UCC 4-1-204. Value Except as otherwise provided in articles 3, 4, and 5 of this title, a person gives value for rights if the person acquires them:(1) In return for a binding commitment to extend credit or for the extension of immediately available credit, whether or not drawn upon and whether or not a charge-back is provided for in the event of difficulties in collection;(2) As security for, or in total or partial satisfaction of, a preexisting claim;(3) By accepting delivery under a preexisting contract for purchase; or(4) In return for any consideration sufficient to support a simple contract. ↩︎
21
(b) If necessary to enable a secured party to exercise under paragraph (3) of subsection (a) of this section the right of a debtor to enforce a mortgage non-judicially, the secured party may record in the office in which a record of the mortgage is recorded:(1) A copy of the security agreement that creates or provides for a security interest in the obligation secured by the mortgage; and(2) The secured party's sworn affidavit in recordable form stating that:(A) A default has occurred; and(B) The secured party is entitled to enforce the mortgage non-judicially. (c) A secured party shall proceed in a commercially reasonable manner if the secured party: ↩︎
22
C.R.S. § 38-38-101(f) (f) Any affidavit recorded pursuant to section 38-35-109(5) affecting the deed of trust described in paragraph (c) of this subsection (1), which affidavit shall be accepted by the public trustee as modifying the deed of trust for all purposes under this article only if the affidavit is filed with the public trustee at the same time as the other documents required under this subsection (1); ↩︎
23
(3) Any person who offers to have recorded or filed in the office of the county clerk and recorder any document purporting to convey, encumber, create a lien against, or otherwise affect the title to real property, knowing or having a reason to know that such document is forged or groundless, contains a material misstatement or false claim, or is otherwise invalid, shall be liable to the owner of such real property for the sum of not less than one thousand dollars or for actual damages caused thereby, whichever is greater, together with reasonable attorney fees. Any grantee or other person purportedly benefited by a recorded document that purports to convey, encumber, create a lien against, or otherwise affect the title to real property and is forged or groundless, contains a material misstatement or false claim, or is otherwise invalid who willfully refuses to release such document of record upon request of the owner of the real property affected shall be liable to such owner for the damages and attorney fees provided for in this subsection (3). ↩︎
24
Comment to UCC 4-3-203 states that: “Because the transferee's rights are derivative of the transferor's rights, those rights must be proved. Because the transferee is not a holder, there is no presumption under Section 3-308 that the transferee, by producing the instrument, is entitled to payment. The instrument, by its terms, is not payable to the transferee and the transferee must account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it. Proof of a transfer to the transferee by a holder is proof that the transferee has acquired the rights of a holder.” ↩︎
25
UCC § 4-9-102(76). ↩︎
26
UCC § 4-1-201(35). ↩︎

No Rubber Stamp for Business Records Exception to Hearsay

James A. Knowlton — Wed, 28 Sep 2011 00:00:00 GMT

To foreclose, you need the original promissory note (Note) with the original endorsement or assignment, if any, and the original recorded deed of trust.¹

As a matter of proof the original Note with endorsements or assignments and the original recorded deed of trust is the best evidence.² CRE 1002 requires that the contents of a writing be proven by the original writing. The original note is authentic and reliable evidence that the debtor owes money³. The original deed of trust establishes the authority of the Public Trustee to sell the property securing the notes. And the original endorsement establishes that the holder, one in possession, is the real person entitled to foreclose on the outstanding debt.

The Colorado foreclosure statute also allows copies of the Note, its assignment, if any, and recorded deed of trust⁴ to commence a foreclosure if accompanied with a certification that the note, assignment and deed of trust are true and correct copies of the original and accompanied by a promise to indemnify the debtor if the original note appears.⁵

Article 3 of the Uniform Commercial Code offers insight into how a certification as to the accuracy of copies of a Note with proper endorsement and deed of trust allow a foreclosure to proceed with a promise to indemnify.

C.R.S. § 4-3-309(b)⁶ simply says that in order for a person to foreclose without the original note, assignment and deed of trust that person must provide some “adequate protection” to the debtor if the original note and deed of trust somehow appears after enforcement of the note. The comment to this section states that “adequate protection” is a flexible concept depending on the “degree of certainty about the facts in the case”.⁷

With the complex process of bundling home loans and transferring them into mortgage backed securities (MBS), there is “a degree of uncertainty” whether the person bringing a foreclose action has a right to foreclose.

For instance, the Note and deed of trust may have been misplaced or lost as they are transferred from the original lender through various intermediaries into a mortgage backed security (MBS). Or there may have been no valid endorsement or endorsements transferring the Note into the MBS as required for the integrity of the MBS.

Producing the original Note with the proper endorsements and the deed of trust shows ownership and the right to enforce the Note by foreclosure. Original notes and valid endorsements also insure clear title when the property is subsequently sold.

Copies of promissory notes are not allowed when obtaining a default judgment⁸and should not be allowed in a foreclosure because foreclosure is the same as obtaining a default judgment.⁹

In most Colorado foreclosures, producing the original note and deed of trust satisfies the foreclosure statute C.R.S. § 38-38-101’s definition of “holder of evidence of debt” and courts will allow a foreclosure to continue. If copies are produced, the foreclosing party can argue enforcement of a lost instrument¹⁰ or prove the copies’ authenticity by arguing their admissibility under the business records exception to the hearsay rule discussed below.¹¹

Even with possession of the original Note and deed of trust, if the Note and deed of trust have not been transferred into the MBS before its closing date, the representative of the MBS has no authority or standing to bring a foreclosure.¹² The endorsement or endorsements trace the transfers and establishes the right of the holder of the Note to enforce it.

The trust, responsible for holding pools of home loans (notes and deed of trusts) in a particular MBS, require a clear separation from the originators of the home loans through various intermediaries to the MBS. An endorsement from the originator into the trust creates the separation and establishes the MBS’s ownership of the home loans.

A complete chain of endorsements from originator into the trust are unlikely because “the rapid growth of mortgage securitization outpaced the ability of the legal and financial system to track mortgage loan ownership.¹³ More common is a blank endorsement on the note or on a separate piece of paper called an allonge. Possession of a Note with an original blank endorsement satisfies Colorado’s foreclosure statute’s requirement that a “holder of evidence of debt”¹⁴ has a right to foreclose.

However, possession of the note with a blank endorsement does not necessarily mean the foreclosing party has the right to foreclose when the holder is a trustee or servicer of a MBS.

As an example, a foreclosing party appears at a Rule 120 hearing with the original Note and Deed of Trust and an “original” rubber stamp endorsement on the Note. There is no endorsement on the copy of the Note filed with Public Trustee to initiate the foreclosure. The foreclosing party is a national bank acting as Trustee for a MBS. The court approves the foreclosure sale based on the plain language of the foreclosure statute requiring possession of the original Note with endorsement and original deed of trust. The court enters its decision despite the fact that the copy of the Note filed with the Public Trustee months earlier did not show the rubber stamped endorsement presented the day of the Rule 120 hearing.

This example illustrates why rubber stamped endorsements requires proof that they are not fabricated. It is not news that tracking transfers of Notes into a trust has been fraught with uncertainty as highlighted by federal and state investigations into “shoddy paperwork and possible forgeries of legal documents by banks, other lenders or their representatives”.¹⁵

Blank, undated, un-notarized endorsements make it difficult to track home loans into a MBS. And as illustrated above “original” rubber stamp endorsements lack trustworthiness and leave it open for abuses that would not otherwise be available if the substantive law governing the transfer of home loans into securities has more sway than the foreclosure statute.

Article 3 and Article 9 of the Uniform Commercial Code are the substantive laws relating to who has the right to enforce a negotiable instrument. The notes of a home loan are negotiable instruments under Article 3.¹⁶¹⁷ The transfer of a home loan into a security is a secured transaction under Article 9.¹⁸¹⁹. The Colorado foreclosure statute is the adjective law or the process by which security interests are enforced.²⁰

Using our example of the “original” rubber stamp blank endorsement, there must be more evidence than simple possession to show the foreclosing party has authority to foreclose when a loan has been transferred into a MBS. Lack of endorsement on Note would prevent foreclosing party from being “holder” under Colorado law.²¹

Normally, business records are inadmissible as hearsay²² because they are out of court statements about when the note and deed of trust were transferred into the MBS. The “original” rubber stamp blank endorsement is another level of hearsay because it is offered for the truth that the person signing the endorsement did in fact endorse the note. Statements of outside or third parties included in a business record are not granted the same presumption of accuracy, "because the third party has no business duty to report the information accurately.²³

However under the business records exception to the hearsay rule, business records may be introduced into evidence if a proper foundation is laid.²⁴ This exception is based on a presumption of trustworthiness that business records maintained and communicated on a regular basis as part of that business’ activity are less likely to be fabricated when introduced into evidence.²⁵

Under this exception, proof of the transfer or assignment of the home loan into a MBS may be admissible hearsay if there is a record of the transfer made “at or near the time” of the transfer, “by a person with knowledge”, during the course of a “regularly conducted business activity”.²⁶

The person testifying will be a representative of the trustee or servicer bringing the foreclosure action. “The rule does not require that the person with knowledge testify or that such person even be identified as long as the representative testifies that the method by which the record is produced includes its making by a person with knowledge.”²⁷

For example, the foundation for a witness who will testify as to the authenticity of the “original” rubber stamp endorsement should be able to demonstrate that the “original” rubber stamp endorsement was executed by a person with authority acting on behalf of the then current owner of the note at or near the time the Note was to be transferred into the MBS.

Based on the above foundational requirements a witness should also be familiar with the procedure of transferring the home loans into the MBS near or at the closing date for transfers into the MBS trust. Such familiarity gives credibility to testimony about the transfer of home loans into a MBS. A copy of the mortgage schedule listing all the home loans lodged in a MBS should be offered as additional proof that a particular home loan is properly lodged in the MBS.

The “original” rubber stamp endorsement would not pass the test for trustworthiness because it appeared after the filing of the foreclosure not “near or at the time” of when it was supposed to be transferred; it was done not in the course “regularly conducted business activity” but for litigation; and the signature on the rubber stamp was not by “by a person with knowledge”.²⁸

The lesson to learn is make sure the court sees the original documents, the Note, deed of trust and the endorsement, when a foreclosed loan is in mortgage backed security.

Notes

1
C.R.S. § 38-38-101. Holder of evidence of debt may elect to foreclose (1) Documents required. (b) The original evidence of debt, including any modifications to the original evidence of debt, together with the original indorsement or assignment thereof, if any, to the holder of the evidence of debt or other proper indorsement or assignment in accordance with subsection (6) of this section … c) The original recorded deed of trust securing the evidence of debt …” ↩︎
2
CRE Rule 1002. Requirement of Original. To prove the content of a writing, recording, or photograph, the original writing, recording, or photograph is required, except as otherwise provided in these rules or by statute of the State of Colorado or of the United States. ↩︎
3
Smith v Weindrop, 833 P.2nd 856, (Colo. App. 1992). Promissory notes are self authenticating under Rule 902(9). ↩︎
4
C.R.S. § 38-38-101 (1)(b)… in lieu of the original, … (II) A copy of the evidence of debt and a certification signed and properly acknowledged by a holder of an evidence of debt … that the copy of the evidence of debt is true and correct … (c) (II) Copies of the recorded deed of trust … and a certification signed and properly acknowledged by a holder of an evidence of debt… certifying or stating that the copies of the recorded deed of trust …are true and correct… ” ↩︎
5
C.R.S. § 38-38-101 (2) Foreclosure by qualified holder without original evidence of debt, original or certified copy of deed of trust, or proper indorsement… shall, by operation of law, be deemed to have agreed to indemnify and defend any person liable for repayment of any portion of the original evidence of debt in the event that the original evidence of debt is presented for payment ..” ↩︎
6
“Enforcement of lost, destroyed, or stolen instrument” b) A person seeking enforcement of an instrument under subsection (a) of this section must prove the terms of the instrument and the person's right to enforce the instrument. If that proof is made, section 4-3-308 applies to the case as if the person seeking enforcement had produced the instrument. The court may not enter judgment in favor of the person seeking enforcement unless it finds that the person required to pay the instrument is adequately protected against loss that might occur by reason of a claim by another person to enforce the instrument. Adequate protection may be provided by any reasonable means. ↩︎
7
“Under Section4- 3-309 adequate protection is a flexible concept. For example, there is substantial risk that a holder in due course may make a demand for payment if the instrument was payable to bearer when it was lost or stolen. On the other hand if the instrument was payable to the person who lost the instrument and that person did not indorse the instrument, no other person could be a holder of the instrument. In some cases there is risk of loss only if there is doubt about whether the facts alleged by the person who lost the instrument are true. Thus, the type of adequate protection that is reasonable in the circumstances may depend on the degree of certainty about the facts in the case.” ↩︎
8
C.R.C.P. Rule 121 Section 1-14(1) (f) “If the action is on a promissory note, the original note shall be presented to the court in order that the court may make a notation of the judgment on the face of the note. If the note is to be withdrawn, a photocopy shall be substituted.” ↩︎
9
See Foothills Holding Corp. v. Tulsa Rig, Reel & Mfg. Co., 155 Colo. 232, 393 P.2d 749, 751 (1964)(suit on a promissory note and an action against particular property may be pursued concurrently or consecutively). ↩︎
10
C.R.S. § 4-3-308 Enforcement of lost, destroyed or stolen instruments. ↩︎
11
In re Goodwin, 779 P 2d 837 (Colo 1989). ↩︎
12
See my April Blog, “Chink in the Armor- A Foreclosure Defense” ↩︎
13
“After the Storm, Foreclosure Fraud & Robo-Signing Continues…” Nye Lavalle, Pew Mortgage Institute Citing the “Congressional Oversight Panel Report of November 16, 2010 titled “Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation.” ↩︎
14
C.R.S. § 38-38-100.3(10) (c). ↩︎
15
“Two States Ask if Paperwork in Mortgage Bundling Was Complete” New York Times, Gretchen Morgenson, June 12. 2011. http://www.nytimes.com/2011/06/13/business/13mortgage.html? ↩︎
16
C.R.S. § 4-3-104(a). ↩︎
17
Haberl v Bigelow, 855 P.2d 1368 (Colo 1993) ↩︎
18
C.R.S. §4-9-109(3). ↩︎
19
Columbus Investments v. Lewis, 48 P.3d 1222 (Colo 2002). ↩︎
20
Allen v. Bailey, 91 Colo. 260, 14 P.2d 1087 (Colo. 1932). ↩︎
21
C.R.S. §§ 4–1–201(20). Barclay Receivables Co. v. Mountain Majesty, Ltd., 903 P.2d 37, 39 (Colo.App.1995) ↩︎
22
CRE 801“out of court statements offered in court for the truth being asserted.” ↩︎
23
Henderson v. Master Klean Janitorial, Inc., 70 P.3d 612 (Colo. App. 2003) ↩︎
24
CRE 803(6) Records of Regularly Conducted Activity. A memorandum report, record, or data compilation, in any form, of acts, events, conditions, opinions, or diagnosis, made at or near the time by, or from information transmitted by, a person with knowledge, if kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the memorandum, report, record, or data compilation, all as shown by the testimony of the custodian or other qualified witness, or by certification that complies with Rule 902(11), Rule 902(12), or a statute permitting certification, unless the source of information or the method or circumstances of preparation indicate lack of trustworthiness. The term "business" as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit. ↩︎
25
See Comment to CRE 803(6). ↩︎
26
Teac Corp. v. Bauer, 678 P.2d 3 (Colo.App.1984) (computer-generated statement of account was admissible as business record where it was based in relevant part upon records supplied by original creditor); ↩︎
27
23 COPRAC §803:6 ↩︎
28
Teac Corp. v. Bauer, 678 P.2d 3 (Colo.App.1984) (computer-generated statement of account was admissible as business record where it was based in relevant part upon records supplied by original creditor); ↩︎

Who Is The Real Party For A PSA Foreclosure?

James A. Knowlton — Wed, 31 Aug 2011 00:00:00 GMT

To foreclose you need possession of the original note and deed to trust representing the residential home loan. If the note and deed of trust have been transferred to a trust as part of securitization, the trustee must comply with Pooling and Servicing Agreement (“PSA”) which gives the Trustee power over all the notes and deed of trust in that particular security.¹

A PSA foreclosure defense is the failure of the note and deed of trust to be transferred into its particular trust or security according to the Pooling and Service Agreement. An argument that a PSA foreclosure defense does not apply to a foreclosure by a Trustee because the homeowner is not a party to the PSA as a third party beneficiary is a misunderstanding of the PSA foreclosure defense.²

A PSA foreclosure defense is not based on the homeowner being a third party beneficiary to the PSA but is based on whether the Trustee has possession of the note and deed of trust, which is a standing issue.

A basic rule of contract law is that “a person not a party to an express contract may bring an action on such contract if the parties to the agreement intended to benefit the non-party, provided that the benefit claim is a direct and not merely an incidental benefit of the contract.” E.B. Roberts Construction Co. v. Concrete Contractors, Inc., 704 P.2d 859, 865 (Colo.1985). Jefferson County School Dist. No. R-1 v. Shorey, 826 P.2d 830 (Colo., 1992).

A homeowner is not a third party beneficiary to a PSA because the PSA is not intended to directly benefit the homeowners.³ The investors in the security which contains a pool of home loans are third party beneficiaries to the PSA because they benefit from the PSA’s requirement that the Trustee oversee the collection of the monthly loan payments and transfer of these funds to the investors.

If the home loan (the note and deed of trust) is not transferred to the trust according to the explicit requirements of the PSA on the transfer of the home loan into the security, the Trustee does not possess the home loan and is precluded from bringing a foreclosure action.

In Colorado, a homeowner can challenge the foreclosing party’s right to bring a foreclosure action in a Rule 120 hearing. Goodwin v. District Court In and For Sixteenth Judicial Dist. 779 P.2d 837, (Colo.1989). Goodwin allows a court in C.R.C.P. 120 motion to decide whether the moving party is a real party in interest.

Courts have the authority to whether a party has a right to bring a foreclosure action because of due process. Due process is a constitutional principle that no person can be deprived of life or liberty or property without adequate legal procedures and safeguards. C.R.S.A. Const. Art. 2, § 25. Plymouth Capital Co., Inc. v. District Court of Elbert County 955 P.2d 1014 (Colo., 1998)

In Colorado, C.R.C.P. Rule 17(a) provides the necessary mechanism to comply with due process by ensuring the “real party in interest” is bringing the foreclosure action. C.R.C.P. 17(a) provides that "every action shall be prosecuted in the name of the real party in interest." "The real party in interest is the party who, by virtue of substantive law, has the right to invoke the aid of the court to vindicate the legal interest in question." In re Goodwin, supra.

Simply, Rule 17(a) ensures the person or entity bringing a foreclosure action has the right to foreclose by asking do they have an "interest," which is material (not incidental) and properly before the court.

With respect to a Trustee bringing a foreclosure action on a home loan within a securitized trust, the question is does the Trustee have an “interest” in the note and deed of trust.

There is Colorado case law that states a trustee who holds legal title to property is a real party in interest. Koch v. Story 47 Colo. 335, 107 P. 1093 (Colo. 1910). Elk-Rifle Water Co. v. Templeton, 173 Colo. 438, 484 P.2d 1211 (Colo. 1971). However, this rule does not apply to a Trustee of a securitized home loan. Colorado is lien theory state, which provides that the holder of a note and deed of trust does not hold legal title to the property. “Colorado has adopted the lien theory of mortgages under which the mortgage or deed of trust creates a lien against real property but does not convey title. Section 38-35-117, C.R.S.⁴ Hohn v. Morrison, 870 P.2d 513 (Colo. App. 1993).

A Trustee can foreclose on a home loan if it has an “interest” in the home loan according to “substantive law” governing the transfer of notes and deeds of trusts into a security.

“We mean by substantive law the positive law of duties and rights which gives rise to a cause of action, as distinguished from adjective law, which pertains to practice and procedure, or the legal machinery by which the substantive law is made effective.” Allen v. Bailey, 91 Colo. 260, 14 P.2d 1087 (Colo. 1932).

In the context of a Rule 120 hearing, the “substantive law” governing the “rights which give” a trustee an “interest” in the home loan and thus the right to foreclose is Article 3 of the Uniform Commercial Code (“UCC”) (C.R.S. §4-3-101 et seq.).

The Colorado foreclosure statute (C.R.S. § 38-38-101 et seq.) sets forth the procedure for foreclosing on a defaulted home loan and is, as such, “adjective law” and not dispositive on who can bring a foreclosure action.

The “substantive law” of Article 3 applies because when the note and deed of trust travel from the original lender in Colorado into a security managed by a Trustee in New York the note becomes a “negotiable instrument”.⁵ In fact the foreclosure statute references Article 3 when it identifies the person entitled to bring a foreclosure action as the “holder”⁶ and defines “holder” in similar terms to Article 3.

The “substantive law” of Article 3 of the Uniform Commercial Code determines whether or not a foreclosing entity is a “entitled to enforce an evidence of debt”. C.R.S. § 4-3-301 provides a “Person entitled to enforce” an instrument⁷ means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to section 4-3-309 or 4-3-418(d). A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument .”

The right to enforce a note in foreclosure depends on the transfer of the note to a person entitled to enforce the “negotiable instrument”. “To be a holder one must meet the two conditions in section 4-1-201(b)(20): (1) he or she must have possession (2) of an instrument drawn, issued, or indorsed to him or her. With rare exceptions, those claiming to be holders have physical ownership of the instrument in question.”⁸

Possession is designed to prevent two or more claimants from qualifying as holders who could take free of the other party's claim of ownership.

The right to possession of the note depends on the transfer. Article 3 provides two ways to transfer a note: “negotiation”⁹ and “transfer”¹⁰. A “negotiation” of a note gives the person in possession the rights of “holder”. A “transfer” gives the person in possession the “right to enforce” the note.

UCC Comment 1 to C.R.S. § 4-3-203(a) explains:

“The right to enforce an instrument and ownership of the instrument are two different concepts….A thief who steals a check payable to bearer becomes the holder of the check and a person entitled to enforce it, but does not become the owner of the check….Moreover, a person who has an ownership right in an instrument might not be a person entitled to enforce the instrument…The right to payment is transferred by delivery of possession of the instrument “by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.”

Under both the Colorado foreclosure statute and Article 3, a “holder” is person in rightful possession of the note: C.R.S. § 4-1-201(20) “Holder” means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession; C.R.S. §38-38-100.3(10)(c) “Holder of an evidence of debt” means the person in actual possession of or person entitled to enforce an evidence of debt. §38-38-100.3(10)(c).

The safest way to transfer a note to ensure a right to payments is to deliver possession with an endorsement¹¹ on the note specifying the name of the party taking ownership of the note. The second safest way to transfer a note is to deliver possession of the note to a party endorsed in blank or endorsed to bearer¹². In both instances the person who has possession of the note is deemed a “holder” with a right to payment on the note.

Endorsement is important because it is the way to know if the person in possession is rightfully in possession. When notes are transferred into a trust for the purpose of securitization, the requirements for endorsements are all the more important. For an outline for all the reason why transfer of a home loan into a securitized trust is stricter than that allowed under Article 3 and state foreclosure laws please refer to my prior blog post “A Chink in the Armor- A Foreclosure Defense”.

The UCC allows stricter requirements for transfers of notes by agreement.¹³ The PSA requires proof of the transfers of the note or a chain of title from original lender to the deposit of the note into a securitized trust for the trust to own the note. The reason for a clear chain of title from lender to the trust serves several purposes. One main reason is to establish the integrity of the trust in order that certificates in the trust can be sold to investors. Another reason is to obtain favorable tax treatment.

A sample of the PSA language which requires a clear chain of title of the note into the trust states:

“In connection with the above transfer and assignment, the Sponsor hereby deposits with the Trustee or the related Custodian, on behalf of the Trustee, with respect to each Mortgage Loan: (i) the original Mortgage Note, endorsed without recourse (A) in blank or to the order of the Trustee or (B) in the case of a Mortgage Loan registered on the MERS system, in blank, and in each case showing an unbroken chain of endorsements.”

If there is no documented chain of title tracking the delivery of the note into the security, the note is not properly lodged within the security and the Trustee has no right to foreclosure as the “real party in interest”.

Therefore, an argument that a homeowner has no right to contest a Trustee’s status as a “real party interest” because the homeowner is not a third party beneficiary of the PSA is an opportunity to explain why a Trustee is bound by the PSA.

C.R.S. § 4-3-203,

Notes

1
Asset Securitization: Comptroller's Handbook, Office of the Comptroller of the Currency, November1997, http://www.occ.treas.gov/handbook/assetsec.pdf. ↩︎
2
“Standing to Invoke PSAs as a Foreclosure Defense”, posted by Adam Levitan, Credit Slips, August 4, 2011. ↩︎
3
See my previous Blog, “Chink in the Armor, A Foreclosure defense” citing an Alabama case, Horace vs. LaSalle Bank National Association, et al., CV-2008-000362.00, (3/30/11) Circuit Court of Russell County Alabama, where Judge found homeowner was third party beneficiary because without the homeowner the security would not be funded. ↩︎
4
§ 38-35-117. Mortgages, not a conveyance--lien theory: Mortgages, trust deeds, or other instruments intended to secure the payment of an obligation affecting title to or an interest in real property shall not be deemed a conveyance, regardless of its terms, so as to enable the owner of the obligation secured to recover possession of real property without foreclosure and sale, but the same shall be deemed a lien. ↩︎
5
C.R.S. 4-3-104(a) Except as provided in subsections (c) and (d) of this section, “negotiable instrument” means an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it:(1) Is payable to bearer or to order at the time it is issued or first comes into possession of a holder;(2) Is payable on demand or at a definite time; and(3) Does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor. ↩︎
6
C.R.S. § 38-38-101. Holder of evidence of debt may elect to foreclose. §38-38-100.3(10) “Holder of an evidence of debt” means the person in actual possession of or person entitled to enforce an evidence of debt. §38-38-100.3(10)(c) The person in possession of a negotiable instrument evidencing a debt, which has been duly negotiated to such person or to bearer or indorsed in blank. Possession of a Note without a proper indorsement to a specific person or “to bearer” is enforceable if the person in possession can “account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it.” Comment 2, ↩︎
7
“Instrument” means a negotiable instrument. C.R.S. §4-3-104. ↩︎
8
Georg v. Metro Fixtures Contractors, Inc. 178 P.3d 1209 (Colo. 2008). ↩︎
9
“Negotiation” means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder. C.R.S. § 4-3-201(a). ↩︎
10
An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument. C.R.S. § 4-3-203(a). ↩︎
11
“Indorsement” means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument. C.R.S. §4-3-204. ↩︎
12
“Bearer” means a person in control of a negotiable electronic document of title or a person in possession of a negotiable instrument, negotiable tangible document of title, or certificated security that is payable to bearer or indorsed in blank. C.R.S. § 4-1-201(5). ↩︎
13
Except as otherwise provided in subsection (b) of this section or elsewhere in this title, the effect of provisions of this title may be varied by agreement. C.R.S. § 4-1-302(1). ↩︎

After Foreclosure: A Housing Surplus

James A. Knowlton — Thu, 30 Jun 2011 00:00:00 GMT

Of the 74.5 million homes in the United States approximately 45 million homeowners borrowed money to buy their homes. Out of these 45 million, six million homeowners have already lost their homes to foreclosure and another ten million are underwater, which mean their homes are worth less than their mortgages.¹ Potentially over 16 million homes could be bank owned and on the market as REO properties.

REO stands for “real estate owned” by a lender typically a bank, government agency, or government loan insurer, after a foreclosure. Once a lender takes possession of the foreclosed property, the lender is responsible for insurance, taxes and maintenance of the property in order to preserve the asset. These expenses add up if the property does not sell. These expenses combined with the decreasing value of real estate highlight a conundrum for lenders: foreclose on distressed property or modify loans and preserve as much of the loan as possible.

As it stands now, real estate values have fallen around 30% since 2006.² Admittedly the reduced value reflects just how over heated the real estate market became when securitizing residential mortgages generated more money than the loans themselves. However, unloading more inventory will only add to the downward pressure on real estate values with a commensurate dampening effect on the overall economy.

The dampening effect works something like this: Federal banking regulations³require lenders to maintain a certain amount of cash to cover a percentage of the difference between the amount of loan and the value of the asset securing the loan. The longer a lender holds the property the more cash they have to hold to cover its loss on the loan. And with its money tied up as collateral for its bad loans, lenders are unable lend to potential buyers. With banks unable to make loans because of this reserve requirements and new stricter lending guidelines, sales of residential property are stalled. The result is a vicious downward spiral. Residential property values continue to slide and banks have their money tied up.

Another effect of this downward spiral in property values is the strain on American communities. Local governments lose income generated from property taxes and are unable to pay for public services. Sprawling neighborhoods of foreclosed properties become waste lands of crime and deterioration without adequate police and fire protection. Schools close down and the higher number of students per classroom in the remaining schools reduces the effectiveness our educational system. Unemployment remains high because manufacturing, construction and service related industries follow the real estate development.

Within this grim landscape, it is as wonder that lenders have not figured out that entering into a new agreement with existing homeowners to stay in their homes by either reducing the interest rate, the amount owed or extending the time to pay holds more hope than foreclosing on distressed real estate. Why not modify loans with people who want to stay in their homes rather than selling these homes after foreclosure for half of what lenders can expect from loan modifications?

A lender’s decision to foreclose is in fact a modification albeit controlled by bank accounting rules called “troubled debt restructuring”.⁴ And even these rules countenance against wholesale foreclosures in favor of more workouts with current homeowners because the more lenders foreclose and sell their REO inventory, the lower the price of REO properties.

Modifying loans to reflect the 30% decline in real estate values is better than selling the properties after foreclosure with a return of 60% to 65% of the loan amount.⁵ Saving 30% to 35% on loans makes good sense and combined with the banks’ tacit acknowledgement that they are partially responsible for the housing bubble, may help communities move forward together.

So, why are lenders stuck on foreclosure rather than modification?

One concern is there will be a rush of homeowners, who are able to pay on their loans, to modify loans in order to lower interest rates and/or reduce the principle amount. Considering the downward pressure on the real estate market, anyone who asks for a modification are most likely candidates for foreclosure in the future and dealing with it now may help stem a further decline.

Another answer may lie in the fact that lenders do not understand the full extent of the financial crises. Or they might understand the financial crisis and are waiting for the government to bail them out as they did during the Savings and Loan scandal in the 1980’s or as they did in 2008 with TARP. Maybe lenders are unsure on the direction of the economy and are stalling by blaming tougher loan guidelines and high unemployment as their reason for not lending money.

There are signs that lenders may want to reconsider blaming the borrowing public or government regulations. Lenders are coming under increased government scrutiny for mortgage fraud⁶ and title companies are becoming leery of insuring title to REO properties because of the uncertainty of the chain of title problems recently highlighted in mortgage backed securities. Another consideration is the talk of “right to rent” legislations which would allow homeowners to stay in their foreclosed homes and pay rent. This legislation would only cover government backed mortgages held by Fannie Mae and Freddie Mac which make up half of the foreclosures.⁷ Consequently, Lenders will have a harder time selling their REO properties if the government is leasing their REO stock.

Hopefully, lenders will see their way to working with distressed homeowners rather than against them.

Unfortunately, the corporate face of banking does not bode well for individuals facing tough economic times. Lenders, who were in a better position to prevent the housing bubble than the individual home buyers, are avoiding responsibility at all cost because they know the tax payer will eventually bail them out.

Notes

1
American’s equity in their homes near a record low, Christopher S. Rugaber, Associated Press June 10, 2011. ↩︎
2
S.&P./Case-Shiller index, tracks the value of residential real estate in 20 metropolitan regions across the United States. ↩︎
3
12 U.S.C. 29, 84 and C.F.R. 34.82 ↩︎
4
Accounting Standards Codified (ASC) 310-40. ↩︎
5
The Next Crisis in Residential Mortgages-New Data Emerges, by Dan Alpert of Westwood Capital, The Big Picture, June 20, 2011. ↩︎
6
Office of the Comptroller of the Currency, Press Release April 13, 2011. See: http://www.occ.treas.gov/news-issuances/news-releases/2011/nr-occ-2011-47.html ↩︎
7
Right to Rent: Will Obama Administration Finally Fix Housing? Dean Baker, Truthout June 27, 2011. ↩︎

Modifying Your Mortgage is not Worth the Effort

James A. Knowlton — Sat, 14 May 2011 00:00:00 GMT

WHY MODIFY A MORTGAGE?

There are approximately 46.7 million mortgages in the United States.¹ About 60 percent of all outstanding residential mortgages by dollar amount are securitized. Over 90 percent of mortgages originated in recent years have been securitized.²

Securitized means the loans are pooled and transferred into a security called mortgaged-backed securities (MBS). The security pays the stream of income from pooled loan payments to investors who buy the securities. The securities are controlled by a trust for the benefit of the investors but the actual collection of the loan payments and decisions on whether to modify or foreclose a loan upon a default falls on the servicer. Services are the connection between the investors who expect their steady stream of income and the home buyers who make the payments. Servicers are often the banks originating the loans but not always. Servicers are paid a steady paycheck when homeowners make their monthly payments. A problem arises when homeowners stop making payments: Servicers look after themselves because there is no incentive to preserve the assets of the investors or help out homeowners who have fallen on hard times.³⁴

There have been approximately 5 million foreclosures and 14 million mortgages that are in default according to Mark Zani, Moody’s Analytics chief economist in article “No end in sight to foreclosure quagmire”.⁵ Foreclosures will continue at an alarming rate. “Lenders filed a record 3.8 million foreclosures in 2010, up 2% from 2009 and an increase of 23% from 2008, according to RealtyTrac.”⁶

DRAWBACKS AND TRAPS OF MODIFICATION

Modifying mortgages is seen as a way to stem the tide of foreclosures. In 2009 legislation was enacted to encourage but not require loan servicers to reduce mortgage payments by lowering the interest rate and extending the loan term. The legislation known as the Home Affordable Modification Program or HAMP has had little success because it was confusing and was only voluntary which means servicers were not interested in modifying loans.⁹ The trial modifications under HAMP, where homeowners agree to pay a lesser amount to prove they can meet the terms of the modification, may have even facilitated foreclosure because the lower payments constituted a default under the original mortgage. See “No end in sight to foreclosure quagmire” above.

The Trap

A word of caution on modifying your home loan outside of HAMP and through the private sector:The servicers, who have been facing a rising tide of litigation relating to chain of title issues including robo signing and filing false affidavits, have resurrected a practice of asking homeowners not to contest a foreclosure or otherwise sue the servicer. These “waiver” provisions are not allowed under HAMP. Even if states have enacted similar prohibitions on waiver provisions in modification agreements, servicers are circumventing the law by including waiver provisions in temporary agreements sometimes referred to as “forbearance agreements”.¹²

WHY WOULD A SERVICER GIVE A HOMEOWNER A BREAK?

There are two more reasons why discussing modification of your loan with the servicer is not worth your time or effort. First, mortgage servicers make money foreclosing on loans not in modifying the loans. Secondly, the servicer may not have the ability to modify a loan according to the structure of a MBS and the contractual relationships of the parties in a MBS.

Servicers Look After Themselves

A servicer’s pay check comes from a percentage of the total unpaid principal balance of the loan pool. Reducing the amount of the loan equates to less money for the servicer and therefore a good reason a servicer has no interest in helping homeowners reduce their payments or loan amount through modification. Servicers also benefit from delinquent accounts because the late fees and interest adds to the overall loan balance and thereby increases the servicers’ income.When deciding to modify a loan or allowing it to go through foreclosure, the servicer’s own self interest will lead to foreclosure because the servicer recover late fees and interest in foreclosures. These fees will most likely be forgiven in a modification. In addition, performing large numbers of loan modifications would cost servicers upfront money in fixed overhead costs, including staffing and physical infrastructure, plus out-of-pocket expenses such as property valuation and credit reports as well as financing costs. “This business model, of creaming funds from collections before investors are paid has been extremely profitable.”¹³

Frankenstein Contracts

The securitization of mortgages creates barriers to modification. The Pooling and Service Agreement (PSA) which controls all parties in a security limit the ability of a servicer to modify a loan.¹⁴ The PSA sets strict parameters for servicers who are handling money that belongs to the investors. These parameters are strict because it is one way that investors retain some control over their money.

Examples of ways to limit servicers include outright prohibition, limited to type, number or circumstance, sometimes third-party consent is required and the most effective is requiringservicers to purchase any loans they renegotiate at the face value outstanding or at a premium.¹⁵

Contracts that do not allow modification is based on a policy originally thought to encourage homeownership by reducing the risk banks undertook in making home loans. The principle underling this policy was the idea that homeowners would be less likely to default on their loans if there was no way to change their terms. This very same principle also helped sell the securities.

Investors, not wanting to shoulder the risk of default of mortgages shifted from the banks to the investors in the securitization process were somehow mollified by the fact that the contracts generating the cash flow they bought could not be changed.

“Contracts that cannot be modified are more likely to perform according to their original terms. This is the idea behind the quest for immutability as a method of managing risks from securitization.” [Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities @1087]

Banks Do Not Want to End Up With All the Losses

In addition to this formal rigidity to modifying loan, there is a structural aspect of MBS that discourages modification.

“Most PSAs restrict mortgage renegotiation to loans that are in default or where default is imminent or reasonably foreseeable in order to protect the SPV’s (Trusts) pass-through tax and off–balance sheet accounting status. Allowing modifications under less dire conditions may indicate that the servicer is actively managing the SPV’s assets. Active management would in turn trigger a new layer of taxation on the SPV’s income, in addition to the tax investors pay on their income from the RMBS. Moreover, because the originator is often the servicer, overly active management of the securitized loans could suggest that it did not truly sell the risk. In response, regulators could require the servicer/originator to bring the loans back onto its balance sheet, defeating the point of securitization.” [Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities @1096]

If investors in the MBS do not want an independent party fooling around with their funding sources and if passive management is required to maintain the favorable tax status of the MSB, the question begging to be asked is why do servicers even entertain the idea of modifying loans?

Considering most loans being foreclosed on are not owned by a local bank, the chances of a homeowner successfully obtaining a modification of their loan seems remote. Securitization has effectively transferred the risk of the housing bubble on to unsuspecting investors of the MBS and the homeowners whose dream of homeownership has been shattered.

James Knowlton is a lawyer in Basalt, Colorado.

Notes

1
http://www.census.gov/compendia/statab/2011/tables/11s0993.pdf ↩︎
2
Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities, Anna Gelpern, Adam J. Levitin, Southern California Law Review, Vol. 82:1075 ↩︎
3
Mortgage Servicing”, Adam J. Levitin & Tara Twomey, Georgetown Public Law and Legal Theory Research Paper No. 11-09,http://scholarship.law.georgetown.edu/facpub/498. ↩︎
4
“Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior” by Diane E. Thompson Of Counsel, National Consumer Law Center, October 2009 ↩︎
5
http://www.11alive.com/news/article/190391/40/No-end-in-sight-to-foreclosure-quagmire ↩︎
6
Jon Prior, HousingWire.com, Wednesday, January 12th, 2011 ↩︎
7
Adjustable Rate Mortgages (ARMS) provide initial low interest only mortgage payments with increases in payments several years later. Most homeowners cannot afford the increased monthly payment and return to the bank to refinance. However, as ARM payments begin to balloon in this economic downturn, homeowners are unable to qualify for refinancing under the stricter loan requirements and end up losing their homes to foreclosure.
8
“Are Foreclosures Contagious?” FDIC Center for Financial Research Working Paper 2011-4.
9
The House of Representatives recently voted to end HAMP”. The Senate needs to vote to make it final which is not expected. ↩︎
10
Obama Anti-Foreclosure Efforts Still Falling Short” Alan Zibel, WSJ, May 6, 2011.
11
“Private Mortgage Modification Reaches 1.5 Million”, by Kerry Curry, HousingWire.com, December 12, 2010
12
“Borrowing Trouble- Some lenders are modifying mortgages only after homeowners waive their right to sue”. Pro Plublica at Slate, Paul Kiel, May 9, 2011. ↩︎
13
“Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior” by Diane E. Thompson of Counsel, National Consumer Law Center, October 2009 ↩︎
14
Three kinds of agreements form the core of a securitization transaction: a pooling agreement, in which the SPV purchases a pool of assets from the originator or an intermediary; a servicing agreement between the servicer and the SPV that sets forth the duties and compensation of the servicer; and an indenture, which sets forth the rights of the investors in the SPV’s securities and the duties of the trustee that oversees the securities and the SPV. Typically, these three agreements are combined into a single document (the PSA). “Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities” @ 1088 ↩︎
15
“Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities” @1090 ↩︎
16
Resolving The Foreclosure Crisis: Modification of Mortgages in Bankruptcy”, by Adam J. Levitin, Wisconsin Law Review, 2009. Electronic copy available at: http://ssrn.com/abstract=1071931.

Chink in the Armor: A Foreclosure Defense

James A. Knowlton — Thu, 07 Apr 2011 00:00:00 GMT

The securitization of home loans may provide a new way to contest foreclosures. An Alabama court recently ruled that a trustee of a pool of home mortgages had no standing to bring a foreclosure action on one of the home mortgages allegedly in the pool despite having possession of the original Promissory Note because the transfer of the Note did not follow the express terms of the Pooling and Service Agreement governing the pooled mortgages.¹

WHAT IS SECURITIZATION?

Securitization² of home loans is the pooling and selling of the cash flow from thousands of mortgages. Mortgages are pooled into an entity, often referred to as a special purpose vehicle, in order to separate them from the banks who originally lent the money. Real Estate Mortgage Investment Conduits (REMICs) are a type of special purpose vehicle used for the pooling ofmortgage loans.³ I use REMIC in this post to identify these special purpose vehicles or trusts because the name reflects their real function as conduits.

REMIC purchases the home loans by selling interests in the REMIC in the form of a security which may be called a bond, a pass-through security or collateralized mortgage obligation (CMO). Investors⁴ in a REMIC buy these securities in order to receive a fairly secure and steady stream of cash from the home owners making their mortgage payments. Consequently, the mortgages, themselves become the collateral for these securities. How the money from the collateral is distributed depends on the quality of the underlying collateral and is subject to rules too complicated for this post. Suffice it to say, that the home loans are rated by their risk of non-payment and based on their rating, a price is set for different classes, or tranches, of home loans. An investor pays more for a higher rated class of home loans and less for a lower rated class of home loans.

Banks usually structure asset-backed securities using trusts.⁵ In choosing a trust structure, banks seek to ensure that the transaction insulates the assets from the reach of the issuer’s creditors or are “bankruptcy remote” and that the issuer, securitization vehicle, and investors receive “flow-through” treatment that minimizes the tax consequences.⁶ Simply, the trust is the legal owner of the pool of mortgages.

The trustee is a third party retained for a fee to administer the trust that holds the underlying assets supporting an asset-backed security. The trustee is primarily concerned with preserving the rights of the investor. Generally, the trustee oversees the disbursement of cash flows as prescribed by the indenture or pooling and servicing agreement, and monitors compliance with appropriate covenants by other parties to the agreement. The trustee also is responsible for declaring an event of default.⁷

The structure of a transaction is governed by the terms of the pooling and servicing agreement. The pooling and servicing agreement is the primary contractual document between all parties involving the transfer of specific home loans from the originator, servicer and ultimately to the specific trust. The pooling and servicing agreement documents the responsibilities of the trustee.⁸

BREACH OF TRUST DEFENSE

Now that you understand how your home loan became collateral in a security sold to the auto workers pension fund, we can dive into how the Alabama court in Horace vs. LaSalle Bank, decided that LaSalle Bank, the trustee of the security allegedly holding Ms Horace’s home loan, could, not now or ever, foreclose on Ms Horace’s home. Judge Albert L. Johnson made two conclusions in his order:

“First, the Court is surprised to the point of astonishment that defendant trust (LaSalle Bank National Association) did not comply with the terms of the its own Pooling and Servicing Agreement and further did not comply with New York Law in attempting to obtain assignment of Plaintiff Horace’s note and mortgage.

Second, plaintiff Horace is a third party beneficiary of the Pooling and Servicing Agreement created by the defendant trust (LaSalle Bank National Association). Indeed without such Pooling and Servicing Agreements, plaintiff Horace and other mortgagors similarly situated would never have been able to obtain financing.”

In drawing his conclusion, Judge Johnson accepted Plaintiff’s argument that:

“According to the terms of the PSA, all promissory notes transferred to the Trust are required to have a complete chain of endorsements from the original payee thereof to either “Blank” or to the Trustee for the specific Trust.”⁹

The Pooling and Service Agreement stated the following regarding an “unbroken chain of endorsements”:

“In connection with such sale, the Depositor has delivered to, and deposited with, the Trustee or the Custodian, as its agent, the following documents or instruments with respect to each Mortgage Loan so assigned: (i) the original Mortgage Note, including any riders thereto, endorsed without recourse (A) in blank or to the order of “LaSalle Bank National Association, as Trustee for Certificate holders of Bear Stearns Asset Backed Securities I LLC, Asset-Backed Certificates, Series 2006-EC2,”or (B) in the case of a loan registered on the MERS system, in blank, and in each case showing an unbroken chain of endorsements from the original payee thereof to the Person endorsing it to the Trustee*”* (Emphasis added.)

And Judge Johnson rejected LaSalle Bank’s Commercial Code, Article 3, “Negotiable Instruments”¹⁰ argument that:

“It is black letter law that the holder of a negotiable instrument is entitled to enforce the terms of the instrument (cite omitted). It is clear that the Note is a negotiable instrument as defined under Alabama law….. Additionally, the Note is endorsed in blank without recourse and is therefore payable to bearer. (Cite omitted). Therefore, any person in possession of the Note is entitled to enforce its provisions.”¹¹

In declining to follow Alabama law on “negotiable instruments” in favor of New York Trust law as it applies to this particular mortgage backed securities, Judge Johnson understandably found the following argument in the “Memorandum of Law in Support of Plaintiff’s Motion for Summary Judgment and In Response t Defendants’ Motion for Summary Judgment”¹² (Memo) persuasive.

The trustee is not an ordinary trustee. The trustee is a corporate trustee who must adhere to the Pooling and Servicing Agreement. (Page 12, Memo)

“[t]he corporate trustee has very little in common with the ordinary trustee . . . . The trustee under a corporate indenture . . . has his [or her] rights and duties defined, not by the fiduciary relationship, but exclusively by the terms of the agreement. His [or her] status is more that of a stakeholder than one of a trustee.” (Cite omitted).

A Trust acquires ownership and control over an asset only when there has been an effective delivery. An effective transfer has the name of the trust on the Note as the intended holder. (Page 11, Memo)

“In the context of mortgage-backed securitization, it is clear that registration of the notes and mortgages in the name of the trustee for the trust is necessary for effective transfer to the trust. Within the Statutes of New York governing Trusts, Estates Powers and Trusts Law (EPTL) section 7-2.1(c) authorizes investment trusts to acquire real or personal property “in the name of the trust as such name is designated in the instrument creating said trust.” (Emphasis added)

Without the registration of the asset with a specific trust, how does anyone know who is to receive the cash flow from the asset. (Page 13, Memo)

“Trust property cannot be, as the Defendant argues, held with incomplete endorsements and assignments that do not indicate that the property is held in trust by a trustee for a specific beneficiary trust. In fact, it is clear in the law of New York that an attempt to transfer to a trust which fails to specify both a trustee and a beneficiary is ineffective as a conveyance to the Trust. “The failure to name a beneficiary for the Trustee renders the assignment without merit.”(Cite Omitted)

New York law expressly requires that for property to be validly delivered to a trust, the property must pass completely out of the control of the donor (and its agents). (Page 13, Memo)

“It is the consummation of the donor’s intent to give that completes the transaction. Intention alone, no matter how fully established, is of no avail without the consummated act of delivery. How could one logically argue that delivering a promissory note endorsed in blank (making it bearer paper) into a trustee’s vault is “delivery beyond the authority and control of the donor” when the vault is managed by the agent of the donor? If the donor were to claim that the promissory note were its property, not the trustee’s, there would be no evidentiary basis for the trustee to claim ownership.” (Cite Omitted)

Trustees are usually large banks who have responsibilities for multiple trusts and therefore it is difficult to know what asset goes into what security without a specific delivery or registration with a specific trust. (Page 14, Memo)

“Trustees for securitizations often occupy many roles simultaneously and conflictingly both as document custodians and trustees for myriad thousands of securitizations as well as for various parties who are active in the securitization process including originators, servicers, sponsors and depositors. Accordingly, it is inconceivable that anything other than registration into “the name of the trust as such name is designated in the instrument creating said trust property” could ever qualify as delivery to any particular securitization trust. Absent such registration, there would be nothing that would indicate which of thousands of trusts in the care of a trustee a particular promissory note might belong to or if it were the personal property of the trustee itself. Absent such registration, a promissory note would simply be bearer paper, and thus the property of anyone who obtained possession of it.”

The Pooling and Servicing Agreement which set up the trust cannot be altered. (Page 11, Memo)

“Because the method of transfer is set forth in the Trust instrument, it is not subject to any variance or exception. (Cite omitted) The Trust documents require that the promissory notes and mortgages be transferred to the Trustee, which under New York trust law requires valid delivery.”

The whole securitization process depends on a complete, fully documented transfer of the home loan mortgages from the bank to the trust in order to comply with the legal objective of being “bankruptcy remote”. (Page 8, Memo)

“First, all notes sold to the Trust were required to have an unbroken chain of endorsements from the original payee to the person endorsing it to the Trustee. This requirement stems from the particular business concern in securitization, namely to evidence that there was in fact a “true sale” of the securitized assets and that they are in no way still property of the originator, sponsor, or depositor, and thus not subject to the claims of creditors of the originator, sponsor or depositor.”¹³

Summary

Possession of the Note is not enough to give a trustee standing to foreclose according to this case thereby undermining industry arguments relying on the commercial code’s “negotiable instruments” provisions. Instead, a complete chain of title may be necessary to prove the one foreclosing has standing. The ramifications for the banking industry would be substantial if this argument gains traction. The effect may be larger as expressed by Nick Wooten, the Plaintiff’s attorney: ”My only wish after being in this fight for the three and a half years is that we will get an honest evaluation of what is really wrong, so we can as a country get back on our feet. If we don’t get control of servicing, they will drive us into a depression that will take 20 years to get out of.” Housing Wire, Alabama judge denies securtization trustee standing to foreclose, Kerri Panchuk, April 1, 2011.

As for Judge Johnson’s second conclusion of law – whether a home owner is a third party beneficiary of a Pooling and Service Agreement governing the security holding the home owner’s loan – is subject to conflicting decisions in Alabama. There are two other Alabama cases that say that a home owner is not a third party beneficiary. They are U.S. v Congress and Wells Fargo Bank v Edward J. Thomas. This subject will have to wait for another post.

James Knowlton is a lawyer in Basalt, Colorado.

Notes

1
Horace vs. LaSalle Bank National Association, et al., CV-2008-000362.00, (3/30/11) Circuit Court of Russell County Alabama. ↩︎
2
Asset Securitization: Comptroller’s Handbook, Office of the Comptroller of the Currency, November1997, http://www.occ.treas.gov/handbook/assetsec.pdf . Last viewed 04/6/2011. ↩︎
3
Also know as a Collateralized Mortgage Obligation or CMO. ↩︎
4
The largest purchasers of securitized assets are typically pension funds, insurance companies, fund managers, and, to a lesser degree, commercial banks. The most compelling reason for investing in asset-backed securities has been their high rate of return relative to other assets of comparable credit risk. Asset Securitization: Comptroller’s Handbook, Office of the Comptroller of the Currency, November1997, ↩︎
5
The securitization process redistributes risk by breaking up the traditional role of a bank into a number of specialized roles: originator, servicer, credit enhancer, underwriter, trustee, and investor. Banks may be involved in several of the roles and often specialize in a particular role or roles to take advantage of expertise or economies of scale. The types and levels of risk to which a particular bank is exposed will depend on the organization’s role in the securitization process. Id. ↩︎
6
Id. ↩︎
7
Id. ↩︎
8
Id. ↩︎
9
“Plaintiff Phyllis Horace’s Motion for Summary Judgement pursuant to Rule 56 of the Alabama Rules of Civil Procedure and Response to Defendant’s Motions for Summary Judgment”, Page 20. ↩︎
10
See my previous post on “MERS and the Evolution of Foreclosure” for an explanation of UCC Article 3, “Negotiable Instruments”. ↩︎
11
Horace vs. LaSalle Bank, Defendants’ Motion for Summary Judgment, page 10. ↩︎
12
Horace vs. LaSalle Bank, “Memorandum of Law in Support of Plaintiff’s Motion for Summary Judgment and In Response to Defendants’ Motion for Summary Judgment”. ↩︎
13
Id. ↩︎

MERS and the Evolution of Foreclosure

James A. Knowlton — Fri, 04 Mar 2011 00:00:00 GMT

Simply, foreclosure is a legal process a bank uses to recover the money it lent by taking ownership of property purchased with the bank’s money after a default. When borrowing money, a borrower will generally execute a promissory note (“Note”) (contract to pay back the money) and a deed of trust (security for a loan containing a right to foreclose). The deed of trust is filed in the public land records in the county where the property is located as notice to the world that there is a lien on the property. A mortgage is another name for a deed of trust. The deed of trust, not the Note, gives the bank the right to foreclose on its security.

Traditionally, a bank would hold onto the original Note and deed of trust until the loan is paid off, either by the terms of the note or at a foreclosure, at which time the Note would be canceled and a release of the deed of trust filed in the public land records.

Today, banks transfer or assign Notes to third parties. Selling the loans provides more money to the banks in order that they may finance more loans. The bank transfers possession of the Note and endorses the name of the new owner on the back of the Note. Upon receipt of the Note and the proper endorsement the new owners step into the shoes of the original bank which includes the right to foreclose.

The transfer of Notes to third parties unrelated to the original transaction has spawned a sprawling secondary market that is at the center of our current global financial crisis. Crucial to the transfer of real estate loans in this secondary market is an electronic registration system, referred to as MERS, created to privately track Notes. MERS stands for Mortgage Electronic Registration System.

Created by large banks with the stated purpose of saving the cost of recording documents relating to real estate transfers and facilitating the transfer of these real estate documents in a secondary market¹, MERS in reality helped turn home ownership into a security.²

MERS has come under increased scrutiny in foreclosure actions because of the 2,871,891 U.S. foreclosures in 2010, the chances are high that MERS, claiming involvement in approximately 50% of US residential loans, is tracking the Notes and is named in the deed of trust as the “nominee” of the person or entity in possession of the Note.

The questions concerning MERS focus on how does MERS legitimately circumvent a centuries old recording system with its private electronic tracking system and how can MERS be a legitimate “nominee” of the ultimate “holder” of a deed of trust and a “mortgagee” at the sam time. Condensed even further how does MERS’ involvement in the transfer of Notes and its self-proclaimed status as “nominee” of the accompanying deed of trusts affect foreclosures.

Specifically, this article reviews the effect of separating a Note from its deed of trust when a Note is assigned to a third party and the recorded deed of trust remains with MERS designated as “nominee” for the holder of the Note.

WHAT MERS DOES

MERS facilitates the transfer of real estate loans into the secondary market by tracking the transfer of the Notes. A typical journey for a residential loan in the secondary market ultimately ends in a security with a pool of other residential loans known as a REMIC³or mortgage backed security.

A bank sells, assigns and transfers the mortgage loans to a “sponsor,” which is typically a financial services company or a mortgage loan conduit or aggregator;
The sponsor sells, assigns and transfers the mortgage loans to a “depositor”;
The Depositor sells, assigns and transfers the mortgage loans to the trustee of a REMIC;
The Trustee will hold the mortgage loans in trust for the benefit of the buyers of the securities or certificate holders.

The transfer of possession of the Note ideally follows this journey but sometimes does not. Rather than recording each assignment of the Note in the local land records, MERS tracks the Notes on its electronic registry.

There is no actual transfer of possession of the deed of trust where MERS is identified in the deed of trust. MERS, as “nominee” for the original lender and any successor and assigns, retains its beneficiary interest in the deed of trust on the only recorded document of the loan transaction in the local public records for property transactions. In short MERS privatized part of the mortgage recording system without legislative or judicial authority. MERS’s authority comes solely from its contract with its members who are the banks making the loans.

The MERS’ system of tracking Notes while maintaining control of the deed of trust conflict with traditional principles of real property law. MERS has essentially separated the promissory note and the security instrument, the deed of trust, allowing the debt to be transferred without an assignment of the security instrument.

DEED OF TRUST FOLLOWS NOTE

The concept that a deed of trust follows the Note is long standing law. The United States Supreme Court first articulated this principle in 1872 in Carpenter v. Longan, 83 U.S. 271,274 (1872): “The note and mortgage are inseparable; the former as essential, the latter as an incident. An assignment of the note carries the mortgage with it, while an assignment of the latter alone is a nullity.”

The Colorado Supreme Court upholds this principle. “The transfer or assignment of a promissory note carries with it, as an incident, the deed of trust or mortgage upon real estate or chattels that secure its payment.” Columbus Investments v. Lewis, 48 P.3d 1222 (Colo. 2002). Stetler v. Winegar, 226 P. 858, 859 (1924). The concept is codified in C.R.S. § 4-9-203(g).

MERS AND COLORADO FORECLOSURES

Colorado foreclosure statutes require possession of the original Note and original deed of trust. C.R.S. §38-38-101 provides the “Holder of evidence of debt may elect to foreclose.” C.R.S. §38-38-100.3(10) defines “holder of evidence of debt” as the person “in actual possession or person entitled to enforce an evidence of debt.” C.R.S. §38-38-101(1)(b) &(c) requires production of the original Note and deed of trust to start a foreclosure.

MERS cannot enforce the promissory note or deed of trust when MERS is the “nominee” solely for purposes of holding the evidence of debt absent some “authority”. “Authority” may be granted by the original evidence of debt or deed of trust, to enforce the evidence of debt as agent, nominee, or trustee or in a similar capacity for the obligee of the evidence of debt. C.R.S. §38-38-100.3(10)(d).

Language in a deed of trust which precludes MERS’, as nominee, to initiate a foreclosure is as follows:

“”MERS” is Mortgage Electronic Registration Systems, Inc. MERS is a separate corporation that is acting solely as nominee for Lender and Lender’s successors and assigns. MERS is the beneficiary under this Security Instrument.”⁴

Language in a deed of trust ostensibly giving MERS “authority” to collect the debt through foreclosure would read as follows:

“Borrower understands and agrees MERS holds only legal title to the interests granted by Borrower in this Security Instrument, but, if necessary to comply with law or custom, MERS (as nominee for Lender and Lender’s successors and assigns) has the right: to exercise any or all of those interests, including, but not limited to, the right to foreclose and sell the Property; and to take any action required of Lender including, but not limited to, releasing and canceling this Security Instrument. ”

Even with this language in a deed of trust, MERS is not entitled to bring a foreclosure action unless it also has possession of the original Note. Most likely MERS will assign the deed of trust to the person bringing the foreclosure action.

MERS involvement in foreclosures is more common when a trustee of a REMIC forecloses on a property. These cases are more complicated because the Notes traveling in the secondary market are covered by a different set of rules called “negotiable instruments” under Article 3 of the Uniform Commercial Code.

When MERS is tracking Notes through several layers of “transferees” in the secondary market the Notes are transferred without an endorsement or in “blank”. The ability to collect or enforce a Note indorsed in “blank” is not that much different from a Note transferred with an indorsement.⁵ Transferring possession of the Note to a specific person (“to order”) or in “blank” (“to bearer”) creates a “holder” or “the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession.” C.R.S. §4-1-201 (20).

Under both the Colorado UCC and Colorado foreclosure law, the person entitled to enforce a Note and the person entitled to bring a foreclosure action is the same person. Colorado UCC § 4-3-301 provides that the “Person entitled to enforce” an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder…” Colorado foreclosure law § 38-38-101 provides the “person in actual possession or person entitled to enforec an evidence of debt may elect to foreclose.”

In the case of a Note transferred in “blank” and tracked through several layers of holders by MERS, the ultimate “holder of the evidence of the debt” should be a trustee of a REMIC or its agent. A trustee is usually a large bank or federal lending institution and as such is entitled to special consideration as a “qualified holder”.

A “qualified holder” does not have to produce the original Note if it provides either a bond one and half times the value of the Note or a “copy of the evidence of debt and a certification signed and properly acknowledged by a holder of an evidence of debt” that: 1)they are a “qualified holder” pursuant to C.R.S.§38-38-100.3(20), 2) that “the copy of the evidence of debt is true and correct” and 3) that they promise to “indemnify and defend any person liable for repayment of any portion of the original evidence of debt in the event that the original evidence of debt is presented for payment” C.R.S. §38-38-101(1)&(2)

Similarly, a “qualified holder” does not have to provide the original deed of trust if it complies with the same verification procedure outlined above for Notes.

One possible justification for the above special consideration of big banks acting as trustees for large pools of loans in a security is the “Pooling and Service Agreement” which sets forth how Notes are transferred into a REMIC or mortgage backed security.

The language in a “Pooling and Servicing Agreement” provides for the transfer of possession of the original Note and deed of trust including loans registered with MERS that follows common law and Articles 3 and 9 of the UCC.

“In connection with the above transfer and assignment, the Sponsor hereby deposits with the Trustee or the related Custodian, on behalf of the Trustee, with respect to each Mortgage Loan: (i) the original Mortgage Note, endorsed without recourse (A) in blank or to the order of the Trustee or (B) in the case of a Mortgage Loan registered on the MERS system, in blank, and in each case showing an unbroken chain of endorsements (ii) the original Mortgage and, if the related Mortgage Loan is a MOM Loan, noting the presence of the MIN and language indicating that such Mortgage Loan is a MOM Loan, which shall have been recorded (or if the original is not available, a copy), with evidence of such recording indicated thereon (or if clause(w) in the proviso below applies, shall be in recordable form), (iii) unless the Mortgage Loan is assigned in the name of MERS, the original assignment to blank, or the assignment (either an original or a certified copy which may be in the form of a blanket assignment if permitted in the jurisdiction in which the Mortgaged Property is located) in blank or to “Citibank, N.A., as Trustee”, with evidence of recording with respect to each Mortgage Loan in the name of the Trustee thereon (or if clause (w) in the proviso below applies or for Mortgage Loans with respect to which the related Mortgaged Property is located in a state other than Maryland, Tennessee, South Carolina, Mississippi and Florida, or an Opinion of Counsel has been provided as set forth in this Section 2.01(b), shall be in recordable form),”⁶

CONCLUSION

The securitization of residential loans has been going on for several years and it is only since the recent financial meltdown caused by these securities being populated with sub-prime loans or loans given with no documentation of ability to pay back the loan that MERS’ role in the securitization of residential loans has come to light. Courts are only recently coming to understand and question MERS’ role in foreclosures. There is no consensus among the states on the efficacy of MERS. Some questions to ask if MERS is involved are listed below.

If the person bringing a foreclosure action is a trustee of a REMIC, MERS most likely tracked the Note on its journey into the security. If MERS is involved, a request to see the actual Note is appropriate because there is a chance the Note has been lost or there has been a break in the chain of endorsements, which is a violation of the Pooling and Service Agreement. Pay particular attention to the timing of the transfers because each REMIC has a deadline when residential loans can be inserted into the REMIC.

Chances are if MERS has been tracking the Notes, they are also listed as a “nominee” in the deed of trust and should execute an assignment of the deed to the “holder” bringing the foreclosure action. I doubt that MERS would bring a foreclosure action on behalf of the “holder” but if they do, MERS would have to have a valid assignment of the Note.

As for MERS being both a “nominee” and a “mortgagee”, the idea that a principal can be its own agent does not square with agency law, which is a subject for another blog.

James Knowlton is a lawyer in Basalt, Colorado.

Notes

1
“MERS is an innovative process that simplifies the way mortgage ownership and servicing rights are originated, sold and tracked. Created by the real estate finance industry, MERS eliminates the need to prepare and record assignments when trading residential and commercial mortgage loans.” www.mersinc.org. ↩︎
2
See Peter M. Carrozzo, Marketing the American Mortgage: The Emergency Home Finance Act of 1970, Standardization and the Secondary Market Revolution, 39 Real Prop. Prob. & Tr. J. 765, 799-800 (2004-2005) (“standardization of mortgage documents created marketable commodities. Once mechanisms were in place for the secondary market to operate, events rapidly moved toward the ultimate goal: the creation of a security which has as its base land [and] yet which will be as freely transferable as stocks and bonds” (internal quotation omitted)). ↩︎
3
Real Estate Mortgage Investment Conduits (REMICs) are a type of special purpose vehicle used for the pooling of mortgage loans and issuance of mortgage-backed securities. They were introduced in 1987 and defined in the United States Internal Revenue Code (Tax Reform Act of 1986)(IRC 860). ↩︎
4
Colorado Single Family, FannieMae/Freddie Mac Uniform Instrument, MERS Form 3006 01/01. ↩︎
5
The UCC replaces the more common spelling of “endorsement” with the less common spelling “indorsement.” ↩︎
6
Pooling and Service Agreement, Article II, Section 2.01, STRUCTURED ASSET MORTGAGE INVESTMENTS II INC., Stearns ALT-A Trust II, Mortgage Pass-Through Certificates. ↩︎