By Lisa M. Goolik
A Florida appellate court has concluded that the Uniform Commercial Code, and not the Florida recording statute for mortgage assignments, should govern the sale or assignment of a note in a mortgage transaction. As a result, HSBC Bank USA, N.A., the bank that was first to take possession of a borrower’s promissory note and related mortgage, was entitled to the priority of its interest, despite the existence of more than one promissory note as the result of a fraudulent scheme (HSBC Bank USA, N.A. v. Perez, May 5, 2015, Gross, J.).
Background. In April 2006, the borrower, Rolando Perez, obtained a loan and mortgage from Federal Guaranty Mortgage Company. The mortgage was recorded the following month in Broward County’s public records. At closing, Perez executed two nearly identical promissory notes in FGMC’s favor, both for the same amount and both secured by the same mortgage. The execution of two promissory notes was part of a larger fraudulent scheme that included other loans.
In June 2006, HSBC Bank took possession of one of the borrower’s “original” promissory notes. The note was specially endorsed from FGMC to American Home Mortgage Corp. and from American Home Mortgage Corp. to HSBC. HSBC did not record its mortgage assignment until April 24, 2009.
Two months after HSBC took possession of its note, in August 2006, LaSalle Bank took possession of the borrower’s second “original” promissory note. The note obtained by LaSalle Bank contained special endorsements completing the chain of ownership. LaSalle Bank recorded this assignment on Aug. 12, 2009.
After Perez defaulted and all payments stopped, both banks commenced separate foreclosure lawsuits. Although the cases were consolidated, HSBC—without naming or serving LaSalle Bank—obtained a final judgment of foreclosure and sold the property. With the issue of the dual promissory note still unresolved, the banks entered into an agreed order vacating the final judgment, sale, and issuance of certificate of title.
Frustrated by the divestment of title, the purchasers intervened in the consolidated lawsuits and sought a declaratory judgment establishing “whether HSBC or LaSalle is the owner and holder of the FGMC Note and Mortgage which both parties seek to enforce.” If HSBC was found to be the rightful owner, the purchasers hoped to ratify the prior sale and retain possession of the property.
The trial court found in favor of U.S. Bank, which had assumed LaSalle Bank’s interest in the matter, after applying Florida’s recording statute for mortgage assignments, Sec. 701.02. The court concluded that because U.S. Bank (LaSalle Bank) obtained its assignment of the same mortgage prior to HSBC’s recording of the assignment, U.S. Bank maintained a priority interest over HSBC as a subsequent bona fide purchaser.
Applicable law. The Florida appellate court began with a determination that Article 9 of the Florida UCC applied to the transaction. While Article 9 generally does not apply to the creation of a mortgage in real property, if the note in a mortgage transaction is sold or assigned, Article 9 applies to the security interest created in favor of the purchaser or assignee of the note, said the court.
Further, the court noted that any doubt that Sec. 701.02 does not apply was alleviated in 2005 when the Florida legislature added subsection 701.02(4). The subsection specifically provides that the UCC governs “the attachment and perfection of a security interest in a mortgage upon real property and in a promissory note or other right to payment or performance secured by that mortgage” and that an “assignment of such a mortgage need not be recorded under this section for purposes of attachment or perfection of a security interest in the mortgage under the Uniform Commercial Code.”
As a result, once HSBC took possession of the note, it acquired an Article 9 security interest in the note, the court found. Under Section 9-109, HSBC’s possession of the note gave it “an attached security interest in the mortgage lien that secure[d] the note.” And once HSBC perfected its security interest in the note, its security interest in the mortgage lien was similarly perfected.
“This scenario is consistent with the notion that the promissory note, not the mortgage, is the operative instrument in a mortgage loan transaction, since ‘a mortgage is but an incident to the debt, the payment of which it secures, and its ownership follows the assignment of the debt,’” the court reasoned.
Attachment. Turning to the issue of attachment, the court found that HSBC’s security interest in the note and underlying lien attached, at the latest, when it took possession of its note. In accordance with Section 9-203 of the Florida UCC, a security interest attaches to collateral “when it becomes enforceable against the debtor with respect to the collateral.” An assignment of a promissory note attaches, or becomes enforceable against the assignor and debtor with respect to the collateral, when: (1) value has been given; (2) the assignor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) the assignor has either “authenticated a security agreement that provides a description of the collateral” or the assignee has taken possession of the note under Section 9-313.
Perfection and priorities. In addition, HSBC’s security interest was perfected when it took possession of the note, the court concluded. Under Section 9-313, a security interest in a promissory note may be perfected by taking possession of the original promissory note. In theory, the inability to produce a note that is in a secured party’s possession would effectively give notice of the secured party’s interest.
Moreover, the timing and method of perfection determine the priority of security interests. In general, conflicting security interests rank according to time of filing or perfection. In addition, Section 9-330 provides that “a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party.”
Thus, the court concluded that, by taking possession of the promissory note before LaSalle Bank, HSBC was the first to perfect its interest in a note connected to the underlying mortgage.
Remedies. The court conceded that the existence of two “original” notes due to the fraudulent scheme causes the application of Article 9 to the instant case “slippery.” However, the court noted that, in the overwhelming majority of cases, “perfection by possession of a note will not be problematic … and avoids the cost of imposing a recording procedure disruptive to the lending industry based on difficult facts.”
Further, the court noted that Florida law does not leave U.S. Bank without a remedy. Under Sec. 673.4161, U.S. Bank has an action for breach of warranty against the transferor of the note. However, the court recognized the remedy may be “more theoretical than practical” due to the scheme to defraud.
This story previously appeared in the Banking and Finance Law Daily.
