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In Re Kemp

440 B.R. 624 (D. N.J. 2010)

BANKRUPTCY; MORTGAGES; NOTES — If a purported mortgagee never had possession of the mortgage note, not because the note had been lost, destroyed or stolen, but because the note was never transferred to it by the original debt holder, it cannot enforce the underlying obligation and therefore its bankruptcy proof of claim may be exponged.

A debtor filed a voluntary petition for relief under Chapter 13 of the Bankruptcy Code. He listed an ownership interest in several properties, including one encumbered by a mortgage. The Chapter 13 plan proposed to make payments over 60 months to satisfy priority claims and to cure arrearages. A creditor-mortgagee filed a secured proof of claim. The debtor filed an adversary complaint against the mortgagee, seeking to expunge its proof of claim, alleging that the mortgagee could not enforce the underlying obligation.

The note and mortgage were executed by the debtor, but no endorsement appeared on the note. Accompanying the note was an unsigned “Allonge to Note” dated the same day as the note in favor of another named lender and directing that the debtor pay to the order of the mortgagee doing business as the other named lender. The other named lender was listed on the mortgage.

Shortly after the execution by the debtor of the note and mortgage, the instruments were pooled with other similar instruments and sold as a package to a bank as trustee. An agreement was executed between the depositor, sellers, a master servicer, and the trustee. Pursuant to the agreement, the depositor was directed to transfer the trust fund, consisting of specified mortgage loans and their proceeds, including the debtor’s loan, to the trustee in return for certificates referred to as asset-backed certificates. The sellers sold, transferred or assigned to the depositor all their right, title, and interest in and to the applicable mortgages, including all interest and principal received and receivable. In turn, the depositor immediately transferred all right, title, and interest in the initial mortgage loans, including the debtor’s loan, to the trustee for the benefit of the certificate holders.

Although the agreement expressly provided that the depositor was to deliver the original mortgage note, endorsed by manual or facsimile signature, with all intervening endorsements that show a complete chain of endorsement from the originator to the person endorsing the note, the note in question had never been endorsed or delivered to the creditor as required by the agreement. A witness testified that the original note never left the possession of the creditor, and the new allonge had never been attached or otherwise affixed to the note. Later, the creditor asserted that it had located the original note, and that the note, along with the alonge and agreement, were available for inspection. When the matter returned to the Court, counsel for the creditor represented to the Court that he had possession of the original note with the new allonge now attached, but presented no additional information regarding the chain of possession of the note.

The Court found that the debtor’s mortgage had been assigned, but that the creditor had not transferred possession of the associated note. The agreement required an endorsement and transfer of the note, but this was not accomplished prior to the filing of the proof of claim.

As a result, the Court found that the creditor’s claim was barred by New Jersey law on two grounds. First, under New Jersey’s Uniform Commercial Code (UCC), the fact that the owner of the note never had possession of the note was fatal to its enforcement. Second, upon the sale of the note and mortgage, the fact that the note was not properly endorsed to the new owner also defeated enforceability.

In New Jersey, the enforcement of a promissory note that is secured by a mortgage is governed by the UCC. A party is entitled to enforce a negotiable instrument if it is the holder of the instrument, a nonholder in possession of the instrument who has the rights of a holder, or a person not in possession of the instrument who is entitled to enforce the instrument. Here, the creditor was none of the three.

The Court found that because the creditor never had possession of the note, it could not qualify as a holder. Where the ownership of an instrument is transferred, the transferee’s attainment of the status of “holder” depends on the negotiation of the instrument to the transferee. Negotiation requires both the transfer of possession of the instrument to the transferee and endorsement by the holder. Here, the Court was not satisfied that the creditor ever had possession of the note, nor was the Court satisfied that the instrument had been endorsed by the creditor.

The creditor did not qualify as a non-holder in possession simply because it did not have possession of the note, and never did. Similarly, the creditor was not a non-holder not in possession because that category covers only lost, destroyed or stolen instruments.

Finally, the Court noted that the recorded assignment of a mortgage does not establish the enforceability of the note. The creditor had a valid claim of ownership, but could not enforce the note. Thus, the claim was disallowed under the Bankruptcy Code.

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