Understanding the Essentials of Note Enforcement

A recent unpublished opinion from the North Carolina Court of Appeals serves as an important reminder with respect to who has the right to enforce a note.  In U.S. Bank, N.A. v. Pinkney, 2016 WL 2647709 (N.C.App. May 10, 2016), U.S. Bank filed a complaint to foreclose real property secured by a deed of trust given by the Pinkneys, who signed a note in favor of Ford Consumer Finance.  Ford properly endorsed the note to Credit Asset, but instead of endorsing the note Credit Asset recorded an assignment of the note to U.S. Bank as the Indenture Trustee under a securitized indenture.  U.S. Bank, Indenture Trustee, purported to indorse the note to U.S. Bank.

In affirming the superior court’s order dismissing the complaint pursuant to N.C.R.Civ.P. 12(b)(6), for failure to state a claim, and rejecting U.S. Bank’s claim that it had standing to enforce the note, the Court of Appeals looked to North Carolina’s power-of-sale foreclosure statute and observed that in order to obtain an order from the clerk of superior court  authorizing a foreclosure sale, the party seeking to foreclose must establish it is the holder as that term is defined in North Carolina’s adoption of the Uniform Commercial Code.  N.C.G.S. § 45-21.16(d); In re Rawls, 777 S.E.2d 796, 798-99 (2015).   While reference to the power-of-sale procedure is puzzling, given U.S. Bank sought a judicial foreclosure, nevertheless the note enforcement rights under the UCC are equally applicable to both judicial and power-of-sale foreclosures.

Because U.S. Bank was not the original holder, the transfer of the note required indorsement on the face of the note by Credit Asset either by name to U.S. Bank or in blank.  The Court found that neither the complaint nor the note itself disclosed the existence of the necessary indorsement from Credit Asset.  The Court rejected U.S. Bank’s contention that the assignment fulfilled the function of an indorsement based on a state statute enacted prior to North Carolina’s adoption of the UCC.  “The UCC is clear that if a party in possession of a note is not the original holder, if the instrument is payable to an identified person, there needs to be an indorsement by each and every previous holder.”  Pinkney, at *5.  

U.S. Bank might have had a viable complaint based on an alternative ground for the enforcement of a note:  that it was a “nonholder in possession of the instrument who has the rights of a holder” pursuant to N.C.G.S. § 25-3-301(ii).  As the Indenture Trustee of a securitized trust, U.S. Bank almost certainly was a party to an agreement authorizing it to act for all or any of the note holders whose notes were subject to the trust.  However, the Court refused to entertain an argument on appeal based on nonholder status because the complaint did not contain this theory and U.S. Bank did not seek to amend its complaint to allege this alternate theory of recovery.

The lessons of this opinion should not be lost on both servicers and their counsel.  Any lender or servicer that anticipates it may have to enforce a note must ensure it is in the position of holder under the UCC at the time it initiates foreclosure.  Before foreclosure is commenced one of the essential checklist items for both the servicer and its attorneys should be to locate the original note and confirm the chain of indorsements is complete.  If there is any doubt that the servicer may not be entitled to enforce the note as holder, the servicer should be prepared to move forward under the alternative theory of nonholder in possession.  This will usually require that some additional evidence is adduced to establish the servicer is authorized to act for the holder.  This may be proven by producing the trust or servicing agreement, and will probably require testimony from an experienced servicer employee with knowledge of the relevant documents.

In any event, the with-prejudice dismissal in this case is not the game-ender it might appear to be.  North Carolina recently adopted the Florida Supreme Court’s logic in Singleton v. Greymar, 882 So.2d 1004 (Fla. 2004), holding that a noteholder is not barred by the doctrine of res judicata from filing a third power-of-sale foreclosure proceeding after two voluntary dismissals of prior foreclosure cases, notwithstanding the “two dismissal rule” found in N.C.R.Civ.P. 41(a).  In re Foreclosure of Beasley, 773 S.E.2d 101 (N.C. App. 2015) (North Carolina courts “have required the strictest factual identity between the original claim, and the new action, which must be based upon the same claim… as the original action” and held that, because each foreclosure was based on a different period of default and a different amount owed, neither of the two dismissals implicated the two dismissal rule).  Id. at 107.  By extension, res judicata should not be a bar to refiling a judicial foreclosure case based on a new event of default.

Also worth noting is the lack of any discussion in the opinion of Civil Procedure Rule 17 which provides, in part, that “[e]very claim shall be prosecuted in the name of the real party in interest….”  N.C.R.Civ.P. 17(a).  The opinion offers no insight whether the superior court, in dismissing the case, adhered to the mandate of Rule 17 that “[n]o action shall be dismissed on the ground that it is not prosecuted in the name of the real party in interest until a reasonable time has been allowed after objection for ratification of commencement of the action by, or joinder or substitution of, the real party in interest….”  Given the basis for dismissal here, U.S. Bank should have been allowed the opportunity to take remedial action to cure the defect.  Apart from pursuing foreclosure based on nonholder status, as discussed above, the bank could have sought to join Credit Asset (the note holder) in the action.