The North Carolina Court of Appeals has raised another roadblock for lenders seeking to recover a debt where the original note has been lost.  In Emerald Portfolio, LLC v. Outer Banks/Kinnakeet Associates, LLC et al., 2016 WL 4598561 (N.C.App. 6 September 2016), the Court held that a party who never possessed a note cannot avail itself of North Carolina’s version of the UCC to enforce the note.

In Emerald Portfolio, an assignee-creditor sought to enforce a note that had been lost by a prior holder, against the maker of the note for the unpaid balance due on the note.  The assignee-creditor also sought to enforce a personal guaranty of that agreement against another defendant. It does not appear that the assignee-creditor sought to foreclose on any collateral that secured repayment of the note.  The trial court granted summary judgment against both the maker and guarantor.  On appeal, the North Carolina Court of Appeals reversed the grant of summary judgment as to the maker but affirmed the judgment against the guarantor.   

The Court based its ruling on the distinction between North Carolina’s “lost note statute” (N.C.G.S. § 25-3-309) and the Model UCC § 3-309.  North Carolina’s version, enacted in 1995, requires that the party seeking to enforce the lost note be in possession of the note when it was lost.  In 2002, the Model UCC was revised to include a provision that the person seeking to enforce be in possession when it was lost, or the person seeking to enforce has acquired ownership of the instrument from the party that lost the note.  North Carolina, unfortunately, did not incorporate that change.  That leaves an assignee-creditor who acquired a loan, but the note was lost prior to the time of acquisition, in an apparent quandary.

All was not lost for Emerald, however.  In affirming the judgment regarding the guaranty, the Court recognized that the guaranty, while “coextensive” with the note, was a separate contract and could be enforced under contract law theories.  This acknowledgment leaves a secured assignee-creditor with some light at the end of the tunnel.

The Emerald Portfolio Court has unwittingly created a third “class” of secured creditor in North Carolina.  First is the traditional “holder” of the promissory note.  When the lender is in possession of a note made payable to its benefit or endorsed in blank, it can proceed to enforce the obligation either through North Carolina’s power of sale “quasi-judicial” foreclosure process or by filing a civil action for judicial foreclosure.  The second class of creditor is a lender who had an appropriately endorsed note but has since lost it after acquiring possession.  In this scenario, the lender can certainly proceed to enforce its obligation through a judicial action by availing itself of North Carolina’s lost note statute.  This class of lender, however, may have some difficulty enforcing the obligation in a quasi-judicial proceeding before the Clerk of Court, since Chapter 45 of the North Carolina General Statutes implicitly limits those proceedings to lenders who can prove they are the “holder” – e.g., in possession of an appropriately endorsed note.  N.C.G.S. § 45-21.16(d).

But what happens when the lender acquires the rights to the loan from an entity that had lost the note?  

While the Court in Emerald Portfolio eliminated the “assignee’s” right to enforce the note, the Court’s distinction between the note and the guaranty – as separate contracts – leaves open the opportunity for the assignee-creditor to seek to enforce its Deed of Trust via a breach of contract theory.  This third class of creditor does not get the protections of a “holder in due course” (meaning that it is subject to the defenses of the maker, such as origination challenges) and cannot obtain a deficiency judgment against the debtor.  This avenue may, however, allow the assignee-secured creditor to at least realize on the collateral through a judicial foreclosure sale.  

Emerald Portfolio teaches three lessons to assignee creditors.  First, they should recognize that state-adopted versions of the UCC are not all the same, and not all states enact the most recent updates to the UCC.  Second, assignee-creditors should thoroughly review the loan portfolios they acquire to ensure original and properly endorsed promissory notes are included in the loan transfers.  Finally, assignee-creditors facing an Emerald Portfolio situation should be creative.  In the situation before the Court, the assignee-creditor could have requested the prior holder (who lost the note) to repurchase the loan or, as suggested above, the assignee-creditor could have proceeded to enforce the deed of trust under a contract theory.