Broken Chain of Title Defeats Creditor’s Claim

Posted by NCBRC - March 24, 2014

A broken chain of title defeated a bank’s right to enforce the Note and mortgage for debtors’ residence. In re Dorsey, No. 13-8036 (B.A.P. 6th Cir. March 7, 2014). In their chapter 7 bankruptcy, the debtors listed Vanderbilt Mortgage as the holder of the secured claim on their property and sought to reaffirm the debt and keep their residence. But the residence quickly fell victim to a battle between a hyena and a vulture and was lost to debtors.

Vanderbilt filed a motion for relief from stay attaching the Note endorsed by the debtors to Popular Financial Services (PFS). On the mortgage, PFS was listed as lender and MERS as nominee. MERS assigned the mortgage to Vanderbilt. Vanderbilt also produced a few pages of a Purchase and Sale Agreement between it and another company not named in this action.

The trustee objected to the motion for relief from stay arguing that the Note was not endorsed in blank or to Vanderbilt and, therefore, was unenforceable by Vanderbilt. The trustee filed an adversary proceeding asserting a superior interest in the Note and seeking declaratory judgment that Vanderbilt did not hold a perfected security interest in the debtors’ property. (Although PFS and MERS were named in the adversary proceeding, they did not take part in the litigation below or on appeal). He sought to sell the property for the benefit of the estate free and clear of liens. The bankruptcy court granted summary judgment in favor of the trustee.

On appeal, the BAP found that under Kentucky law a non-“holder” may acquire the rights of a holder in due course if the instrument has been transferred from someone with the right to enforce and the purpose of the transfer is to give the transferee the same enforcement rights as the transferor. Vanderbilt argued that it acquired the rights of a “holder” of the Note as transferee through either the PSA or the Mortgage assignment.

Characterizing the trustee’s argument as an avoidance action under section 544 rather than an objection to proof of claim, the court focused on the rights of the parties as they existed at the time of the petition. Under Ky. Rev. Stat. 355.3-203, an instrument is transferred when it is delivered by someone other than its issuer for the purpose of giving the recipient the right to enforce the instrument. Vanderbilt argued that either or both the PSA and the Assignment of Mortgage, along with Vanderbilt’s possession of the Note, were sufficient to show that a requisite “transfer” had occurred. The BAP disagreed.

The court found that the Purchase and Sale Agreement was not a “transfer” within the meaning of Kentucky law because it was not signed by the original lender and there was no evidence of a purpose to give Vanderbilt the rights of a holder in due course on the face of the document. For the same reason, the court also rejected Vanderbilt’s argument that the Mortgage Assignment showed an intent to transfer the right to enforce the Note. Under Kentucky law, a mortgage may be enforced only by the party entitled to enforce the underlying debt and while language in the mortgage document itself may create a separate obligation to pay the underlying debt, the bankruptcy court did not find that to be the case for this mortgage.

The court found that because the chain of title was broken, Vanderbilt was not a holder of the Note, and had not acquired a non-holder right of enforcement. Once the underlying Note became unenforceable, the mortgage could not be separately enforced.

Dorsey opinion

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