Priority of Noteholders in Duplicate Note Scheme

Posted by NCBRC - May 12, 2015

A Florida appellate court addressing a fraudulent scheme involving selling duplicate promissory notes, found that “the bank that first perfected its interest in a note and related mortgage is entitled to the priority of its interest.” HSBC Bank USA v. Perez, No. 4D13-3193 (Fla. Dist. Ct. App. May 6, 2015).

Under the scheme, the borrower obtained a loan and mortgage from Federal Guaranty Mortgage Company for which he endorsed two nearly identical promissory notes. One note was then endorsed and assigned to HSBC and the other to LaSalle Banks as part of Pooling and Service Agreements. When the borrower defaulted on the loan both banks sought to foreclose. In determining which bank had priority for purposes of foreclosure, the trial court applied Florida’s general recording statute, section 701.02 and resolved the question in favor of LaSalle as a bona fide purchaser. The District Court of Appeals reversed, finding that the Florida UCC governing negotiable instruments controlled and, under the relevant provisions, the entity that first perfected its interest in the trust and the mortgage had priority.

The appellate court began with a discussion of Article 9 of Florida’s UCC, (Chapter 679 of the Florida Statutes), finding that, while the UCC does not apply to the creation of a real property mortgage, it comes into play upon assignment of the note and mortgage (mortgage is “incidental” to the note and travels with it) and applies to the security interest created in favor of the purchaser or assignee of the note. The court turned to the application of the UCC where, as here, two parties held identical and competing security interests to determine the priority of those interests. Because both parties had given value for the promissory note, had rights in the collateral, and had taken possession of the note, both had security interests that had “attached,” under section 679.2031(1), (2), Fla. Stat. (2008).

The next question, therefore, was which of the two parties perfected its interest first. “Perfection is significant because it serves two important purposes: (1) determining matters of priority and (2) providing third parties with notice of the transaction.” Timing and method of perfection are the relevant factors for prioritizing competing interests. Under normal circumstances in which there is only one “original” promissory note, possession gives sufficient notice to a subsequent buyer of the prior, competing, interest. The court concluded: “In this case, 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.” HSBC, therefore, had priority to assert its rights under the mortgage.

In answer to LaSalle’s argument that it had priority as a bona fide purchaser against an entity that had failed to record its interest, the court surveyed the history of Florida’s recording statute beginning at its inception in 1828. The court found that, historically, the recording statute was not intended to address subsequent assignees of the same note and mortgage, but “was apparently passed to protect purchasers of the land in situations in which the mortgagee makes a fraudulent satisfaction of the mortgage subsequent to an unrecorded assignment.” In 2005, the legislature further clarified the issue by enacting section 701.02(4) which specifies that “that it is the Uniform Commercial Code, and not recording pursuant to section 701.02, that determines ‘attachment and perfection’ of a security interest in a note and mortgage.”

The court recognized that LaSalle’s recourse to an action for breach of warranty against the transferor of the note was unlikely to yield satisfactory results given the fraudulent nature of the original transaction. However, it offered no comfort to the unfortunate LaSalle.

HSBC Ct App opinion

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