Daily Development for Thursday, November 21, 2002

 

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of
Law
UMKC School
of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City,
Missouri
prandolph@cctr.umkc.edu

 

MORTGAGES; PARTICIPATION; CHARACTERIZATION AS A LOAN: Specific factors in the manner of the fractional assignments of mortgage may indicate an intention to create a loan and not a participation plan. thus entitling the assignees to the proceeds from any foreclosure sale. The assignments merely gave the assignees an unperfected security interest in mortgagor's note.

 

Came Realty LLC v. DeMaio 746 N.Y.S.2d 555 (Sup. 2002).

 

DeMaio gave a note and mortgage and note to Churchill. Churchill went bankrupt and .Plaintiff sought to foreclose the mortgage.

 

Churchill, prior to bankruptcy, had assigned fractional mortgage notes of the DeMaio mortgage. The fractional mortgage notes had a one (1) year term and a 11% interest rate as opposed to the thirty (30) year term and 9% interest rate of the DeMaio note. The investors never took possession of the original DeMaio note and mortgage. Churchill guaranteed them their return. Churchill's principle was later found guilty of fraud in connection with the scheme to sell these interests.

 

The assignees of the fractional assignments of mortgage contended that they were entitled to a share of the foreclosure proceeds. The court described their argument as being that they had "a perfected security interest in the note." It does not say how their interest became perfected. Although the court doesn't say so, it appears that their argument was that they were perfected because Churchill held the note as their trustee.

 

The plaintiff, however, contended that the fractional assignments of mortgage represent loans made by the assignees with a guaranteed return on their investment and thus, did not entitle them to the proceeds from a foreclosure sale but, at best, give them an security interest in the DeMaio note, which interest was unperfected.

 

Because of the discrepancy in the term and interest rate of the assignments and the original DeMaio note, the court agreed with the Plaintiff and held that a loan was created instead of a mortgage participation plan.

 

Comment 1: The investors argument made no sense at all. They couldn't both be participants and have a "security interest in the note." Either their interests, as participants, was as owners of the note, or they were lenders. If they were lenders, under the old Article 9, they were perfected only by having possession of the note. Now, under the new Article 9, it is possible to make a UCC filing of a security interest in "realty paper" that will, it is hoped, satisfy the perfection requirements of bankruptcy, although the priority still would be "bumped" by a competing claimant holding possession of the note.

 

Comment 2: These investors were victims, and likely nothing was going to help them. The practice lesson, however, is that parties who seek to be participants in a mortgage loan but also want to have a guarantee of performance from the party putting the participation together should be careful what they wish for. If there is a guarantee by the transferor, even of performance of the note maker on the original terms of the note, this likely will be viewed as a "loan" and not a "participation," with the consequent disastrous results if the party forming the participation, and holding the note, goes bankrupt.

 

Further, parties who wish to be participants, even when there is no guarantee, would be wise to have the note segregated, even if it remains on the premises of the lead lender, so that the lead lender's "trustee" status, holding as an agent for the other participants, and not on its own account, is clear.

 

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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