Daily Development for
By: Patrick A.
Randolph, Jr.
Elmer F. Pierson Professor of
Of Counsel: Blackwell Sanders Peper Martin
Kansas City,
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
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