Vermont Supreme Court Finds No Principled Basis for Depriving Homeowner of State Law Protection By Allowing Bank to Use Standing as Sword

The Vermont Supreme Court issued an interesting decision October 18, 2013, Dernier v. Mortgage Network, Inc., Mortgage Electronic Registration Systems, Inc., and U.S. Bank National Association.  They reversed in part the trial court’s dismissal of the homeowner’s mortgage-related claims, and remanded back to trial court for further proceedings.   In so doing, the Vermont Supreme Court adopted the rationale of the 1st Cir. in Culhane, that whether or not a homeowner can sue for deficiencies in note transfers under the relevant PSA (depending on whether the homeowner can argue that the assignment was void and not voidable), under state law, the homeowner can argue that the defendant lacks substantive authority to foreclose his loan:

 Defendant argues that these cases mean that it has no obligation to hold the note prior to bringing a foreclosure action, and it must control the timing of bringing any such action. It argues that plaintiffs’ preemptive strike is an impermissible attempt to obtain a decision that it cannot foreclose because it doesn’t hold the note at the time of plaintiffs’ action. We do not read Kimball or Rouleau as having any relevance to our decision, apart from the holding in Kimball, discussed above, that a mortgagee can cure a deficiency in its standing to bring a foreclosure action. As we point out above, a mortgage foreclosure action or suit on a note represent a judicial collection method after certain procedural steps are taken and attempts are made at non-judicial collection. Assuming the controversy has become ripe and the adverse consequences for the mortgagors are reasonably to be expected, we see no right in the mortgagee to prevent a preemptive action by plaintiffs and delay its formal judicial collection action. Neither Kimball nor Rouleau gives defendant exclusive control over the timing of judicial intervention.

¶ 48. While we reject the bulk of defendant’s argument on standing, we recognize that some courts have found no standing on the rationale we employed with respect to the PSA and have added that plaintiffs have no interest in whom they are obligated to pay, only whether they pay and whether the payment is properly credited against their legal obligation. There is a difference, however, between challenging compliance with the PSA and challenging the assignments of the note and mortgage to defendant as fraudulent and irregular. As we held above, plaintiffs cannot rely on the terms of the PSA to challenge defendant’s actions or status, whether raised offensively, as here, or raised in defense to a suit on the note or a foreclosure action.

¶ 49. What is labeled as a lack of standing is actually a decision that the governing substantive law offers no relief. If, however, a mortgagor could obtain relief under a different procedural vehiclefor example, in a defense to a suit to enforce the note or a foreclosure actionthe rationale for this theory of lack of standing would evaporate. This is the holding of the recent decision of the U.S. Court of Appeals in Culhane v. Aurora Loan Services, 708 F.3d 282, 291 (1st Cir. 2013). In Culhane, the court explained that:

There is no principled basis for employing standing doctrine as a sword to deprive mortgagors of legal protection conferred upon them under state law. . . . We hold, therefore, that a mortgagor has standing to challenge the assignment of a mortgage on her home to the extent that such a challenge is necessary to contest a foreclosing entity’s status qua mortgagee.Id. at 291; see also U.S. Bank Nat’l Ass’n v. Ibanez, 941 N.E.2d 40 (Mass. 2011) (creating the state law protection relied upon by Culhane).

We must look to Vermont law to determine whether plaintiffs have a defense to enforcement of the mortgage. In doing so, we are looking only at whether plaintiffs presented at least one viable theory of relief. The trial court did not base its decision on the viability of plaintiffs’ claims, if properly presented; it ruled only on standing. Neither party has briefed here the merits of plaintiffs’ claims in view of the trial court decision. Thus, our analysis of the merits is very limited.

¶ 51. Because we have ruled that the mortgage follows the note, we look first at the note. The parties concede that the note is a negotiable instrument, governed primarily by Article 3 of the Uniform Commercial Code. Under UCC § 3-301, 9A V.S.A. § 3-301, the following parties can enforce a negotiable instrument:

(i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to section 3-309 or 3-418(d) of this title.[9] A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument.9A V.S.A. § 3-301. Generally, a person becomes a holder through negotiation based on transfer of possession. Id. § 3-201. Negotiation is effective even if obtained by fraud, duress, or mistake, or in breach of duty or as part of an illegal transaction. Id. § 3-202(a). “Transfer of an instrument, whether or not the transfer is a negotiation, vests in the transferee any right of the transferor to enforce the instrument . . . .” Id. § 3-203(b). However, a person taking an instrument “is subject to a claim of a property or possessory right in the instrument or its proceeds, including a claim to rescind a negotiation and to recover the instrument or its proceeds.” Id. § 3-306.

¶ 52. Essentially, plaintiffs rely upon claims recognized by § 3-306. In making such claims, however, they face a large obstacle in Article 3’s provision that a stranger to a contract cannot enforce it, the principle we relied upon above to hold that plaintiffs could not enforce compliance with the PSA. Section 3-305(c) provides that an “obligor may not assert against the person entitled to enforce the instrument a defense, claim in recoupment, or claim to the instrument (§ 3-306) of another person,” with certain exceptions. 9A V.S.A. § 3-305(c). Plaintiffs’ claims involve attempts to enforce rights of an earlier holder of the note, and are barred by this provision unless an exception applies. The only relevant exception is where “the obligor proves that the instrument is a lost or stolen instrument.” Id.

¶ 53. While plaintiffs’ complaint did not use the terms “lost” or “stolen,” their allegations are consistent with this theory. The complaint alleges that the note was fraudulently acquired by defendant, based on a fraudulent endorsement with a forged endorsement signature, that was created by defendant. These allegations are sufficient to give plaintiffs standing.[10] The court erred in dismissing Counts 1 and 2 of the amended complaint for lack of standing, to the extent that these counts alleged irregularities in the transfer of the note and mortgage unconnected to the pooling and servicing agreement.

Murkier is the Court’s reasoning for saying that a homeowner cannot challenge the validity of the transfers of HIS note using evidence provided by the Defendants’ own PSA, that sets forth a mandatory chain.  The Court recognizes the common law proviso that a non-party to an assignment can challenge an assignment if the defect would make it void.  But then the Court wrongly concludes that New York Trust law would make the assignment voidable and not void, and then implicitly conceding that because the beneficiaries to the trust can ratify the defect, on the pleadings, the homeowner cannot raise a PSA defect, even though it provides evidence of falsity and fraud in the transfers.

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