From the January, 2003 issue of The Title Insurance Law Newsletter
The New York judge handling the Island Mortgage bankruptcy has ruled against another title company that got a rubber closing check, finding that the loan investors have first rights in the mortgages and notes.
Broward Title Company of Florida closed a series of loans for Island Mortgage. Island was owned by AppOnline.com, Inc. A director of AppOnline owned Action Abstract, whose National Settlement Services Corp. placed title orders for Island Mortgage deals in a number of states.
The Broward adversary involved two loans it closed in June, 2000, the same month that Island shut down. In each case, Island sent a loan funding check with the loan closing package. Both checks were returned NSF, and the loans were never funded. In both cases, Broward was instructed to, and did, deliver the original note to the loan investor (Matrix Capital Bank and HSA Residential Mortgage Services ("RMST"), respectively).
Broward sought to be declared the equitable owner of the loans. The same bankruptcy court rejected a similar claim by a Georgia title agent in a decision reported last month. In that case, the court held that the title agent violated that state's good funds law, and therefore had no legal right on which to claim the loans. Prudential Securities Credit Corp., LLC v. Stewart Title Guaranty Company, et al. (In re Apponline.com, Inc.), 284 B.R. 181 (Bkcy.E.D.N.Y. 2002).
Matrix and RMST argued that they were holders in due course of the loans. Broward said they were not, because the notes were not unconditional promises to pay due to the fact that they were tied to separate agreements--the mortgages. The court rejected this argument based on cases that have found that a reference to a separate agreement which is the security instrument does not make a note conditional.
Broward also argued that Matrix and RMST were not "good faith" purchasers of the loans because they were, or should have been, aware of Island Mortgage's irregular business conduct and financial problems. The court said that Broward had not proven that the loan investors had guilty knowledge:
UCC § 3 304(7) states that "to constitute notice of a claim or defense, the purchaser must have notice of the claim or defense or knowledge of such facts that his action in taking an instrument amounts to bad faith." Under New York law, a subjective test is employed to determine whether a holder has notice of a claim or defense.
The existence of "suspicious circumstances" does not constitute notice.
At the time it received the Ciceron Note and Ciceron Mortgage, RMST had no knowledge or notice of any claims or defenses against the enforcement of the Ciceron Note or the Ciceron Mortgage.
Likewise, at the time Matrix purchased the Amarante Note and Amarante Mortgage, Matrix had no actual knowledge that Island Mortgage would fail to finance the transaction and Broward would end up funding the transaction. Any knowledge Matrix had of Island Mortgage's irregularities in its relationship with Matrix to that point is insufficient to defeat Matrix's claim of lack of notice. Clearly, both RMST and Matrix took the notes in question for value, in good faith, without actual knowledge of either Broward's equitable claims or Island Mortgage's failure to fund the loans in question.
Ultimately, the court said, it was Broward that was in the best position to prevent the harm, and which must therefore suffer the loss:
It is axiomatic that the holder in due course doctrine serves to encourage beneficial commercial transactions by making banks more willing to purchase notes on the secondary mortgage market. Gregory E. Maggs, The Holder in Due Course Doctrine as a Default Rule, 32 Ga. L.Rev. 783 (1998). Negotiability of notes such as the Amarante Note and the Ciceron Note is in "the national interest in keeping commercial paper flowing." The holder in due course doctrine helps to promote fairness by ensuring that liability is allocated to the party best able to prevent the loss
. In this case, Broward was in a position to ascertain that the funds delivered by Island Mortgage, Action Abstract or David Duboff, P.C. were good funds. Although this Court believes that Broward acted in good faith without any intent to adversely affect anyone's rights, Broward has unfortunately harmed itself. Without having good funds wired to it, or checks representing the funders payment to it cleared by a bank before it disbursed funds, it took the risk that any disbursement from its escrow account prior thereto could result in Broward sustaining a loss. The fact that Broward and the Debtor established a course of conduct where these checks were not deposited until after the closing did not insulate Broward from the claims of RMST and Matrix as holders in due course. As a result of these findings, all of Broward's equitable claims against RMST and Matrix are dismissed.
Broward Title Co. v. Jacobs (In re AppOnline.com., Inc.), ___ B.R. ___, 2002 WL 31740438 (Bankr.E.D.N.Y.).
