Foreclosures—Mortgagee's Interest Was Not Voided Because Mortgagors Had Acquired the Property By Fraud—Rightful Owner Executed A Mortgage and Note Extension and Modification Agreement (CEMA) Acknowledging Mortgagee's Rights—Dissent Characterized Majority Decision That the Plaintiff Did Not Have to Produce the Note As Unprecedented

A defendant appealed from a trial court order which, inter alia, granted the plaintiff's motion for summary judgment on its cause of action to foreclose on a mortgage and denied the defendant's cross motion for summary judgment dismissing the action.

The plaintiff sought a judgment of foreclosure and sale based upon a mortgage and note extension and modification agreement (CEMA) which the defendant had executed. The plaintiff had lent $500,000 to borrowers who had claimed to own the real estate property that they sought to mortgage (property). The borrowers had signed a note and a mortgage. However, the borrowers had acquired the property through “fraudulent means.” After the lawful owner, the defendant, reacquired the property, he executed the CEMA with the lender. The CEMA contained the defendant's acknowledgement of the plaintiff's rights under the note and mortgage and the plaintiff's agreement to forbear from foreclosing for a year, “presumably to permit [defendant] to obtain refinancing.”

The Appellate Division (court) held that the motion court had properly granted the plaintiff summary judgment. The court explained that “under the circumstances of this case, we find that [plaintiff's] interest…as a mortgagee was not rendered null and void because his borrowers,…, had acquired the property by fraudulent means.” The court cited the “mortgage and CEMA, along with undisputed evidence establishing both the existence of the note, which obviated the need to submit the note as proof that [plaintiff] had the right to foreclose, and the nonpayment.”

The defendant had deeded the property to a relative (“A”), for no consideration, so that “A” could “obtain a mortgage for him to make repairs and pay accumulated debt.” “A” expected that the defendant would pay the loan and “A” would subsequently transfer the deed back to the defendant. Several years later, the defendant's lawyer sent a paralegal to obtain “A's” signature on a deed to transfer the property back to the defendant. The paralegal fraudulently inserted his mother's (“B's”) name as the grantee and thereafter, “B” “unlawfully deeded the property to herself” and the paralegal. In December 2005, the plaintiff lent $500,000 to “B” and the paralegal, “pursuant to their signing a note and mortgage in favor of [plaintiff]….” “B” and the paralegal thereafter defaulted on payments due under the note. The defendant thereafter learned of the fraudulent transfer and sued “A” to recover his property. The defendant abandoned his lawsuit against “A” when she agreed to sue “B” and the paralegal to recover the property. “B” and the paralegal thereafter agreed to transfer title to the property back to the defendant.

When the defendant initially learned of the plaintiff's intention to foreclose on the defendant's “reclaimed property,” he executed the CEMA with the plaintiff, “extending and modifying the terms of [plaintiff's] mortgage.” The CEMA stated that the paralegal and “B” “were conveying the property to [defendant],…that [plaintiff] agreed to extend and modify the terms of the note” that the paralegal and “B” had executed, that the defendant “consented to the conveyance of the property” and “he was not personally assuming payment of the note executed by [paralegal and 'B'].” The CEMA further provided that the defendant “warranted that the principal outstanding balance under the note was $500,000; that [paralegal and 'B'] had no deductions, counterclaims, defenses, or offsets to the note or mortgage; and that the note and mortgage remained in full force and effect and were fully enforceable in accord with their terms and the modification in the CEMA.” The CEMA also specified that the defendant “'ratifie[d] and reaffirm[ed]' that the terms and provisions of the note and mortgage remained in effect, and were true and correct, without modification, 'except as necessary to implement' the CEMA.” Additionally, the defendant had warranted that the CEMA was “a 'valid, enforceable and binding obligation of [his].'” The CEMA also contained the defendant's representation and warranty that “there [we]re no deductions, counterclaims, defenses, or offsets of any nature…to any of [his] obligations under the note or mortgage, as…modified [by the CEMA].”

After making four payments on the plaintiff's mortgage for four months following the CEMA's execution, the defendant ceased making payments. The plaintiff thereafter commenced the subject action, moved for summary judgment and submitted a copy of the CEMA and the mortgage contract. The plaintiff did not provide a copy of the note.

The defendant opposed the motion and cross-moved for summary judgment dismissing the complaint, contending that “the mortgage was unenforceable as it was based on a void deed.” The trial court granted the plaintiff's motion for summary judgment and denied the defendant's cross motion. The trial court found that the defendant had failed to offer sufficient evidence to raise a triable issue of fact.

Based on the defendant's execution of the CEMA “and other unique facts of this case,” the court found that the failure to produce the note did not prevent the plaintiff “from establishing a prima facie case for foreclosure.” The court reasoned that pursuant to the CEMA, the defendant “ratified and affirmed all the terms of the note and mortgage and warranted that there were no deductions, counterclaims, defenses, and/or setoffs to any obligations under the note.” The court cited the CEMA, the mortgage contract and the “unchallenged deposition testimony of the existence of the note and nonpayment.”

The court stated that “[u]nlike the dissent,” it did “not view this action as a typical mortgage foreclosure action.” “In a typical mortgage foreclosure transaction, a prima facie case is based on production of the unpaid note and mortgage, which establishes that the plaintiff is entitled to foreclose on the unpaid note.” The court concluded that here, a prima facie case was established by submission of the mortgage and the CEMA and that UCC 3-804 did not require a different result. UCC 3-804 “allows one to maintain an action as a 'holder' on a promissory note even though the instrument has been lost or destroyed.” The court believed that such statute was inapplicable, where it was established that the plaintiff “has the right to sue on the note as the undisputed 'holder' of the note.” “UCC 3-804 is intended to provide a method of recovery on instruments that are lost, destroyed or stolen” and pursuant to UCC 3-804, “the plaintiff must establish the terms of the instrument and his ownership, and must account for its absence.”

The court opined that in the subject case, “[t]he note's absence is accounted for by the CEMA and there is no legitimate question that [plaintiff] is the party entitled to enforce under the note, as evinced by the mortgage…and the CEMA, in which [defendant] acknowledges [plaintiff's] right under the note and mortgage, and the deposition testimony indicating the existence of the note.”

The court noted that when the defendant had entered into the CEMA, he was represented by counsel and he knew that the plaintiff “remained the lawful holder of the note and mortgage” and the defendant “waived lack of standing as a defense by failing to raise it in the answer, or by a pre-answer motion….” The court cited judicial precedent which found that a “plaintiff established a prima facie case for foreclosure 'by submitting proof of the existence of the mortgage and note made by and executed on behalf of [the defendant], certain forbearance agreements and [the defendant's] default.'” The court held that “[i]n such a situation, the submission of the forbearance agreement, like the CEMA here,” established “the plaintiff's entitlement to foreclosure, along with proof of the note and mortgage, thus the failure to submit the note was not a fatal defect.”

The court further explained that UCC Article 3 “dictates that only a holder in due course can sue on a note so that an obligor is not subject to double liability if the note later turns up in the possession of another claiming to be a holder in due course.” The court reasoned that “[s]uch a risk does not exist in this case where [defendant] has assumed no personal liability for the note and the mortgage would be extinguished upon foreclosure.” The court believed that the dissent seemed to be “under the misconception that [plaintiff] can only enforce his rights under the subject note and mortgage if [plaintiff] had assumed the mortgagors' (borrowers) personal obligations under the note.” Although the “mortgage instrument is not independently enforceable as a debt….” and “may be enforced only by the person who is entitled to enforce the note's obligations that the mortgage secures,” the court opined that the plaintiff's “failure to submit the note, under the circumstances of this case, does not negate his entitlement to summary judgment of foreclosure….” The court stated that “the burden shifted to [defendant] to produce admissible proof sufficient to raise a triable issue of fact.”

The court further stated that the defendant had “improperly” labeled “the instrument by which the improper transfer took place as both a 'fraudulent/forged deed.'” The deed had been “the result of fraudulent inducement, rather than the result of a forged deed or one executed under false pretenses.” “The subsequent deed transfer was the result of a classic fraudulent inducement, because the owner believed that she was signing the deed in order to transfer the property back to its original owner, [defendant]. Instead, the deed transferred the property to ['B'] and then [to the paralegal] before they obtained a loan and mortgage from [plaintiff].” Thus, the court concluded that “the deed…was voidable, not void ab initio.”

The defendant argued that the plaintiff was “not a bona fide encumbrancer entitled to protection under Real Property Law §266.” The court acknowledged that “the evidence…presents an issue of fact as to whether [defendant] was in actual possession of the property when [plaintiff] acquired his mortgage interest, which was sufficient to require an inquiry by [plaintiff] into 'the existence of any right which [the owner may be] able to establish'….” However, the court held that the defendant's arguments faced an “unsurmountable obstacle, the CEMA.” The CEMA made clear that the defendant had acknowledged the plaintiff's “rights under the note and mortgage and waived any claims or defenses as to the same.”

The court did not believe that the CEMA was “ambiguous as to its intended purpose.” The defendant argued that an ambiguity was created by the CEMA language that the defendant was “not personally assuming payment of the note.” The court explained that such language simply meant that if the plaintiff pursued “a foreclosure and sale of the property and the proceeds of the sale were less than the amount due and owing to [plaintiff] under the note and mortgage, [defendant] would not be personally liable to pay the deficient amount.” The court did not believe that the language was “inconsistent with the remaining terms of the CEMA….”

The court emphasized that the defendant could not avoid the mortgage obligation on the ground of fraud, when after he learned of the fraud, he affirmed in the CEMA “that his property was subject to [plaintiff's] lien up to the amount of the unpaid note. A party can ratify a contract by failing to timely disaffirm it or by acts, like here, that are consistent with a showing of an intent to be bound by the contract, even if the contract was otherwise voidable….” Since the defendant had paid accrued interest for four consecutive months, pursuant to the CEMA, the court believed that the defendant had “expressly and impliedly ratified [plaintiff's] mortgage on the property….”

Additionally, the defendant had signed the CEMA while he was represented by counsel and it was irrelevant that the defendant now “claims to have misunderstood the legal implications and ramifications of the terms of the CEMA.” The court noted that “[t]he fact that no one allegedly explained the agreement to the signer does not make the agreement unenforceable unless it rises to the level of fraud, overreaching or unconscionability….”

The court found that there was no showing of unconscionability and the defendant's allegation that “his lawyer improperly induced him to sign the CEMA is refuted by his counsel's detailed explanation for entering into the CEMA.” The defendant's counsel had explained that the mortgage for which “A” was liable, was in default even though the defendant had agreed to make payments on the loan. “The $500,000 second mortgage loan covered the debt of the first mortgage loan taken out by ['A'] on behalf of [defendant].” Thus, under the circumstances, the defendant's counsel “reasonably concluded that [plaintiff], as a mortgagee, had a valid equitable subrogation claim for $450,000….” The defendant's counsel explained that “[defendant] had already agreed to waive seeking the remaining $50,000 from the parties who defrauded him, in exchange for regaining title to the property.”

The court also rejected the defendant's claim that the CEMA was unenforceable for lack of consideration. By entering into the CEMA, the defendant had “agreed to forbear from foreclosing on the property for a year to permit [defendant] to obtain refinancing.” The court rejected the defendant's other contentions and held that the plaintiff's motion for summary judgment to foreclose on the unsatisfied mortgage, should be granted and denied the defendant's cross motion for summary judgment dismissing the action.

A dissenting opinion asserted that the majority's opinion was based “on the accuracy of two statements…, both of which are unsupported by any evidence.” Although the majority stated that the plaintiff loaned $500,000 to the borrowers, the dissent argued that the plaintiff had not sworn “in any of his affidavits that he loaned $500,000 to anyone, and the record before the court does not include any documents showing that he did so.” The dissent also noted that “the majority states that the alleged borrowers signed a note.” However, the record “did not include any note, or any affidavit by anyone who claims to have drafted or signed the alleged note, or even by anyone who claims to have seen or ever possessed the alleged note. In fact, plaintiff's failure to produce the note on which he sues deprives him of a fundamental element of his prima facie case for foreclosure….” The dissent opined that the “[p]laintiff can only cure this deficiency by explaining the absence of the note and proving its terms, which he has failed to do.” The court cited UCC 3-804 and two appellate decisions.

The dissent further stated that the note may not exist and therefore, the majority's assumption that the “plaintiff is the 'undisputed holder' of the note” could be an error. The dissent characterized the majority opinion as an “unprecedented holding…that plaintiff may make out a prima facie case for foreclosure without either producing the note or explaining its absence and proving its terms.”

The dissent also argued that the majority decision is “premised on a significant error of law. A foreclosure proceeding is premised on the breach of a note, not, as the majority states, a breach of a mortgage, since 'a mortgage is merely security for a debt or other obligation and cannot exist independently of the debt or obligation'….” The dissent asserted that the defendant “raised triable issues of fact as to plaintiff's entitlement to a judgment of foreclosure, including whether [defendant] had any obligation to pay plaintiff on which he could have defaulted, and whether plaintiff is the holder of a bona fide obligation.” The dissent would “reverse the grant of summary judgment to [plaintiff], and affirm the denial of summary judgment to [defendant].”

The dissent had also noted that while the plaintiff is a college graduate in the business of lending money secured by mortgages, the defendant lacked a formal education after the age of 14 when he “quit school to work on his family's farm in Tobago.” The defendant now works by “doing plumbing repairs on a freelance basis….” Additionally, the dissent noted that the paralegal had presented “A” with “a blank deed, which she signed; no notary was present when she did so. She believed that she was signing the deed in order to transfer the Property back to [defendant].” The dissent further stated that an acknowledgment of “A's” signature by a notary appears on the deed. “A” had not authorized the transfer of the property to “B” and had not seen the completed deed until years later.

The dissent further observed that although the plaintiff received the title report prior to closing, he had not examined the schedules attached to it. Before making the loan, the plaintiff had never spoken to “B”, had not requested that the paralegal and “B” complete a loan application, had not conducted a credit check, had not run an internet search on the property and did not have the property appraised prior to closing. He had “only looked at the Property from the outside.”

The dissent also argued that the CEMA did not embody the terms of the note and contrary to the majority's statement that the CEMA obligated the defendant to make interest payments to the plaintiff, the CEMA provided that the defendant was “not assuming payments due under the alleged note.” The dissent opined that the CEMA is, “at best, ambiguous as to who is obligated to make interest payments, as the motion court previously found in its Oct. 10, 2012 order denying plaintiff's first motion for summary judgment.” The dissent argued that “[t]his ambiguity had not been resolved, and remained the law of this case at the time the motion court granted plaintiff's second motion for summary judgment, which is the subject of this appeal.”

Additionally, the dissent noted that the defendant asserted that “he had difficulty understanding written documents, legal concepts, or words such as 'indemnify,' 'convey,' or 'legitimate,'” he thought the CEMA obligated “'the person who took…the [m]ortgage to pay' it,” and that he thought the CEMA was a forbearance agreement that did not vest the plaintiff with the right to foreclose against him.

The dissent would have reversed the summary judgment to the plaintiff because it believed the plaintiff “failed to make out a prima facie case entitling him to a judgment of foreclosure, since he…failed to produce the note” and the plaintiff had “offered no explanation whatsoever for the note's absence, and no proof of its contents.” The dissent believed that the CEMA could not take the place of the missing note, “because that document does not set forth the terms of the alleged note” and the plaintiff “failed to present 'undisputed evidence' that [defendant]…defaulted since,…, the [CEMA]” was ambiguous as to whether it obligated the defendant to make payments on the note.

The dissent also reasoned that there was no claim that the defendant was obligated under the note or mortgage and the statements under the CEMA did “not impose any obligation on him, or constitute a ratification of either document.” Rather, the CEMA only stated that the defendant acknowledged that “there are no defenses or counterclaims to his obligations under the note or mortgage.” The dissent also believed that the defendant “raised material questions of fact as to the [CEMA's] enforceability.” The dissent stated that the majority seemed to hold any ambiguity of the CEMA was resolved by the settlement agreement in “A's” action against the paralegal and “B”. However, the dissent noted that “no one has produced that settlement agreement.” The defendant's deposition testimony quoted parts of the alleged settlement agreement, but neither party had presented a certified copy of the complete transcript of the proceedings, or a signed writing.

The dissent further argued that since the defendant was not a party to “A's” action, it was “unlikely that any settlement of that action would bind him.” The dissent opined that, since the settlement agreement allegedly “addressed interests in real property and an obligation to pay for the debt of another, an oral agreement would also violate the statute of frauds….” The dissent believed that the defendant's deposition testimony, rather than resolve ambiguities, demonstrated that the plaintiff and the defendant “had directly contrary purposes and understandings in entering into” the CEMA.

The dissent believed the defendant raised questions of fact as to whether the plaintiff was a “bona fide encumbrancer entitled to protection under Real Property Law §266.” The dissent agreed that “a deed that is the result of fraudulent inducement is voidable….” However, the dissent thought that the majority failed to address the relevance of the doctrine to the subject case, “where a mortgagee had previous notice of fraud affecting the grantor's title,” where the plaintiff “may not be a bona fide encumbrancer, and may not be protected….” The dissent noted that “'[a] mortgagee will be charged with constructive notice if it is aware of facts that would lead a reasonable, prudent lender to make inquiries of the circumstances of the transaction at issue.' If 'a reasonable inquiry' would reveal some evidence of fraud, then failure to make some investigation will divest the mortgagee of bona fide encumbrancer status.”

The dissent further stated that the mortgage raised issues as to whether the plaintiff “conducted a reasonable inquiry, since the cover pages state that the Property is residential, and the mortgage itself states that it is not; moreover, public records and a cursory perusal of the outside of the Property would have revealed that it is a residential building.” The plaintiff had admitted that “he received a title report…prior to the closing, but did not read it completely.” The title report showed that the defendant “had obtained a lis pendens on the property in his 2004 action against [the relative].” Similarly, the plaintiff knew, at the time of the closing on the mortgage, that another mortgage existed in “A's” name, even though the paralegal and “B” claimed to own the Property. Finally, the dissent noted that the plaintiff “admitted…that he conducted virtually no investigation into [the paralegal and 'B''s] creditworthiness and bona fides and into the Property and its history and value, other than viewing the outside of the building and walking around the neighborhood; and [defendant] testified that plaintiff later admitted to him that he had not even done that.” The dissent concluded that the plaintiff “failed to make out a prima facie case entitling him to a judgment of foreclosure, and [defendant]…raised issues of fact requiring a trial.”

Weiss v. Phillips, App. Div., First Dept., Case No. 810090/10, decided Nov. 21, 2017. Opinion by Renwick, J. Acosta, P.J., Renwick, Mazzarelli, Gische, Gesmer, JJ. All concur except Gesmer, J., who dissents in part in an opinion.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John's University School of Law.