For the private investor no other set of information has more of an impact than the chain of assignments and indorsements. There is so much information in the public realm and not all of it is accurate. Some of the inaccuracies come simply from public misinformation and is disseminated in blogs, public comment and even bar stool conversation. Certain defenses made by distressed borrowers are taken out of context of the legal case and evolve into myth and misinformation.
An “assignment” refers to a document which assigns the rights and interests given by a mortgage or deed of trust to a third party. Remember a mortgage or deed of trust is given from a borrower to a lender. The borrower gives certain legal rights to the lender to enforce the promissory note. The enforcement rights and process are governed by the state in which the subject property is located and the actual contract or security instrument itself.
Now let’s just pause right there and conduct an interesting exerciser. I am going to search the internet (using Google) for the words “assignment of mortgage” and discuss what comes up for a moment. Well, in short it is a cornucopia of confusion. First we have articles (and videos) that talk about a borrower’s right to assign a mortgage. Does a Borrower have a right to [re] assign a mortgage? (Where the making of the loan is the first assignment, if you will, of a mortgage, the borrower granted the lender rights in the real property) It depends on the security instrument itself. If the security instrument specifically states no assignments of the mortgage can be made by the mortgagee (lender) then the lender must gain permission to transfer the rights which were granted to them from the borrower. That said the typical security instruments in use today does not specifically prohibit the mortgagee from transferring their rights to a third party. So most mortgages and deeds of trust at large are assignable and the borrower has no domain over that assignment. The mortgagee is free to assign to a third party on their own discretion. (Some other regulations apply but are outside the scope of this article)
Some of the articles and videos go on to talk about how assignments of mortgage are an “investment strategy”. These are Real Estate Investment Clubs – clubs which promote themselves to teach investors how to invest in real property and related assets. So right there is a source of massive misinformation for investors. They are not correct in their understanding or definition or utility of an assignment of mortgage. (It actually irritates me this is so wrong!) The articles and videos go on to talk about how an assignment of mortgage can be used to take a property “Subject To” the existing mortgage. Somehow they believe a borrower has a right to assign something they have already assigned and possess no rights to re-assign. What a mess.
Go back to our original ideas of what is a security instrument. The security instrument (mortgage or deed of trust) is a legal interest given from the borrower to the [original] lender. Once I give you something, I no longer have it to give. You have it. I cannot [re] give it to someone else. A borrower has absolutely no right to assign the mortgage which secures the mortgagee (lender). That type of doctrine would essentially render the security instrument pointless and meaningless. An assignment of mortgage or deed of trust is not a strategy it is an instrument which transfer interest from the party who holds the interest (thus making them capable of transfer) to a third party. In certain circumstances the borrower can retain a right to approve a transfer locking them into the original lender however that is not the same as being able re-assign at their own will.
This is a good example of just how distorted the public and private investors understandings can become on these matters. The articles and videos talk with such confidence if you didn’t know any better you would think they are correct. Hopefully at this point you can see their error in their understanding here. Details matter in this industry and words are not interchangeable. Perhaps when they looked up the definition they were confused by the idea of a borrower being able to grant a re-assignment, I don’t know. However, that is the only power a borrower has and it only exists if it is explicitly stated within the security instrument. Which again is fairly rare now-a-days.
Moving on to our other instrument is the indorsement (“endorsement”). I do not really know why we have devolved into using the word “endorsement” more commonly than “indorsement” but we have. The word “endorsement” has taken on the meaning of “indorsement” to that extent they are interchangeable words now. For this article we are using the less common spelling just for the sake of distinction. Now let’s define the meaning, “indorsement” according to Black Law Dictionary 2nd edition is defined as – The act of a payee, drawee, accommodation indorser, or holder of a bill, note, check, or other negotiable instrument, in writing his name upon the back of the same, with or without further or qualifying words, whereby the property in the same is assigned and transferred to another. Notes fall under our Uniform Commercial Code (UCC) which is a set of rules that defines use, structure and other legal ideas. Those codes are federal rules that are accepted in all 50 states and Washington D.C..
So now with that definition we also understand that a note can be indorsed and that indorsement is an assignment and transfer onto itself. Usually with mortgage notes you will see the indorsement as a stamp which reads “Pay to the Order Of” and list either blank (no name filled out) or a specific third party. Most of the in note indorsements today will be found somewhere on the actual front side of the note (where the writing is) and not the actual back of the paper. I would presume this is a function of the photo and image copy trends that emerged. If you placed it on the back of the note it may be overlooked in a copy. Either location is fine and enforceable. Further, there can be more than one on the note itself. Plenty of room in the margins and at the bottom of the page usually and some legal counsel prefers this over the alternative.
That leads us to the alternative which is an “allonge”. Allonge is simply an indorsement which is placed on to a separate page which then becomes a part of the original note. The words “Pay to the Order of” will be present just like the in note indorsement. There is literally no difference and they do the same thing. Transfer and assign ownership and rights to the note to the party by which the indorsement is made out to.
OK, we understand the types and locations so now let’s move on to the structure. A note can be negotiable or non-negotiable. Negotiable means the instrument can be transferred from the holder to another third party. The holder is who is getting paid. A non-negotiable instrument is not transferable. So an indorsement is only meaningful on or with a negotiable instrument. We will come back to the differences and their impact in a moment.
An indorsement to blank is actually known as a “blank indorsement” (Makes sense don’t you think?) on a negotiable note that means the note is considered a “bearer instrument”. That means, he who has possession of the instrument (note) and can present the instrument (“to bear”) is the beneficiary of that instrument or he who get’s paid. In that idea possession of the instrument is all that is needed to establish the standing or the right to receive payments from the borrower based on the note terms.
An indorsement to a specific third party is called a “special indorsement”. A special indorsement converts a bearer instrument (indorsement to blank) into a “order instrument”. A negotiable note that is considered an order instrument thanks to its special indorsement only benefits the named party. In other words, the party is ordered to be paid. An ordered instrument can no longer be paid to a bearer. This means the order party must present the instrument and no other party presenting the instrument is recognized.
Alright, so now that we know what stuff is and a little about how they operate. We can move on to talking in part about how those instruments create impacts in the market place and legal landscape. This will help make better decisions and to seek proper counsel and hopefully separate fact from fiction.
Now a distinction among an indorsement and an assignment is simply the assignment is often required to be assigned in public record. Indorsements or allonges do not carry this requirement. The reasons for this is an assignment functions to give us an idea of encumbrance of real property. That is, a buyer of real property should be entitle to understand who may have claim to the real property they seek to purchase. Further claims to real property need be understood by the public for the public’s good. That is what the mortgage or deed of trust did. It granted an interest to the lender which gives them a claim to the real property. If we did not record mortgages, lenders could pop up and make claim to sold property causing havoc in our system. To an extent, the same goes with the assignment, to clear title if we did not have a record of a claim laid onto real property clearing title would be pretty tough.
Now it is important to note, the mortgage itself is not a thing of value per se. The mortgage is merely a pledge of the property as collateral for the note. The note carries the value. The mortgage only exists so long as the debt memorialized by the note exists. So if a note is paid in full the security instrument has essentially exhausted it’s utility.
This brings us to a legal idea which says “the mortgage follows the note”. In its simplicity this means that if you are the beneficiary of the note then you are also benefited by the notes security in the real property by way of the mortgage or deed of trust. They can not be separated. A mortgage or deed of trust has no value without it’s note. The security instrument is merely a pledge. That pledge is only for the debt in the note. Therefore the note is really the only thing of value.
So then let us look at what happens when the note is indorsed to a new party. Provided the note is negotiable the bearer or the special party becomes the new beneficiary. The mortgage or deed of trust still stands in real property record as collateral for that note. So the beneficiary of the note automatically receives benefit from the security instrument since they are the owner of the note. Now if we just execute an indorsement and nothing with the an assignment what we have is the beneficial interest of the note moved to a new party and by proxy so did the secured interest. That is because the secured interest follows the note. What has not happened at this juncture in our story is the assignment has not been recorded in real property records to give public notice of that change of interest, however the interests in the note have moved and thus so has the secured interest. We can think of it as simply moving without giving the public notice.
So then we come to a question, does lack of public notice invalidate the transfer itself? Well, no. How could it? Provided the note is negotiable and can be indorsed to new party then failing to give public notice does not invalidate the bearer or special party who enjoys ownership of the note.
To be clear, an assigned note carries all rights and interests with it. So provided the indorsement creating the assignment is proper and the note is in fact negotiable a party essentially need not assign a mortgage or deed of trust in public record to enforce the terms of the note and security instrument.
This is very confusing for new investors. As we came out of the mortgage crisis the public was exposed to a vast array of legal battles putting this doctrine to the test. Most of the battles took place but the public only paid attention to the headline and not the content. There was little overturn in the doctrine that the mortgage follows the note. What did happen was the revelation that some notes are considered negotiable (able to be transferred via indorsement) and some notes are not.
For those notes which do not qualify as a negotiable instrument the assignment must be present. That is the note only follows the assignment of mortgage or deed of trust. We can say to some extent a note follows the security instrument in title and a security instrument follows a note in equity.
Now the industry as a whole practices both concepts most of the time but not all of the time is it needed. A buyer of a loan will get both an assignment of security instrument which creates the transfer in title along with getting an indorsement creating transfer in equity. This creates confusion with some new loan investors as to what is actually needed on a per loan transaction. What the investor needs to understand when contemplating a break in an assignment chain is whether or not the indorsement sufficiently transfer ownership or if the note is negotiable in nature and a simple indorsement to blank or a special indorsement to them specifically allows the beneficial interest to transfer.
For now, mainly based on the length of this post we will break there. We will produce some follow up and continuations to the concepts which we touched on here. I hope thus far our readers have garnered some important distinctions and have can start to understand what they need to derive in their evaluation of these two different instruments and how they may stand to affect their investing into loans.