Hold Up, You Lost Me – North Carolina’s Ruling on the Lost Note Affidavits as Evidence

Lately, creditors have been losing sleep over lost or misplaced promissory notes and how to go about enforcing their rights to collect on the underlying debt. Such a scenario puts the creditor in the awkward position of having a ticket to the show, but no way of getting to the theater. Will I be able to foreclose? Will the action have to be in front of a judge? What do I have to prove to entitle me to an order for sale? Until recently, there wasn’t much direction from our courts on how to collect on accounts that lacked a promissory note; however on February 07, 2017 the North Carolina Court of Appeals rendered an opinion that allows creditors to rest a little easier. 

While unpublished, the In re: Iannucci case ensures that creditors may use lost note affidavits as evidence in foreclosure hearings, so long as the affidavit complies with North Carolina law. In this case, a creditor acquired the payment rights in a promissory note and shortly thereafter lost the original note. After default, this creditor sought to foreclose before the clerk of court using an affidavit traditionally used in place of lost instruments. Initially the clerk of court refused to issue an order for sale, reasoning that the provisions of N.C. Gen. Stat. §45-21.16(d) taken in their most literal context require her to determine whether there is ‘a valid debt of which the party seeking to foreclose is the holder,’ and that the use of a lost note affidavit defeated this finding. While the creditor lost that battle, it timely appealed the matter to Superior Court in an effort to win the war. 

This time, the trial court considered the lost note affidavit and ruled in favor of the creditor. Unsatisfied with a win some, lose some outcome, the debtor appealed this ruling to our Court of Appeals, defiantly alleging that the Superior Court Judge erroneously admitted the lost note affidavit because it contained a legal conclusion, and further asserting that the information within the affidavit was inadmissible hearsay. 

The Court of Appeals found both arguments to be a lost cause, reasoning that any conclusions of law within an affidavit could be disregarded by the Court, and further concluded that the lost note affidavit offered into evidence contained the use it or lose it language to fall within the business records exception.  Specifically, the affiant stated that the information averred in the affidavit was based on a review of records kept in the ordinary course of business, and that the entries were made by employees of the creditor at or near the time of the occurrence.  

Almost at a loss for words, the debtor finally made the technical argument first made before the clerk of court, that a lost note affidavit could not satisfy the provisions of N.C. Gen. Stat. §45-21.16(d) because it would be impossible to prove that there is  ‘a valid debt of which the party seeking to foreclose is the holder’.  The Court disregarded this argument, taking the position that the provisions of North Carolina’s UCC (N.C. Gen. Stat. §25-3-309) allow a creditor to enforce an instrument if it is able to show the following: 

(1) That the creditor was in possession of and entitled  to enforce the instrument at the time it was lost;

(2) That the loss of possession was not due to a transfer of the party entitled to enforce the instrument; and 

(3) That the creditor cannot reasonably obtain possession of the instrument due to its loss or destruction. 

The real utility of the Iannuicci ruling comes with the court’s application of the UCC to a power of sale foreclosure. Until this ruling, some clerks of court in North Carolina took a literal interpretation of N.C. Gen. Stat.§ 45-21.16(d), similar to the clerk of court in this case, insisting that a creditor offering a lost note affidavit could not foreclose in the traditional power of sale proceeding. The Iannucci ruling served to bridge the gap between North Carolina’s foreclosure laws and its UCC, allowing a creditor to use a lost note affidavit to stand in the place of the promissory note in a power of sale foreclosure. 

Creditors, however, should be careful not to lose the forest for the trees, as the content and allegations in any lost note affidavit are of principal importance. In the Iannucci case, the creditor seeking foreclosure was the creditor that lost the instrument. The provisions of N.C. Gen. Stat. §25-3-309 allow the forgetful creditor to  enforce its instrument, but the protections of the UCC fail to apply to subsequent creditors. 

By contrast, if a creditor loses its promissory note and thereafter sells its payment rights to a third party creditor, that third party creditor’s collection efforts before the clerk of court will fail. The distinguishing reason for this is that the affidavit submitted to the clerk will either be executed by the prior creditor, defeating subsection (2) of N.C. Gen. Stat. §25-3-309, or the third party creditor’s affidavit will be unable to aver that the creditor owned the note at the time is was lost. In either instance, the creditor may not proceed in a power of sale foreclosure, and must instead make a choice of either establishing its authority to collect before a Superior Court Judge, or alternatively force the prior creditor to repurchase its debt. 

A prudent creditor should confirm with its collection attorney as to both the form and the content of a lost note affidavit prior to filing a collection action, as this maximizes your chance of gaining your collateral without losing your shirt.

Published by John A. Mandulak on February 24, 2017